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Tax: Assess reasonable compensation

Whether compensation paid to a corporate employees is reasonable is a question of fact to be determined from the surrounding circumstances. How would the resolutions of this problem be affected by each of the following factors?

a. The employee owns no stock but is the mother in law of the sole shareholder.
b. The shareholder-employee does not have a college degree.
c. The shareholder-employer works 40 hours per week for another unrelated employer.
d. The shareholder-employee was underpaid for services during the formative period of the corporation.
e. The corporation has never paid dividend.
f. Year-end bonuses are paid to all employees, but officer-shareholders receive disproportionately larger bonuses.

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a. The employee owns no stock but is the mother in law of the sole shareholder.

Mother in law would probably prefer a dividend paid directly to her. The employee would rather have salary because it would be paid directly to him. Those are both motivations for actions, but neither explains whether the compensation is reasonable or not. We know the employee could take the paycheck and then give the money to his mother in law; that's a reportable gift. To characterize the amount compensation and negate the double taxation of dividends, the company better have some good records to justify compensation to the employee.

b. The shareholder-employee does not ...

Solution Summary

The 424 word solution provides several sentences in response to each of the six problems presented.