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Unreasonable Compensation in a Professional Corporation

By James D. Cotterman

Until 2001, the general view was that IRS determinations of “unreasonable compensation” were not a concern for shareholder employees of professional corporations. That equanimity was shattered – at least for those paying attention – by the 2001 Tax Court decision in Pediatric Surgical Associates P.C. v. Commissioner (T.C. Memorandum 2001-81). In that case, the tax court determined that compensation paid to the shareholder physicians in a Texas surgical practice was unreasonably high because it exceeded the value of the services performed by the firm's shareholder physicians.

This seminal tax court opinion turned on the issue of profits generated by the non-shareholder surgeons. Analogous compensation scenarios are common in law firms PCs, so they could face similar IRS determinations, with similarly costly results. Lawyers who are PC shareholders should pay close attention to this case.

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