Tax Memo – Executive Compensation
MEMORANDUM
TO: Mr. Kim
FROM: XXXXXX
DATE:
RE: Tax Memo #2-Executive Compensation
Mr. Kim is the sole shareholder and CEO of KimTech, Inc., a technology company valued at approximately $5,000,000 and this corporation is listed as a C Corporation and wants to know, will Kims compensation be deemed reasonable if looking at the reasonableness of Kims compensation package in light of the five factors enumerated in the Elliotts case. Before deducting Kims compensation the net pretax profits was $1,000,000. Kims salary was $100,000 and a bonus of $800,000 and this caused the company to have an even smaller after-tax profit and all of it was kept by the company and none given to Kim as paid dividends. Under Elliotts case of 1983 v Commisioner, the five factors are the employers role in the company, external comparisons, character and condition of the company, conflict of interest, and internal consistency. In the case it states,
Section 162(a)(1) of the Internal Revenue Code permits a corporation to deduct “a reasonable allowance for salaries or other compensation for personal services actually rendered.” There is a two-prong test for deductibility under section162(a)(1): (1) the amount of the compensation must be reasonable and (2) the payments must in fact be purely for services. Treas. Reg. § 1.162-7(a) (1960); Nor-Cal, 503 F.2d at 362.
This shows that there is a test set in place to test this tax code so that it is right for each person. The IRS will not redeem Kims compensation to be reasonable because of the fact that the bonus alone was 80 percent of the company earnings. Then along with the $100,000 of his salary, that would make it 90 percent of the company earnings. With such high earnings, the IRS could look at this as Kim is trying to avoid paying taxes. On the other hand, Kim can fight that he is beneficial to the company and does a lot of the work. That he does the work of more than one person. The first factor of employers role in the company, the case, American Foundry v. Commissioner, looks at the hours worked for that person and if the person has had a major increase from their prior amount of earnings. The second factor of external comparison, Kim can argue that other people in the same position make about $500,000, as stated in the facts of this case, and he puts in extra hours and work to compensate for the extra money for Kim. The third factor of character and condition of the company, Kim needs to provide proof that he is a major factor in why the company is doing so well, and why they have gained such a high profit. The forth factor of conflict of interest, Kim would need to show that his earnings are at par with standards of the industry and more than likely better than