Reasonable Compensation - Alive and Well?
By Stuart M. Lewis, Esq.
Buchanan, Ingersoll & Rooney PC, Washington, DC
Section 162 of the Code provides a deduction for an employer's
business expenses, including a deduction for reasonable compensation
paid to employees. The term “reasonable compensation” has
a long, inglorious history.
For many years, the IRS has, without great success, tried to impose
limits on deductible compensation through the application of the
reasonable compensation standard. Congress provided some help to the
IRS with the enactment of the $1 million standard in §162(m) but
the result of those limitations has had more to do with careful
planning by tax advisors than with any substantial limitation on the
deductibility of compensation.
2009 may well be the year of reasonable compensation limitations.
Recent outrage by Congress and the public over bonuses paid to AIG
employees and over “excessive” compensation in general,
has produced a climate in which reasonable compensation limits may
become meaningful. In fact, a senior member of the Senate Finance
Committee has formally suggested to the IRS that it renew its efforts
to impose limitations to the reasonable compensation standard on
multi-million dollar salaries.
In addition, it currently appears that in the AIG aftermath
Congress may well impose limitations on the deductibility of deferred
compensation and could even go further by tightening the rules under
§162(m) or providing other efforts designed to ensure that
corporations cannot deduct the full amount of compensation, deferred
or otherwise, in the case of executives with large salaries.
While clearly there is unjustified, astronomical compensation being
paid to some executives, Congress should temper its current outrage
with a more serious reflection on why corporations pay large amounts
of compensation in the first place. In many cases, incentive
compensation is fully justified by market forces and competitive
pressures, factors which should be relevant in a capitalistic society.
More to the point, it should be up to the owners of the business,
i.e., the shareholders, whether compensation amounts paid to
executives are justified or not. As long as adequate processes are in
place to ensure that the business owners fully understand and agree
with who can have compensation packages, it seems inappropriate for
the IRS or Congress to develop more stringent standards.
For more information, in the Tax Management Portfolios, see
Moran, 390 T.M., Reasonable Compensation, and in Tax Practice
Series, see ¶5420, Reasonable Compensation.
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