Opinion ID: 489299
Heading Depth: 2
Heading Rank: 1

Heading: Shareholders as Employees

Text: 33 We start our analysis with the principle that the Commissioner's determination of reasonableness carries a presumption of correctness; 26 the burden is on the taxpayer to show that he is entitled to a deduction larger than that allowed by the Commissioner. 27 When, as here, the payments are made to shareholder-employees who control the corporation, the trial court must carefully scrutinize the payments to ensure that they are not disguised dividends. 28 As the Treasury Regulations state: 34 Any amount paid in the form of compensation, but not in fact as the purchase price of services, is not deductible. An ostensible salary paid by a corporation may be a distribution of a dividend on stock. This is likely to occur in the case of a corporation having few shareholders, practically all of whom draw salaries. If in such a case the salaries are in excess of those ordinarily paid for similar services, and the excessive payments correspond or bear a close relationship to the stockholdings of the officers or employees, it would seem likely that the salaries are not paid wholly for services rendered, but that the excessive payments are a distribution of earnings upon the stock. 29 35 In the instant case, the payments made to Mr. Owensby and to Mr. Kritikos corresponded exactly to their stockholdings. 30 The taxpayers argue, however, that the evidence presented at trial demonstrated that Mr. Owensby and Mr. Kritikos were equally responsible for the success of the corporations and merited equal compensation. The taxpayers argue therefore that the correlation between stockholdings and payments is irrelevant. Although we agree that a correlation can be explained in this manner and that a trial court should consider this fact when making its decision, 31 we do not agree that the correlation becomes irrelevant once such an explanation is offered. 36 When the payments made are unquestionably at the high end of the spectrum of compensation paid within a field of work, the correlation between stockholdings and payments makes it necessary for the court to consider whether the payments are disguised dividends even if the shareholder-employees contributed services in proportion to their stockholdings. In such a case, it is not unreasonable for the court to conclude that a portion of the payments represent compensation for services and the remainder represents a disguised dividend. As noted before, the trial court must scrutinize payments made to shareholder-employees who control the corporation, especially when these payments are in proportion to stockholdings. As the regulations explain, however, even payments made to shareholders in proportion to their ownership are, as a general rule, improper only if they are in excess of what is usually paid for similar services. 32 We examine below whether the payments exceeded usual compensation for similar services. 37