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Factors Indicating Employee-Shareholder Reasonable Compensation

NAME___________________________    TAXPAYER IDENTIFICATION NO._________________

 

The level of importance of each factor (and the questions listed under each) depend on the unique facts and circumstances that underlie each client situation. Furthermore, the courts and the IRS might consider other factors in determining whether compensation is reasonable

 

“Yes” answers tend to indicate reasonable levels of compensation.

“No” answers do not automatically mean that compensation is excessive.

 

1. Character and Condition of Corporation:

  • Are financial ratios favorable?
  • Are sales and profits stable or growing?
  • Does the company prosper in a highly competitive industry?
  • Does the company prosper in poor economic or industry conditions?
  • Is the business complex or highly specialized?
  • Have significant investments been made in company assets during the year(s) in question?

2. Roles of Employee-Shareholders:

  • Do they possess unique technical, marketing, or innovation skills, etc. that would be difficult to replace?
  • Have they made identifiable contributions to the success of the company?
  • Would the business flounder without them?
  • Do they have heavy experience in the industry?
  • Do they work long hours and have heavy workloads?
  • Do they have high levels of education or specialized training?
  • Do they handle diverse aspects of the business?
  • Do they have excellent decision-making and strategic planning skills?
  • Do they have long lengths of service which demonstrate loyalty and commitment?
  • Do they operate with low levels of staff support?
  • Do they have low levels of other fringe benefits?

 

3. Internal Consistency in Establishing Compensation Levels:

  • Does the company have a compensation policy that can be documented and that has been followed consistently over the years?
  • Are there some similarities to how compensation or bonuses of other employees are determined?
  • Is compensation clearly related to company results and not just enough to “zero out” taxable income?

 

6. Comparative Compensation Levels for Other Businesses:

  • Are compensation levels reasonable in comparison to what employees of similar businesses receive for  like duties?
  • Does the employee-shareholder in effect perform the duties of several positions (CFO, marketing director, personnel manager, etc.) for one salary?
  • Is the business itself or the role of the individual so unique that comparisons with other companies are difficult or impossible?
  • Are the quality and/or quantity of services provided by the employee shareholder clearly exceptional—as evidenced by the performance of the company as a whole?

 

5. Conflicts of Interest in Setting Compensation Levels:

  • Is it clear that compensation levels are not simply tied to stock ownership?
  • Have dividends been paid in the years in question? (Absence of dividends is not in itself evidence of excessive compensation.)
  • If dividends alone do not provide a significant return on investment, would a hypothetical independent investor be satisfied with the return on equity or growth in value of the company?