Labelgraphics, Inc. - Page 32

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          bonus for his efforts in successfully developing the Micro Clean            
          100 process.                                                                
               This $406,000 of reasonable compensation, we estimate,                 
          results in a revised return on equity for petitioner of                     
          approximately 10.20 percent for the 1990 fiscal year.7  We think            
          an independent investor would be satisfied with this return on              
          equity and with petitioner's 1990 fiscal year financial                     
          performance. Despite the slight decline in business experienced             
          for that year, Mr. Martin still had done an excellent job in                
          managing petitioner.  As previously discussed, petitioner was               
          encountering increased competition in the Portland market and was           
          experiencing some loss of sales due to its customers' relocating            
          their manufacturing facilities overseas.  Moreover, petitioner              

               7Petitioner's organizational minutes provide that if the               
          Internal Revenue Service or a court of competent jurisdiction               
          determines any "salary to any stockholder officer" to be a                  
          dividend, the payment shall immediately be treated as a loan to             
          the officer (with interest payable at the legal rate from the               
          date of payment thereof), due and payable within 1 year from the            
          date of determination.  If Mr. Martin's total compensation was              
          $406,000, rather than $878,913, petitioner's 1990 fiscal year               
          income would be increased $472,913, giving it a revised net                 
          income before taxes of $320,274 (the ($152,639) net loss                    
          reflected on the 1990 fiscal year financial statement, plus                 
          $472,913).  Assuming combined Federal and State income taxes are            
          imposed equal to 40 percent of this revised net income before               
          taxes, petitioner's revised net taxable income after taxes would            
          be $192,164 ($320,274 multiplied by 60 percent) and its revised             
          equity would be $1,884,143 (revised retained earnings, plus                 
          invested capital, less treasury stock, per 1990 fiscal year                 
          financial statement).  This would represent a revised return on             
          equity of approximately 10.20 percent ($192,164 divided by                  
          $1,884,143).                                                                





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