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(4) Conflict of Interest
The next factor considers potential conflicts of interest.
This factor examines whether a relationship exists between the
company and employee that might permit the company to disguise
nondeductible corporate distributions as section 162(a)(1)
deductible compensation. We must closely scrutinize cases where the
paying corporation is controlled by the compensated employee.
Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d at 1322-1324;
Elliotts, Inc. v. Commissioner, supra at 1246-1247. However, “the
mere existence of such a relationship * * * when coupled with an
absence of dividend payments, does not necessarily lead to the
conclusion that the amount of compensation is unreasonably high.”
Id. at 1246. We adopt the perspective of an independent investor
to determine whether the investor would be satisfied with the
company’s return on equity after the compensation at issue was paid.
Id. at 1247. Return on equity is calculated by dividing taxable
income before net operating losses by the shareholder’s equity. Id.
at 1245, 1247.
Mr. Leonard was not a direct shareholder of petitioner; rather,
he indirectly owned all of petitioner's stock by virtue of his
ownership of RLLH. Thus, this is a scenario that we must closely
scrutinize for the effects of a conflict of interest.
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