Section of Taxation Publications
  VOL. 57
NO. 3
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 Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
What Is Reasonable Compensation for Deduction Purposes? Two Tests Exist But Neither Paints a Clear Picture, as Evidenced in Devine Bros. v. Commissioner
Jason L. Behrens


The case law may be plentiful, but when it comes to determining what is considered reasonable compensation paid to employees of corporations, the task is far from straightforward. The courts have relentlessly struggled to derive a coherent test to make that determination, and in the process, essentially two approaches have emerged. In Devine Bros., Inc. v. Commissioner, the Tax Court held that salary and bonuses paid to a major shareholder and officer of the corporation were not unreasonable compensation under section 162(a)(1) of the Code; thus, the deductions claimed by the corporate employer were permissible. In arriving at that result, the court, in effect, blended two tests, thereby raising the question whether there are now really three tests.

Part I of this Note summarizes the facts of Devine Bros. and discusses the relevant authorities and case law. Part II presents the parties’ arguments and explores the opinion of the court, explaining the court’s reasoning behind its result. Part III analyzes the reasoning used by the court to support the taxpayer’s arguments and highlights holes in those arguments that the Service could have exploited to rebut the presumption created by the taxpayer’s evidence; namely, that the compensation was reasonable, and thus, deductible. Part III further explains how the vagueness of the opinion is not fully attributable to the court because the law with respect to section 162(a)(1) is not entirely clear. Finally, Part III suggests the method courts will most likely adopt for dealing with the question of reasonable compensation in future cases.


Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center


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