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MI paid certain of TMI’s expenses relating to
TMI’s operation of Indianapolis-style race cars from
Feb. 1, 1997, to Jan. 31, 1999 (the TMI expenses), but
had no written agreement with TMI regarding the payment
and/or reimbursement of the TMI expenses. For TYE 1998
and calendar year 1998, the TMI expenses that MI paid
were $6,563,548 and $5,703,251, respectively.
During 1997 and 1998, when S attended the Indy 500
and the other Indy Racing League events, S spent time
talking with MI’s vendors, employees, and customers.
When MI staged grand openings for new stores, TMI
participated by sending drivers and providing an Indy
car for display. MI also worked the TMI connection
into store promotional materials and sales incentives
for employees.
S regularly made loans of his compensation to MI.
The loans were payable on demand. In TYE 1998, MI
capitalized accrued interest on the loans in the amount
of $639,302 and claimed the full amount as a
depreciation deduction. On Jan. 29, 1999, MI issued a
check to S for the interest. S reported the interest
income on his 1999 income tax return.
R determined that MI’s deduction claimed for S’s
compensation was “unreasonable and excessive” to the
extent of $19,261,609; the TMI expenses were not
ordinary and necessary business expenses of MI and,
therefore, not deductible; MI’s payment of the TMI
expenses was a constructive dividend to S; S
constructively received interest income that accrued in
1998 on his loans to MI; and MI and S were liable for
sec. 6662(a), I.R.C., accuracy-related penalties for
negligence or disregard of rules or regulations with
respect to the TMI expenses deduction, constructive
dividend, and constructive receipt of interest income.
1. Held: Although the rate of return on
investment generated by MI for the year at issue
satisfied the independent investor test as articulated
in Exacto Spring Corp. v. Commissioner, 196 F.3d 833
(7th Cir. 1999), revg. and remanding T.C. Memo. 1998-
220, so that a presumption of reasonableness attached
to S’s compensation, sec. 1.162-7(b)(3), Income Tax
Regs., provides that reasonable compensation “is only
such amount as would ordinarily be paid for like
services by like enterprises under like circumstances”
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Last modified: May 25, 2011