By Edward Zelinsky
Many Americans have seen the now-infamous Star Trek video made by the IRS with taxpayer funds. It is painful to watch. Captain Kirk (known in the 21st century as William Shatner) pronounced himself “appalled at the utter waste of U.S. tax dollars.” The video’s dialogue is depressingly sophomoric. The acting talents of the IRS employees are comparable to the acting talents of law professors, that is to say, nonexistent.
But this video is not the worst IRS boondoggle to recently come to light. That award goes to the IRS for spending public resources to litigate K&K Veterinary Supply, Inc. v. Commissioner.
This was a reasonable compensation case, so-called because the IRS attacked the reasonability and therefore the tax deductibility of the salaries paid to employees of a closely-held corporation. The IRS never contests as unreasonable the multi-million dollar salaries routinely paid by publicly-traded corporations to failed and ethically-challenged executives. What the IRS deems unreasonable are the far smaller salaries paid to the hard-working and successful owners of closely-held corporations.
The facts of K&K Veterinary Supply, Inc. are typical of these reasonable compensation cases: a successful, family-owned corporation paid salaries on the order of $981,728 to the corporation’s sole shareholder and $215,000 to his wife. These individuals paid federal income taxes on these salaries. The IRS’s goal (which it achieved) was to get a second, corporate tax on part of these amounts on the theory that these salaries were unreasonable and therefore not fully deductible for corporate income tax purposes.
The salaries paid in K&K Veterinary Supply, Inc. constitute a lot of money for most of us. But these salaries are pocket change for the Masters of the Universe who control our major publicly-traded corporations. Many of these executives are competent, ethical individuals who earn their pay honorably. But others are not.
Why does the IRS challenge the compensation paid to the owner in K&K Veterinary Supply, Inc. as unreasonable but not the millions paid to Jamie Dimon of JPMorgan Chase? Perhaps because Mr. Dimon’s compensation (like that of other presidents of major corporations) is set by a nominally independent board of directors and professional compensation consultants. However, it is today hard to take seriously the purported independence or professionalism of these kinds of directors and consultants.
In a case like K&K Veterinary Supply, Inc., the IRS effectively attacks entrepreneurial success in family-owned corporations as unreasonable. The problematic nature of these cases contrasts with recent and commendable IRS successes in combating illegal tax shelters including unreported foreign bank accounts. It is these kinds of productive activities to which the IRS should be devoting its resources, not Star Trek videos or reasonable compensation cases like K&K Veterinary Supply, Inc.
Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America. His monthly column appears here.