Some accounting firms are warning privately held companies organized as C Corps. that if the principals are being especially well-compensated, they'd better be prepared to justify it to the Internal Revenue Service, with full documentation. Otherwise, the agency could rule that the excess compensation be treated as dividends, and taxed accordingly.
Accountant Andy Press, a partner in the Cleveland firm of Bick Fredman & Co., recalls one client who went under the IRS microscope for his lofty compensation.
"About five years ago, I had a client, an auto dealer, who made $900,000. The [IRS] agent, who was making maybe $25,000, thought that was unreasonable. But we just documented it, and demonstrated that he was responsible for fleet sales, and that brought in a lot of money."
In the end, that argument won the day.
Tax specialists say you might be better off to skip this reasonableness test altogether, by converting from a C Corp. to a limited liability corporation.