Definition of Reasonable Compensation
§ 162(a)(1) of the Internal Revenue Code allows for “a reasonable allowance for salaries or other compensation for personal services actually rendered."
The reasonable compensation section of the tax code often comes into play because the double taxation of corporations. If the officers and executives of a corporation are substantially identical with its major shareholders, a temptation may arise to distribute some of the earnings of the corporation under the label of additional compensation for services, rather than under the dividend label to save on taxes.
The reduction in dividend tax lessens that tax advantage of compensation over dividends, but in many situations a significant tax advantage for compensation remains. There are still many controversies between businesses and the IRS over what is considered reasonable compensation for a corporate officer.
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