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Under § 162(a)(1) of the Internal Revenue Code of 1954, only "reasonable" compensation is deductible.
Petitioner Harolds Club, a Nevada gaming club, challenged an order allowing an annual salary of $ 10,000 plus 15 percent of petitioner's net income as a business expense deduction. Petitioner had originally sought to deduct an annual salary of $ 10,000 plus 20 percent of its net income as a business expense deduction. Petitioner contended that the full amount of the salary claimed in the tax returns should have been allowed as a business expense deduction.
Should the court allow the full amount of salary claimed in the tax returns as a business expense deduction?
The court affirmed the order, finding petitioner's arguments to be without merit. The court explained that under § 162(a)(1) of the Internal Revenue Code of 1954, only "reasonable" compensation was deductible. The court further explained that the disallowance of a deduction for an unreasonable salary with resulting adverse tax effects had a regulatory effect to the extent that it discouraged employers from disbursing as salaries to employees what, if disbursed at all, should be distributed to such employees or others as dividends or gifts.