In a recently decided Tax Court case, Aries Communications Inc. & Subs. v. Commissioner, T.C. Memo. 2013-97 (April 10, 2013), the taxpayer, a C corporation, deducted approximately $6.9 million in compensation paid to its sole shareholder for his role as president, chief financial officer, and general manager of a radio broadcasting business. Upon examination, the IRS disallowed a large portion of the $6.9 million deduction, arguing that only approximately $0.8 million of the compensation was ‘reasonable.’ The Tax Court disagreed with both the taxpayer and the IRS, holding that approximately $2.7 million was deductible as reasonable compensation.
This case is another reminder that closely held corporations cannot avoid double-taxation by paying their shareholder-employees excessive amounts of compensation (see also Multi-Pak Corp. v. Commissioner, T.C. Memo. 2010-139 (June 22, 2010)). It also is a good reminder that the IRS is willing to go to court over the issue when the amount of compensation paid to a corporation’s shareholder-employees is not considered reasonable in light of the facts and circumstances. Accordingly, closely held corporations should strive to ensure that their shareholder-employees are receiving compensation that is commensurate with the services being rendered. Corporations and their shareholder-employees also should make sure they understand the factors that may be employed by the IRS and the courts in evaluating the reasonableness of such compensation. A thorough understanding of the relevant factors will help taxpayers proactively evaluate the risks associated with compensation-related planning, potentially resulting in better outcomes upon examination or trial (see Menard, Inc. v. Commissioner, 560 F.3d 620 (7th Cir. 2009)).