Opinion ID: 489299
Heading Depth: 2
Heading Rank: 7

Heading: Compensation Practices of Comparable Companies

Text: 56 After reviewing all of the above factors, the district court concluded that the most important factor in this case was what similar enterprises in similar circumstances would pay for similar services. The Treasury Regulations recognize that in a case like the instant one, the central inquiry often focuses on the market value of the services rendered: 57 In any event the allowance for the compensation paid may not exceed what is reasonable under all of the circumstances. It is, in general, just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises under like circumstances. 59 58 At trial, both parties presented expert testimony as to what a like enterprise would pay for like services. The Tax Court discounted the testimony presented by the Commissioner's experts and chose instead to credit the testimony of the taxpayers' experts. The Tax Court refused, however, to accept the ultimate conclusion of the taxpayers' experts. The taxpayers assert that this was erroneous. We have examined the testimony of the taxpayers' expert witnesses and their report, and for the reasons explained below, we conclude that the Tax Court did not err. 59 The Taxpayers' experts identified 23 publicly traded corporations engaged in either the consulting engineering field or the oil exploration and production field as comparable companies with compensation information available. These companies were then placed in three categories: companies with revenues under $10,000,000; companies with revenues between $10,000,000 and $30,000,000; and companies with payment practices in the top quartile of the 23 companies. In each category, the experts calculated the average amounts the top three executives could expect to earn in cash and stock options 60 for an outstanding performance. 61 For the years at issue, and for the $10-30 million and top 25 percent categories, the figures were as follows:The taxpayers' experts argued that Mr. Owensby and Mr. Kritikos should each be compensated as the highest paid executive in the top 25 percent category. Or in other words, reasonable compensation for each was up to $1,019,924 in 1978 and $992,868 in 1979. 62 These experts concluded that the appropriate category was the top 25 percent, because the corporations paid cash compensation to all of their employees, both shareholders and nonshareholders, at the top of the spectrum of that paid by the 23 companies. The Tax Court concluded, however, that because the corporations on a consolidated basis had revenues of $20,226,385 and $24,555,167 in 1978 and 1979 respectively, the appropriate category for comparison was the $10-30 million in revenue category. It therefore concluded that reasonable compensation for each of the individual taxpayers for 1978 and 1979 was $546,376 and $560,065 respectively. 60 The taxpayers argue that such a conclusion is unwarranted. The taxpayers contend that because the Tax Court found the taxpayers' experts highly qualified and experienced, it was required to accept their testimony in toto. The judgment of the Tax Court as a finder of fact is, however, not so constrained. Even when the Tax Court accepts the general methodology of a highly qualified expert witness, the court may reject the expert's ultimate conclusion if the record does not support that conclusion. 63 Moreover, this is not a case where the Tax Court's decision to reject the taxpayers' experts' ultimate conclusion enjoys no support in the record. 64 Indeed, our review of the record convinces us of the propriety of the Tax Court's choice. 65 In this case, the Tax Court did not substitute its own judgment for that of the expert. Rather, the court appropriately relied upon the experts for information that the experts were able to provide. The court then arrived at its ultimate conclusion based on commonsense rather than lemminglike reliance upon the testimony of the experts. 61 Although we have concerns about the method of calculation used by the taxpayers' experts, 66 we accept their methods of calculating the cash compensation and the value of stock options granted as well as their choice of comparable companies, because the district court did so and the Commissioner has not challenged that conclusion. The only question, therefore, is whether the corporations as a consolidated entity should be compared to the top 25 percent category or to the $10-30 million in revenue category. 62 We note that the Tax Court failed to articulate clearly or convincingly its reasons for rejecting the top 25 percent category. Indeed, the muddled reasons apparently offered by the Tax Court are refuted by that court's own opinion. But, in the circumstances of this case we will not overturn the Tax Court's conclusion with regard to this factor because the record unquestionably supports that conclusion. 63 When a taxpayer in a case such as this asserts that it merits treatment different from the norm--in this case, the norm is the $10-30 million in revenue category--then it must offer some support for that position. In this case, the taxpayers asserted that their overall cash compensation practices entitled them to be treated as a top 25 percent category company. Although it may well be true that the corporations as a consolidated entity paid average cash compensation to all of their employees that would put the entity at the top of the group of the 23 comparable companies, the important question, however, is how does it rank in regard to total compensation. Because the corporations pay only cash compensation while the comparable corporations compensate their employees with both cash and stock options, comparing only cash compensation will of course place the corporations as an entity at the top of the group in terms of payment practices. 67 When comparing total compensation, however, it is clear that the corporations are not necessarily in the top echelon. Indeed, the taxpayers' experts' study, which was admitted into evidence at trial, states that based on total compensation for 1978 and 1979, the highest paid nonshareholder-employees of the corporations would be considered underpaid when compared to [similarly situated individuals in] publicly held companies who provide stock option opportunities. This is especially true during the four-year period included in our study. 68 64 A review of the total compensation paid to the shareholders of the corporations as compared to that paid to the top nonshareholder-employees demonstrates that the corporations as an entity should not be compared to the top 25 percent category. In 1978 and 1979, the corporations, on a consolidated basis, paid the following amounts to the highest paid employees: 65 Total Compensation for Highest Paid Employees ------------------------------------------------- Owensby $853,971 $843,079 Kritikos $853,971 $843,079 Piner $779,300 $525,000 Genois $159,737 $200,806 Linder $138,833 $148,574 66 The disparity between the compensation paid to the shareholders--Mr. Owensby, Mr. Kritikos, and Mr. Piner--and that paid to the nonshareholders is patent. In 1978, the average shareholder-employee was paid $829,081, while the highest paid nonshareholder-employee received less than 20 percent of that amount. In 1979, the highest paid nonshareholder-employee earned only 27 percent of that paid to the average shareholder-employee. The report of the taxpayers' experts supports the conclusion that such wide variances in compensation do not generally exist in comparable publicly held companies. According to the experts' report, in all categories and for all performances, even the third highest paid employee always received at least 50 percent of that earned by the highest paid employee. 69 67 Because the taxpayers failed to prove that the companies as an entity provided total average compensation to all employees in the top quartile of the group of comparable companies, the record supports the Tax Court's decision to compare the corporations as an entity to the $10-30 million in revenue category rather than to the top 25 percent category.