(Reprinted from Benefits & Compensation Solutions magazine)

What is Reasonable Compensation?
By Stephen D. Kirkland, CPA, CMC, CFC

The income tax laws allow corporations to deduct ordinary and necessary expenses incurred in carrying on their businesses. This includes compensation for services performed by officers and stockholders, but only if certain requirements are met.

The requirements vary depending on whether the corporation is publicly-traded or privately-owned.

Publicly-Traded

A corporation is publicly-traded if it has a class of common stock that is registered under the 1934 Securities Exchange Act.

Section 162(m) of the Internal Revenue Code limits a publicly-traded corporation’s tax deduction for compensation paid to a “covered employee” to a maximum of $1,000,000 per year. A covered employee is an individual who is the corporation’s CEO or is one of the four highest paid officers other than the CEO.

Certain types of compensation are not subject to this $1,000,000 limit and are not included in the calculation:
(1) commissions;
(2) performance goal remuneration (if approved by outside directors and shareholders and certain tests are met);
(3) contributions to qualified retirement plans;
(4) tax excludable employee welfare benefits; and
(5) certain amounts under a pre-1993 written contract.
Stock options are generally not included in compensation if they meet the requirements for performance-based compensation; however, some grants of restricted stock may not qualify for the exclusion.