AC553 Tax Memorandum 2

AC553 Tax Memorandum 2 - Memorandum To: Mr. Kim From: Date:...

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Memorandum To: Mr. Kim From: Date: December 7, 2010 Re: Tax Memo #2- Executive Compensation Issues Mr. Kim, sole shareholder and CEO of KimTech, Inc., a technology company which is a C corporation. All income, as well as expenses must be reported on the Form 1120. KimTech 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. Section 162(a) (1) of the Internal Revenue Code permits a corporation to deduct “a reasonable allowance for salaries or other compensation for personal services actually rendered.” There is a two-prong test for deductibility under section 162(a) (1): (1) the amount of the compensation must be reasonable and (2) the payments must in face be purely for services. I evaluate the reasonableness of Kim’s compensation package in light of the five factors enumerated in the Elliotts case. I conclude if KimTech Inc. audited by the IRS, Mr. Kim’s compensation will not be deemed reasonable. Therefore, KimTech needs to evaluate its employee compensation packages and adjust Mr. Kim’s position in the company. In Elliotts case, the first category of factors concerns the employee’s role in the taxpaying company. Relevant considerations include the position held by the employee, hours worked, and duties performed. In our case, KimTech has three officers, a CEO, a CFO and a VP of Sales and Marketing. I am not sure what Mr. Kim’s work duties are. Mr. Kim needs to prove to IRS that he is a capable executive and he has special expertise to direct the company. The second set of relevant factor is a comparison of the employee’s salary with those paid by similar companies for similar services. In 2007, Mr. Kim’s compensation package includes salary of $100,000 and bonus of $800,000, which was much higher than the average compensation for CEOs of similar-size companies in the same industry. For a C- corporation like KimTech, the IRS would look to ensure that owners
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AC553 Tax Memorandum 2 - Memorandum To: Mr. Kim From: Date:...

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