Reference no: EM132673175

Problem - Uneven Compensation Playing Field

The top five executives of publicly traded corporations are subject to a $1 million limit each on the corporate deductibility of compensation paid to them. Many other highly paid individuals are not subject to this $1 million cap on deductibility.

In closely held, private corporations, an employee's salary must be reasonable. If part of an employee's salary is unreasonable, an IRS agent can disallow that portion and treat it as a distribution (usually classified as a dividend to the shareholder). Any deduction for compensation by the corporation must reflect a reasonable allowance for salaries or other compensation for personal services, reflecting what would ordinarily be paid for like services by like enterprises under like circumstances. Frequently, the permitted deduction to the corporation exceeds $1 million.

Among those to whom the cap does not apply are highly paid entertainers and celebrities receiving royalties or other compensation (other than as an executive of a company). For example, George Clooney, Kylie Jenner, Judy Sheindlin (Judge Judy), and Dwayne "The Rock" Johnson received $239 million, $166.5 million, $147 million, and $124 million, respectively. These are in addition to the highly paid athletes discussed at the beginning of this chapter. Discuss the fairness of tax policy that subjects the compensation of certain business executives to a limitation on deductibility by their corporate employers while allowing compensation paid to noncovered executives, entertainers, sport stars, and others to be exempted from this limitation.