Question

Explain the tax consequences to both the corporation and a​ shareholder-employee if an IRS agent determines that a portion of the compensation paid in a prior tax year exceeds a reasonable compensation level.

A.

If the IRS determines a portion of the compensation paid is​ unreasonable, then the corporation loses its tax deduction for that portion of the payment.​ However, the​ shareholder-employee will then have a decrease in compensation for the current year and the amount will be treated as fringe benefits to them.

B.

If the IRS determines a portion of the compensation paid is​ unreasonable, then the corporation can still take its tax deduction for that portion of the payment.​ However, the​ shareholder-employee will still be liable for this amount on their personal return as compensation for the year.

C.

If the IRS determines a portion of the compensation paid is​ unreasonable, then the corporation can still take its tax deduction for that portion of the payment. The​ shareholder-employee will then have a decrease in compensation for the current year and the amount will be treated as fringe benefits to them.

D.

If the IRS determines a portion of the compensation paid is​ unreasonable, then the corporation loses its tax deduction for that portion of the payment. The​ shareholder-employee will still be liable for this amount on their personal return as compensation for the year

Answer 1

Since unreasonable compensation can be treated as dividend paid to shareholders which is taxable and for which deduction is not allowed to corporation.

Therefore the correct answer is option D i.e.

If the IRS determines a portion of the compensation paid is​ unreasonable, then the corporation loses its tax deduction for that portion of the payment. The​ shareholder-employee will still be liable for this amount on their personal return as compensation for the year