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Tax Court Weighs in on Reasonable Compensation


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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