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Tax Court Weighs in on Reasonable Compensation

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Generally, wages paid to employees are tax deductible by the employer, as long as the payments are “reasonable” in amount. Not always so, according to Hood, TC Memo 2022-15, 3/2/22.

Mar 22nd 2022
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The Tax Court recently found that there's indeed a limit on the tax deductibility of wages paid to employees by the employer. 

What constitutes a “reasonable” compensation for this purpose? It depends on the particular circumstances. Traditionally, the courts have relied on several key factors to make a determination if compensation is reasonable or not.

Background: It makes a big tax difference to employers if amounts are paid to highly-compensation employees as compensation or dividends. If the amount is treated as compensation, it is deductible from the employer’s taxable income. Conversely, dividends aren’t deductible, and effectively represent a second level of tax on corporate income.

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