Section of Taxation Publications
  VOL. 53
NO. 4
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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.

Determining the Deductibility of Executive Compensation: Exacto Spring Corp. v. Commissioner

Heather L. Hathaway


In Exacto Spring Corp. v. Commissioner, the Seventh Circuit held that the salary a closely held corporate taxpayer paid to its Chief Executive Officer (CEO) was reasonable within the meaning of section 162(a)(1) and therefore deductible as an ordinary and necessary business expense. In reversing the decision of the Tax Court, the Seventh Circuit employed an independent investor test rather than the traditional multifactor balancing test to determine that the salary paid was reasonable. Previous courts have viewed the multifactor test through the lens of an independent investor, but Exacto Spring is the first case in which a court has held that the independent investor test alone is sufficient to make a determination of reasonableness.

Part I of this Note provides background on section 162(a)(1) and explains the evolution of the salary reasonableness test in the context of the closely held corporation. Part II describes the facts of Exacto Spring and explains the decisions of both the Tax Court and the Seventh Circuit. Part III analyzes the Seventh Circuit’s decision, and Part IV considers the tax planning implications of Exacto Spring.


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


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