Brewer Homes was a retail seller of mobile homes. It was a C corporation owned by a married couple, Jack and Mary Brewer. From the early '70's to the mid-90's, the company provided its owners with a comfortable living. However, in the mid-90's its business really took off. It had upwards of 22 employees and was able to pay Jack Brewer $762,186 in salary and bonuses 1995 and $863,559 in 1996. After an audit (and apparently some negotiation), the IRS determined that reasonable compensation for Mr. Brewer was $604,117 for 1995 and $485,966 for 1996. The remainder of the compensation in those years was deemed to not be a deductible expense, but, instead, a dividend to the Brewers.
The Court applied analysed the case using the following nine factors:
- The shareholder/taxpayer's qualifications;
- The nature, extent, and scope of the shareholder/taxpayer's work;
- The size and complexity of the corporation;
- The comparison of the shareholder/taxpayer's salary with the gross and net income of the corporation;
- Prevailing economic conditions;
- A comparison of the purported salary paid with other distributions to shareholders;
- Compensation for comparable positions in comparable concerns;
- The salary policy of the corporation with respect to other employees; and
- The amount paid to the shareholder/taxpayer in previous years.
- Is the shareholder the principal provider of compensable labor? Thus, if we are dealing with a professional practice where the income of the business is virtually exclusively driven by the professional services rendered by shareholder/owner, there is likely to be a finding that virtually all of the income is subject to FICA. That might not be the case, for example, if the service business is pyramidal, such as in an accounting firm with a large number of junior accountants who generate profit.
- Is there a significant capital component to the business? For instance, a veterinary surgeon may have far less capital invested in equipment than, say, a radiologist. It might be relatively simple to carve out some income of the business as being a return on capital and thus free from recharacterization as compensation subject to FICA. It is worthy of some note that in the First Circuit reasonable compensation case that I commented on previously, that Court rejected the use of a "return on capital" analysis.