James_Holliday_Tax_Memorandum2 - MEMORANDUM TO: Mr. Kim...

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MEMORANDUM TO: Mr. Kim FROM: James Holliday DATE: 12/5/10 RE: Tax Memo #2-Executive Compensation 1. Assuming that 2007 is a typical year for KimTech, in terms of profitability and compensation practices, evaluate the reasonableness of Kim's compensation package in light of the five factors enumerated in the Elliotts case. If audited by the IRS, will Kim's compensation be deemed reasonable? Why or why not? What can KimTech do to show that Kim's compensation is reasonable? The first issue is that the reasonableness of Kim's compensation package is to be evaluated in the light of the five factors enumerated in the Elliot's case. The issue is will IRS evaluate Kim's compensation to be reasonable and if Kim's compensation package is reasonable under the test. The relevant case law is Elliotts, Inc. v. Commissioner (1983) that is used to ascertain reasonable compensation under section 162(a)(1). The five factors are employee's role in the company, external comparisons, character and condition of the company, conflict of interest, and internal consistency. IRS will not deem Kim's compensation to be reasonable. The reason is that his bonus alone is 80% of the company's earning. Moreover, he has an additional fixed salary of $100,000. This makes his compensation equal to 90% of the net pretax compensation. The IRS will perceive the high compensation as an attempt to avoid paying taxes. However, Kim can defend himself using the five factors established in Elliott's case. With respect to employees role in the company, Kim
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This note was uploaded on 05/01/2011 for the course FINANCE 516 taught by Professor Anderson during the Spring '11 term at Keller Graduate School of Management.

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James_Holliday_Tax_Memorandum2 - MEMORANDUM TO: Mr. Kim...

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