Submitted By maurk24
Issue 2 : Was Ostrovsky’s estimation of Watson’s wages of $91,044 reasonable? Should the court have used DEWPC’s true estimation to assess the tax avoidance penalty? Brief description of issue
After concluding that David Watson should not have earned only $24,000 in salary-based compensation, the court needed to estimate Watson’s fair and probable compensation, had he been paid in the proper amount for services rendered. The court called in Igor Ostrovsky, a government expert who worked on various reasonable compensation cases for the IRS, to examine Watson’s case and determine the market value of earned compensation. This estimate would then provide a basis for assessing tax penalties. After estimating compensation based on similar firm offerings for an equivalent position and calculating average billing rates, Ostrovsky determined that Watson’s wages should have been set at $91,044 with an accompanying tax deficiency judgment against DEWPC totaling $23,431.23. DEWPC subsequently appealed Ostrovsky’s judgment, claiming that Ostrovsky did not qualify as an “expert” and therefore “inappropriately characterized” $91,044 as wages for the purpose of assessing the FICA tax.
Conclusion by Court
The Eighth Circuit held that Ostrovsky was qualified based on his extensive field experience. Furthermore, because DEWPC did not provide evidence of reasonable compensation amounts during cross-examination, Ostrovsky’s opinion is the most reliable form of reasonable compensation provided to the court. Therefore, judgment is affirmed; Ostrovsky’s opinion is upheld for compensation set at $91,044 and penalties totaling $23,431.23.
In the argument of “reasonable compensation”, the court cites Charles Schneider & Co., 500 F.2d at 151. In this case, the court determines that salary distributions valued over certain estimates are unreasonable. To determine “reasonability”, the court references I.R.C. § 162(a)(1). Under I.R.C. § 162(a)(1), a business may deduct "a reasonable allowance for salaries or other compensation for personal services actually rendered" as ordinary and necessary business expenses.” Factors that estimate the reasonability of compensation in Charles Schneider & Co., 500 F.2d at 151 are ascertained from case facts. Information such as employee qualifications, nature, extent and scope of the work performed, a comparison of salaries paid with gross and net income, comparison of salaries with distributions to stockholders, and the prevailing rate of comparable compensation for similar positions all play into determining reasonability. The same information can be ascertained through testimonies provided by DEWPC and Watson and were used by Ostrovsky to determine reasonable compensation.
Analysis of Issue 2
Clearly, Ostrovsky’s estimation of reasonable compensation for rendered services set at $91,044 was correct. Ostrovsky possesses extensive field experience and used appropriate methods of measurement to assess proper salary and the coinciding penalty. By using factors to determine reasonability outlined in Charles Schneider & Co., 500 F.2d at 151 and using comparable compensation for related positions, Ostrovsky provided the court with the best reasonable estimation of Watson’s wages. Because DEWPC did not provide any information to create an estimate of their own, their appeal held no merit.