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Any amount paid in the form of compensation, but not in
fact as the purchase price of services, is not
deductible. An ostensible salary paid by a corporation
may be a distribution of a dividend on stock. This is
likely to occur in the case of a corporation having few
shareholders, practically all of whom draw salaries.
If in such a case the salaries are in excess of those
ordinarily paid for similar services and the excessive
payments correspond or bear a close relationship to the
stockholdings of the officers or employees, it would
seem likely that the salaries are not paid wholly for
services rendered, but that the excessive payments are
a distribution of earnings upon the stock. * * *
As respondent points out, there is nothing in Exacto Spring Corp.
to indicate that the Court of Appeals now requires a finding of
bad faith to support a conclusion that some part of an
executive’s salary is not purely for services or that the Court
of Appeals has rejected section 1.162-7(b)(1), Income Tax Regs.
(fact that salaries are higher than those ordinarily paid for
similar services is evidence that the salaries are probably not
paid solely for services rendered).
Payments to employee/shareholders of closely held
corporations merit strict scrutiny. Exacto Spring Corp. v.
Commissioner, 196 F.3d at 838; Dexsil Corp. v. Commissioner, 147
F.3d 96 (2d Cir. 1998), remanding T.C. Memo. 1995-135; sec.
1.162-7(b)(1), Income Tax Regs. Mr. Menard owned directly 100
percent of the voting stock and 56 percent of the nonvoting stock
of Menards. The only other shareholders were primarily members
of his family or trusts established for the benefit of Mr. Menard
and family members. The majority of Menards’s board of directors
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