Sue is thirty years old and is president and a 51% shareholder of C Corporation. She informs you that C Corporation has ten shareholders, all unrelated. Other than herself, no shareholder owns more than 10% of the company's stock. Sue plans to recommend to the board of directors that it authorize the payment of a bonus to hers and three other top employees. She asks you, as the company's tax advisor, to counsel her on what the company needs to do so that the company can get a deduction for the planned bonus payments.
After further discussions with Sue, you learn that the company's business is commercial real estate development. The company had net revenues last year totaling $10,000,000. The company is an accrual basis taxpayer, and each of the intended recipients employs the cash basis method of tax accounting. She would prefer the bonuses to actually be paid next year, but deducted by the company this year. One of the intended recipients is Sue's executive assistant, who is not currently a shareholder in the company. Sue would like the bonus to equal 100% of each recipient's current salary. The current salaries of the intended recipients are as follows:
President ........................................$500,000
Executive Assistant ...........................$100,000
Chief Financial Officer ......................$300,000
Vice President of Operations ...............$250,000
The CFO and vice president of operations are shareholders in the company, each owning 10% of the stock.
Sue had indicated to you that she believes the annual salaries are comparable or, perhaps, a little on the high side when compared to her company's competitors. You also learn that the company regularly pays out dividends to shareholders and plans to continue to do so.
a. Write a memo to your supervisor communicating your research results.
b. Write a letter to the company communicating your research results.
c. Assume the company proceeds with Sue's plan and declares the bonuses before year-end. The following year, the company pays the bonuses on March 1. Your firm prepares the tax return, deducting the bonus payments. The IRS, after an extensive audit, disallows the entire bonus deduction, taking the position that the bonuses were entirely "unreasonable." Write a protest letter to the IRS on behalf of the company.