- 39 -
O.S.C. & Associates, Inc. v. Commissioner, 187 F.3d 1116, 1121
(9th Cir. 1999), affg. T.C. Memo. 1997-300. Such an absence may
raise a red flag that invites special scrutiny by the Court and
justify an inference that some of the purported compensation was
actually a distribution of profits. Charles Schneider & Co. v.
Commissioner, 500 F.2d at 153.
Such an absence and inference, however, does not
automatically convert compensation that would otherwise be
reasonable into a dividend. Corporations are not required to pay
dividends. Instead, an individual shareholder may participate in
the success of a corporation through the appreciation in the
value of his or her stock brought on by retained earnings and the
possibility of a future return. Thus, a corporate employer with
little or no dividend history may be able to pay and deduct large
amounts of compensation if the Court is convinced that a
reasonable person would still have invested in the corporation.
Critical to this test is whether the shareholders of the
corporation received a fair rate of return (without taking into
account any compensation paid to them) from the total of their
initial and subsequent investments. Owensby & Kritikos, Inc. v.
Commissioner, supra at 1326-1327; Medina v. Commissioner, T.C.
Memo. 1983-253; see also Rev. Rul. 79-8, 1979-1 C.B. 92
(compensation is not unreasonable merely because a corporation
pays an insubstantial portion of its earnings as dividends).
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