Tax Memorandum Week 4 - Memorandum To Mr K im From Date Re...

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Memorandum To: Mr. Kim From: Date: February 14, 2010 Re: Tax Memo #2- Executive Compensation Issues Mr. Kim, sole shareholder and CEO of KimTech, Inc., which is a C corporation (separate taxpaying entity). All income, as well as expenses must be reported on the Form 1120. Mr. Kim is evaluating employee compensation to better understand reasonable compensation packages and the requirements to meet those obligations. KimTech must be aware that there are constraints when developing a compensation package. The amounts for CEOs and executives must be a reasonable amount. Under Code Sec. 162(m), there are limits to the amount of annual compensation allowed to be deducted by a public company for each of its top four executives to $1 million. Compensation that is not subject to this limit includes, compensation is performance based within IRS regulations (DrinkerBiddle, 2008). Also, for C- corporations (private companies), the IRS would look to ensure that owners don’t receive an excessive salary. To determine the amount of salary that’s
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reasonable, the IRS will examine the records of other companies in the same industry. It’s helpful to get Human Resources involved in receiving compensation packages to avoid becoming a target for IRS audits. For a review of executive compensation to be most useful, the plans should be examined not only as the IRS would view them but also with the company’s own purposes in mind (Sosnin, 2005). The independent investor approach is used as a measure of performance based on a corporation’s return on equity. It tests for what is reasonable for private companies by the increase in value of stock, as well as dividends paid. This particular approach has been used for 26 years by various courts, one being the Tax Court. The Tax Court developed a seven factor test for determining whether compensation is reasonable, which includes: type and extent of the services rendered, the scarcity of qualified employees, the qualifications and prior earning capacity of the employee, the contributions of the employee to the business venture,
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