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Economically Analyzing the Definition of 'Reasonable Compensation' as It Relates to Employment-Tax Liability Under the Analysis of David E. Watson, P.C. v. United States

50 Pages Posted: 6 May 2011  

Ryan M. Vassar

affiliation not provided to SSRN

Date Written: May 5, 2011

Abstract

This note analyzes the “definition” of “reasonable compensation” under the Internal Revenue Service’s (“IRS”) revenue ruling and how the Internal Revenue Code (the “Code”) applies that definition in determining employment-tax liability. The revenue ruling requires compensation to shareholder-employees of a small corporation to be reasonable. The IRS’s subsequent re-characterization of “unreasonable” payments – i.e., those that should have been originally characterized as wages – subjects the re-characterized portion to penalties, interest, and additional taxes; specifically, taxes under the Federal Insurance Contributions Act (“FICA”).

The case, here, involves a shareholder-employee of a Subchapter S corporation. The IRS challenged the shareholder-employee’s amount of FICA-tax liability after determining his salary was unreasonably low, by re-characterizing a portion of his distributions, or dividends, he received from his S-corporation.

Keywords: shareholder, employee, compensation, wage, salary, salaries, partner, employment, tax, revenue, corporate, corporation, internal, service, federal, insurance, contributions, s corporation, s-corporation, distribution, dividend

JEL Classification: H2, H20, H21, H24, H25, H26, H29, J3, J30, J44, K00, K1, K10, K19, K2, K20, K22, K34, K42, L51, L8

Suggested Citation

Vassar, Ryan M., Economically Analyzing the Definition of 'Reasonable Compensation' as It Relates to Employment-Tax Liability Under the Analysis of David E. Watson, P.C. v. United States (May 5, 2011). Available at SSRN: https://ssrn.com/abstract=1832167 or http://dx.doi.org/10.2139/ssrn.1832167

Ryan M. Vassar (Contact Author)

affiliation not provided to SSRN

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