- 18 - The jurisprudence of the Court of Appeals for the Ninth Circuit is set forth in Elliotts, Inc. v. Commissioner, 716 F.2d 1241, 1244-1245 (9th Cir. 1983), revg. T.C. Memo. 1980-282, wherein it adopts and applies the two-pronged test set forth in the regulations as follows: In determining the deductibility of compensation payments paid to shareholder-employees, we will continue to concentrate on the reasonableness of those payments. In the rare case where there is evidence that an otherwise reasonable compensation payment contains a disguised dividend, the inquiry may expand into compensatory intent apart from reasonableness. * * * The inquiry into reasonableness is a broad one and will, in effect, subsume the inquiry into compensatory intent in most cases. In evaluating the reasonableness of compensation paid to a shareholder-employee * * * it is helpful to consider the matter from the perspective of a hypothetical independent investor. A relevant inquiry is whether an inactive, independent investor would be willing to compensate the employee as he was compensated. The nature and quality of the services should be considered, as well as the effect of those services on the return the investor is seeing on his investment. * * * In considering the reasonableness of compensation “from the perspective of a hypothetical independent investor”, the Court of Appeals for the Ninth Circuit in Elliotts, Inc. applies a five- factor test: (1) The employee’s role in the company; (2) a comparison of the compensation paid to the employee with the compensation paid to similarly situated employees in similar companies (external comparison); (3) the character and condition of the company; (4) whether a conflict of interest exists that might permit the company to disguise dividend payments asPage: Previous 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 Next
Last modified: May 25, 2011