Question

Explain why the IRS would be concerned that a closely held C corporation only pay

its shareholders reasonable compensation.

Answer 1

The IRS is concerned that a closely held C corporation only pays its shareholders reasonable compensation to prevent tax avoidance, maintain fairness, and ensure correct tax treatment.

Step-by-step explanation:

When it comes to a closely held C corporation, the Internal Revenue Service (IRS) would be concerned that the corporation only pays its shareholders reasonable compensation for several reasons.

1. Preventing tax avoidance: Paying shareholders reasonable compensation ensures that the corporation does not try to avoid taxes by classifying employee salaries as corporate expenses. This helps prevent abuse of the corporate tax system.
2. Maintaining fairness: The IRS wants to ensure that the compensation paid to shareholders is reasonable and comparable to what others in similar roles would receive. Unreasonable compensation could be seen as an attempt to manipulate tax obligations and unfairly reduce the corporation's tax liability.
3. Ensuring correct tax treatment: By requiring reasonable compensation, the IRS can accurately assess the tax liability of both the corporation and the shareholders. Overcompensating shareholders could result in improper categorization of income and subsequent tax noncompliance.

Overall, the IRS is concerned about reasonable compensation to ensure the fair and accurate taxation of closely held C corporations, preventing tax evasion, and maintaining an equitable tax system.