Understanding the Maximum Reasonable Compensation Law: Key Insights
Definition & Meaning
The maximum reasonable compensation law refers to guidelines established by the Internal Revenue Service (IRS) to determine the appropriate level of compensation for corporate executives and employees, particularly in closely held corporations. This law aims to ensure that compensation packages, including salaries, bonuses, and benefits, are consistent with what similar employers would pay for comparable services. The IRS defines "reasonable" compensation as the amount that is typically paid for similar roles in comparable companies, helping to prevent tax avoidance through excessively low or high compensation levels.
Legal Use & context
This term is primarily used in tax law and corporate governance. It is particularly relevant for closely held corporations, where owners may also be employees. Legal challenges often arise when the IRS questions whether the compensation paid to stockholder-employees is reasonable. Users can manage some aspects of this issue themselves using legal templates available through US Legal Forms, particularly for compliance documentation or compensation agreements.
Real-world examples
Here are a couple of examples of abatement:
Example 1: A closely held corporation pays its CEO a salary of $200,000, along with bonuses and benefits totaling $50,000. If similar companies in the industry typically pay their CEOs $250,000, the IRS may challenge the lower compensation as unreasonable.
Example 2: A family-owned business compensates a family member who is also a key employee with a salary significantly below market rates to minimize tax liabilities. This could attract IRS scrutiny under the maximum reasonable compensation law.