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162(a)(1) compensation payments. Close scrutiny may be used when
the paying corporation is controlled by the compensated employee,
as in the instant case. Elliotts, Inc. v. Commissioner, 716 F.2d
at 1246-1247. However, the mere fact that the individual whose
compensation is under scrutiny is the sole shareholder of the
company, even when coupled with an absence of dividend payments,
does not necessarily lead to the conclusion that the amount of
compensation is unreasonably high. Id.
The Court of Appeals for the Ninth Circuit determined that
the reasonableness of compensation should be evaluated from the
perspective of a hypothetical independent investor. The prime
indicator is the return on the investor’s equity. Id. at 1247.
If the company’s earnings on equity after payment of the
questioned compensation remain at a level that would satisfy a
hypothetical independent investor, there is a strong indication
that the employee is providing compensable services and that
profits are not being siphoned out of the company disguised as
salary. Id. The Court of Appeals in Elliotts calculated the
return on equity using the yearend shareholders equity. Id.
This Court follows that approach. See Golsen v. Commissioner, 54
T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir. 1971); Lumber City
Corp. v. Commissioner, T.C. Memo. 1996-171.
Petitioner had a 42-percent return on equity after dividing
the net income book value by the yearend shareholders equity. In
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