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MAXIMUM REASONABLE COMPENSATION
In the IRS determination of reasonable compensation, one of the main considerations is that of comparable wages. Maximum reasonable compensation is the highest amount of compensation (both salary and bonus) allowed to be used as a business expense for services rendered in comparable circumstances.
ERI's Executive Compensation Assessor (XA) contains a Survey and Proxy Analyses module that provides information on maximum reasonable compensation for over 2,000 top-management jobs (collected, combined, and analyzed from SEC proxy reporting and/or management compensation surveys).
Methodology
The Survey and Proxy Analyses table was created at the request of the IRS for assessment of the reasonableness of owner/manager compensation. This table was developed with methodology designed to support those who provide expert-witness work in federal, tax, and state courts.
ERI used IRS cases to develop the definition of maximum reasonable compensation in terms of the standard error of the distribution of compensation for comparable executives. This measure is approximately 2.0 standard error.
The standard error is an estimate of the variability or random error of the sample statistic to the population parameter.
Example: A population has a mean of 6. You would expect that samples taken from this population would also have means of 6. However, that is rarely the case. The means of the samples taken from this population will vary due to sampling errors. Standard error is a measure of the expected variation of the sample mean around the true mean of the population.
Using the IRS cases, ERI developed a statistical definition for maximum reasonable compensation. ERI defines maximum reasonable compensation as the range of pay containing roughly 95% of the executive population. This applies the standard error of the distribution of observed compensation for comparable executives to show a range corresponding to approximately two standard errors above and below the mean. Since ERI observations are restricted to only the publicly disclosed executive salaries rather than the sum total of all observations from all survey sources whose updated competitive figures are reflected in the database, ERI's reliability statistics are considered to be extremely conservative.
Adjustable Data
ERI's XA allows you to specify additional criteria to make the executive compensation estimates as applicable to your organization as possible. The Executive Compensation Assessor lets you adjust for: industry, revenue size, employee performance level, organization pay strategy, and salary planning date.
The Survey and Proxy Analyses feature is also useful for the following executive compensation analyses:
- valuations (where owner/manager compensation affects stock value)
- estate planning
- appraisals
- charitable gifts
- buy/sell a business
- Employee Stock Ownership Plan feasibility
- reasonable compensation
- accumulated earnings
- divorce and other litigation
- insurance funding
- equity compensation
Memory Jogger
According to ERI's Executive Compensation Assessor methodology, maximum reasonable compensation is the range of pay containing roughly what percent of the population?