- 67 -
investor” test must instead be used.34 Exacto Spring Corp. v.
Commissioner, 196 F.3d 833 (7th Cir. 1999), revg. Heitz v.
Commissioner, T.C. Memo. 1998-220. As Exacto Spring Corp.
concerned reasonable compensation for purposes of section 162(a),
it is distinguishable from the instant case, and therefore we are
not bound by Golsen v. Commissioner, 54 T.C. 742 (1970), affd.
445 F.2d 985 (10th Cir. 1971), to follow it here.
Nonetheless, the disfavor with which the Court of Appeals
views the traditional multifactor test for reasonable
compensation prompts us to consider carefully whether it is
appropriate to extend the independent investor test of Exacto
34 In Exacto Spring Corp. v. Commissioner, 196 F.3d 833 (7th
Cir. 1999), revg. Heitz v. Commissioner, T.C. Memo. 1998-220, the
Court of Appeals for the Seventh Circuit rejected a multifactor
test for reasonable compensation in a sec. 162(a)(1) context
(which examined such factors as the employee’s skills and duties,
prior earning capacity, the prevailing compensation paid to
employees with comparable jobs, etc.) because, inter alia, the
factors conventionally used in a multifactor test “do not bear a
clear relation * * * to the primary purpose of section 162(a)(1),
which is to prevent dividends (or in some cases gifts), which are
not deductible from corporate income, from being disguised as
salary, which is.” Id. at 835. The Court of Appeals held
instead that the independent investor test, which “dissolves the
old [multifactor test] and returns the inquiry to basics”, id. at
838, must be used. The independent investor test as fashioned by
the Court of Appeals for the Seventh Circuit looks solely at the
rate of return that has been generated for the corporation’s
owners by its “managers” (i.e., its high-level employees whose
compensation is at issue). If the rate of return (after
compensating the managers) is one that would, according to expert
opinion, be acceptable to an independent investor, considering
the risks of the investment, then the managers’ compensation is
presumptively reasonable. Id. at 838-839.
Page: Previous 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 NextLast modified: May 25, 2011