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Compensation paid by a corporation whose stock is closely
held (as in the case at hand) is to be given special scrutiny.
Elliotts, Inc. v. Commissioner, supra at 1243; Pepsi-Cola
Bottling Co. of Salina, Inc. v. Commissioner, supra at 179. As
the Court of Appeals for the Ninth Circuit has explained, a
closely held corporation will normally have an interest to
characterize payments to a shareholder-employee as deductible
compensation, rather than as nondeductible dividends, and the
shareholder-employee and corporation are likely not to be dealing
at arm’s length. Elliotts, Inc. v. Commissioner, supra. The
problem of determining whether a purported compensation payment
is actually a disguised dividend, the Court of Appeals further
noted, is aggravated when a shareholder-employee is the
corporation’s sole shareholder. An employee who is sole
shareholder not only has complete control over the corporation’s
operations but is the only eligible dividend recipient. Id.
Case law has provided an extensive list of factors that are
relevant in determining reasonable compensation. Mayson
Manufacturing Co. v. Commissioner, 178 F.2d 115, 119 (6th Cir.
1949), revg. and remanding a Memorandum Opinion of this Court.
9(...continued)
in court proceedings under certain circumstances. However, sec.
7491 generally applies and is effective only to court proceedings
arising in connection with examinations commencing after July 22,
1998, and is not applicable to this case. RRA sec. 3001(c)(1),
112 Stat. 727. Respondent’s examination of petitioner’s return
for the fiscal year ended July 31, 1996, began well before July
22, 1998.
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