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its time to (and performed services on behalf of) the operations
of these other entities.
OPINION
Once again, we are faced with perhaps one of the most
litigated issues in Federal income taxation, the deductibility of
compensation paid to shareholders/employees in the setting of a
closely held corporation. In order for employee compensation to
be deductible by a cash method taxpayer, the compensation must
be: (1) Paid in the taxable year for services rendered to the
taxpayer in the conduct of its trade or business, (2) reasonable
in amount, and (3) ordinary and necessary in character. Sec.
162(a)(1); Elliotts, Inc. v. Commissioner, 716 F.2d 1241, 1243
(9th Cir. 1983), revg. and remanding T.C. Memo. 1980-282; sec.
1.162-7(a), Income Tax Regs. While each criterion may be at
issue from time to time, it is the reasonableness standard that
presents the most difficult issue. As the Court has observed:
Inherently there is a natural tension between:
(1) Shareholders/employees who feel that they are entitled to
be paid from a corporation's profits, even to the exhaustion
thereof, of an amount that reflects their skills and efforts,
and (2) a provision in the tax law that conditions the
deductibility of compensation on the concept of
reasonableness. What is reasonable to the
entrepreneur/employee often may not be to the tax collector.
* * * The term "reasonable", however, must reflect the
intrinsic value of employees in the broadest and most
comprehensive sense. [Mad Auto Wrecking, Inc. v.
Commissioner, T.C. Memo. 1995-153.]
The parties do not dispute that the Officers' compensation
was an ordinary and necessary expense of petitioner. Thus, we
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