ASSIGNMENTWrite a memorandum addressing each of the three issues listed below. The memorandum should be no less than one page and no more than three pages in length. FACTSMr. Kim is the sole shareholder and CEO of KimTech, Inc., a technology company valued at approximately $5,000,000. KimTech is a C corporation for federal tax purposes. In 2007, KimTech had net pretax profits–before deducting Kim’s compensation–of $1,000,000. After deducting Kim’s base salary of $100,000 and bonus of $800,000, the company was left with a small after-tax profit, which was retained by KimTech (i.e., no dividends were paid to Kim). KimTech has two other officers, a CFO and a VP of Sales and Marketing, each of whom received salaries of $100,000 and no bonuses. Kim’s bonus was awarded by the board of directors, which consists of three directors: Kim, who serves as Chairman, the CFO and the VP of Sales and Marketing. In determining Kim’s bonus, the board multiplied pretax profits, before Kim’s compensation, by 80% (i.e., $1,000,000 x .8 = $800,000 bonus). In recent years, KimTech’s value has been appreciating at 7% per year. Assume that the average compensation for CEOs of similar-sized companies in the same industry is $500,000 (salary and bonus combined).APPLICABLE LAWUse the typical tax resources both primary and secondary which include statutes, regulations, and court decisions to formulate your advice regarding each of the three issues listed below:ISSUES1. Assuming that 2007 is a typical year for KimTech, in terms of profitability and compensation practices, evaluate the reasonableness of Kim’s compensation package in light of the five factors enumerated in the Elliotts case. If audited by the IRS, will Kim’s compensation be deemed reasonable? Why or why not? What can KimTech do to show that Kim’s compensation is reasonable?2. Assuming that 2007 is a typical year for KimTech, in terms of profitability and compensation practices, evaluate the reasonableness of Kim’s compensation using the independent investor/return on equity approach. Is Kim’s compensation package reasonable under this test? Why or why not?3. Is contingent compensation (e.g., a compensation package involving a significant bonus) more likely to result in a determination that compensation is unreasonable than a compensation package that is all, or primarily, a fixed salary? FORMATUse the following heading and other specifics:MEMORANDUMTO: Mr. KimFROM: Your NameDATE: Today’s DateRE: Tax Memo #2-Executive CompensationFor each issue, begin by restating the issue. Then, explain and discuss the tax rules that apply to the issue, which you gleaned from the sources listed in the Applicable Law section above. Then, conclude with a definitive answer to the issue, supported by citations to the sources used. So, for each issue, you should:State the issue, Explain and discuss the applicable law (IRC sections, regulations, court decision, etc.), and Present your answer in the form of a concluding paragraph that refers to specific language from the IRC sections, regulations, court decisions, and other sources (if applicable) to support the conclusion.CITATIONSCitations are required. You must provide cites whenever you refer to the sources of tax law used in this memorandum. You may cite your sources in numbered footnotes, numbered endnotes, or in parentheses immediately after the sentence mentioning the cited source.
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