Thursday, January 16, 2003
Richard E. Devine, Sr., and Richard E. Devine, Jr., were the sole shareholders of Devine Brothers, Inc. Sr. was the president and board chairman, and Jr. was the vice-president and a board member. For the fiscal year ending in 1994, Devine paid Sr. $51,663 and Jr. $66,897 in salary. For fiscal year ending in 1995, Devine paid Sr. $260,378 and Jr. $112,599 in salary. Devine began business in 1918, and by 1961 the stock was 100% owned by Sr., who later began slowly transferring the stock to Jr. Devine never paid dividends from its inception through 1995. IRS deemed $65,000 of Sr.'s 1995 salary to be a dividend, disallowing the deduction for that for that amount, and assessed a $25,086 deficiency. As this was a 1995 case, the burden of proof was on the taxpayer.
Tax Court ruled in favor of Devine. I am beginning to wonder whether the Tax Court is leaving out crucial information from the opinions that make the IRS's positions seem slightly more reasonable than they appear in the Court�s opinions. Tax Court states regarding the $65,000 disallowance, "Respondent gives no reasoning for his calculation of the "excessive" compensation." Really? The IRS just picked $65,000 out of the air? Either Tax Court is leaving out something, or this is a shockingly arbitrary exercise of power.
The sad thing here is that I read the facts, I was actually sympathizing with the IRS. A company manages to stay in business for 77 years without ever paying dividends? The sole shareholders pay themselves wildly varying amounts of "salary" year to year? Sure sounds to me like their giving themselves investor profit and calling it employee compensation. But somehow IRS failed to put together an actual case. Devine met their burden by bringing witnesses who testified that Sr.'s salary in 1995 was comparable to other similarly situated executives, while his 1994 salary was significantly below that of similarly situated executives. This created the inference that the bonuses paid in 1995 were meant to compensate for underpayment in 1994. This sounds weak to me, but it does present a prima facia case. According to Tax Court, IRS responded by offering no justification of its $65,000 disallowance and stipulating that Sr.'s salary was within the range of salaries paid to similarly situated executives. Thus, it was a weak case from the taxpayer versus no case from the IRS.
Again, is the IRS really this stupid and arbitrary, or is Tax Court merely making them look this way by mischaracterizing their arguments?