Employee is the majority shareholder (248 of 250 outstanding shares) and president of Corporation. Shortly after Corporation was incorporated, its Directors adopted a resolution establishing a contingent compensation contract for Employee. The plan provided for Corporation to pay Employee a nominal salary plus an annual bonus based on a percentage of Corporations net income. In the early years of the plan, payments to Employee averaged $50,000 annually. In recent years, Corporations profits have increased substantially and, as an consequences, Employee has received payments averaging more than $200,000 per year.

(a) What are Corporations possible alternative tax treatments for the payments?

(b) What factors should be considered in determining the proper tax treatment for the payments?

(c) The problem assumes Employee always owned 248 of the Corporations 250 shares. Might it be important to learn that the compensation contract was made at a time when Employee held only 10 out of the 250 outstanding shares?