Marie owns one-half of the stock of Starke Corporation and serves as its President. The remaining stock is owned by 10 investors, none of whom owns more than 10% of the outstanding shares. Marie entered a hedge agreement with the corporation three years ago about salary payments that are declared unreasonable compensation by the IRS. Two years ago, the Corporation paid Marie a salary and bonus of $500,000. The IRS subsequently held that $200,000 of the salary is unreasonable compensation. Last year, Starke Corporation and the IRS agreed that $150,000 of the compensation is, in fact, unreasonable. This year, the $150,000 is repaid by Marie to the corporation. How much of the $500,000 compensation was taxable to Marie when originally paid and how much is taxable in the current year?
A)The entire $500,000 is taxable to Marie in the year of receipt and $150,000 of the compensation is deductible by Marie last year.
B)Marie must amend the return of two years ago to adjust her taxable compensation to the agreed- upon reasonable amount.
C)The entire $500,000 is taxable to Marie in the year of receipt and $150,000 of the compensation is deductible by Marie this year.
D)Marie must not include the agreed-upon amount in her return since it is not deductible.

Question

Quizplus · Accepted Answer

The entire $500,000 is taxable to Marie in the year of receipt because at that time it was deemed reasonable compensation. However, since $150,000 was later determined to be unreasonable compensation, Marie can deduct that amount in the current year when she repays it to the corporation. Therefore, $350,000 ($500,000 - $150,000) is taxable in the year of receipt and $150,000 is deductible in the current year.

Marie Owns One-Half of the Stock of Starke Corporation and Serves