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Elliotts, Inc. v. Commissioner, 716 F.2d 1241, 1245-1248 (9th
Cir. 1983), revg. T.C. Memo. 1980-282. Where shareholder-
officers who are in control of a corporation set their own
compensation, careful scrutiny is required to determine whether
the alleged compensation is in fact a distribution of profits and
a constructive dividend. Home Interiors & Gifts, Inc. v.
Commissioner, supra at 1156.
The Court of Appeals for the Second Circuit has adopted an
independent investor test whereby the fact-finder must apply the
above multifactor test from the perspective of an independent
investor. In general, this test questions whether, given the
dividends and return on equity enjoyed by a disinterested
stockholder, that stockholder would approve the amount of
disputed compensation paid to the employee on the basis of the
facts of each particular case. See Rapco, Inc. v. Commissioner,
supra at 954-955; see also Elliotts, Inc. v. Commissioner, supra
at 1247; Haffner’s Serv. Stations, Inc. v. Commissioner, T.C.
Memo. 2002-38, affd. 326 F.3d 1 (1st Cir. 2003). That test
allows us to decide whether the amount of compensation paid to a
taxpayer-corporation’s shareholder-employees by the corporation
would have been the same had they engaged in arm’s-length
negotiation. See Miller & Sons Drywall, Inc. v. Commissioner,
T.C. Memo. 2005-114. One important inquiry is whether this
hypothetical independent investor received a fair return on his
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