In the article in titled Executive Compensation: What\'s Reasonable? by Philip G

Question

In the article in titled Executive Compensation: What's Reasonable?   by Philip Garrett Panitz, the author cautions CPA’s in advising clients on the tax issue of executive compensation. The author suggests that the deductibility of executive compensation is one of the biggest and potentially most dangerous tax issues facing corporations. Read the article and examine why you think excessive compensation continue to be an issue raised by the IRS in closely held corporations.

http://www.journalofaccountancy.com/Issues/2009/Jun/20081250.htm

Explanation / Answer

IRS has literal guidelines in place for deduction of salary over $1 million to top executives. It talks about objectivity in compensation that deals with the proper reasoning behind those excessive compensation. In the absence of proper reasoning, deduction of excessive compensation will be disallowed by the IRS. Criteria for deduction is already mentioned under IRC § 162(m)(4)(C). Companies plan compensation as a combination of fixed pay and variable pay. In this regard, variable pay should only be performance based and it will also be scrutinized by IRS as per the guidelines.

Even for the smaller companies who are paying less than $1 million to its top executive / promoter has to justify that compensation (E.J. Harrison & Sons Inc. v. Commissioner, TC). Otherwise, IRS will disallow the deduction of that compensation.

In this regard, companies can opt for independent investor test. In this test, Different ROE is examined at a different salary level. Satisfactory ROE achieved at a particular salary level should be the compensation plan for that company.

It has been a big issue for IRS to consider, as far as deductions are concerned then CPA’s should guide companies as per the IRS provisions.As higher deductions lead to lower tax collection.

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