IRS Reasonable Executive Compensation

Tips for Being Perceived as Reasonable

To paraphrase a court decision…

A compensation formula should compensate employees reasonably for the:

• services rendered
• performance achieved
• responsibilities assumed

• AND

• experience and dedication of the employee

At the same time, the compensation formula should allow investors a satisfactory return on equity.

Here are some observations about being perceived as reasonable:

• Compensation isn't just salary. Compensation also includes bonuses, as well as other benefits and perquisites.
• Make comparisons. Reasonable compensation requires a comparison to others. So, making comparisons with others is important. This is not only external comparison. Compensation of others within the company and even the position of the company in the labor market are also important.
• The shareholder-employee plays an important role. In a small company, the shareholder-employee may wear many hats and be central to all decision making. This is often reflected in the knowledge and experience of this person.
• Have a compensation plan in place. This plan should be developed at the beginning of the year and should spell out the conditions under which things like bonuses are to be granted. This plan should be approved by the board of directors and should be in meeting minutes. Further, these minutes should be published.
• Declare a dividend. Declaring a dividend during the year is helpful in establishing the fact that there's a difference between investor and employee interests.
• Get advice. This isn't the time to save money by doing it yourself. Obtaining and using a professional's advice on reasonable compensation provides evidence of reasonableness.
• Be consistent. Large swings of compensation are triggers for examination of practices. If there are large changes, be prepared to explain exactly why they occurred.