Final answer:
IRS guidelines require that the compensation paid to employee-shareholders must be reasonable and justified as a business expense. High salaries may trigger an audit and potential penalties if found unreasonably excessive. Corporations must balance fair compensation with legal and ethical obligations.
Step-by-step explanation:
The deduction of salaries paid to employee-shareholders is a significant consideration for corporations, especially when it comes to ensuring compliance with tax regulations and maintaining the balance between rewarding employee-shareholders fairly and maximizing shareholder value. The Internal Revenue Service (IRS) sets specific guidelines which dictate that compensation paid to employee-shareholders must be reasonable and not excessively high in comparison to the services provided. This means the corporation must be able to justify the salary amounts as ordinary and necessary business expenses.
Corporations need to be mindful of these regulations because salaries that are deemed unreasonably high may not be fully deductible and could prompt an IRS audit or even penalties. Furthermore, where an employee is also a shareholder, especially in closely held corporations, the IRS pays closer attention to ensure that the distributions and salary are not disguised dividends that evade the corporate income tax or dividends taxes.
Moreover, other considerations, such as the McCutcheon v. Federal Election Commission and Citizens United v. Federal Election Commission decisions, highlight that while corporations have certain liberties such as the ability to spend unlimited amounts on political campaigns, they must still adhere to strict corporate governance rules and fulfil their fiduciary duties to their shareholders. Thus, a corporation must strike a balance between compensating its employee shareholders and ensuring they operate within the realms of the law and corporate ethics.