Best Practices for Reasonableness of Compensation Analysis in Taxation Disputes

Abstract

The U.S. Tax Court case Clary Hood, Inc v. Commissioner involves a closely held C corporation’s dispute regarding the reasonableness of executive/shareholder compensation tax deductions. There was no dispute in this litigation that CHI was an extremely successful specialty construction company during the tax years at issue. And, there was no dispute in this litigation that Clary Hood, the company CEO and (with his wife) shareholder, was largely responsible for the construction company’s success during the tax years at issue. The disputed issue in the litigation was whether the bonuses paid to Hood in 2015 and 2016 exceed a reasonable amount of executive compensation for the services Hood actually performed for the company. In its memorandum decision, the Tax Court provided a fulsome discussion of the methodology and analysis it applied in addressing this reasonableness of executive/shareholder compensation issue. This judicial discussion provides meaningful practical guidance.