Taxes and Business Decisions 325EXECUTIVE COMPENSATION
Brad’s compensation package raises a number of interesting tax issues that may
not be readily apparent but deserve careful consideration in crafting an offer to
him. Any offer of compensation to an executive of his caliber will include, at
the very least, a significant salary and bonus package. These will not normally
raise any sophisticated tax problems; the corporation will deduct these pay-
ments, and Brad will be required to include them in his taxable income. The
IRS is not likely to challenge the deductibility of even a very generous salary,
since Brad is not a stockholder or family member and, thus, there is little like-
lihood of an attempt to disguise a dividend.
Business Expenses
However, even in the area of salary, there are opportunities for the use of tax
strategies. For example, Brad’s duties may include the entertainment of clients
or travel to suppliers and other business destinations. Brad could conceivably
fund these activities out of his own pocket on the theory that such amounts
have been figured into his salary. Such a procedure avoids the need for the
bookkeeping associated with expense accounts. If his salary ref lects these ex-
pectations, Brad may not mind declaring the extra amount as taxable income,
since he will be entitled to an offsetting deduction for these business expenses.
Unfortunately, however, Brad would be in for an unpleasant surprise
under these circumstances. First of all, these expenses may not all be de-
ductible in full. Meals and entertainment expenses are deductible, if at all, only
to the extent they are not “lavish and extravagant,” and even then they are de-
ductible only for a portion of the amount expended. In addition, Brad’s busi-
ness expenses as an employee are considered “miscellaneous deductions”; they
are deductible only to the extent that they and other similarly classified deduc-
tions exceed 2% of Brad’s adjusted gross income. Thus, if Brad’s adjusted gross
income is $150,000, the first $3,000 of miscellaneous deductions will not be
deductible.
Moreover, as itemized deductions, these deductions are valuable only to
the extent that they along with all other itemized deductions available to Brad
exceed the “standard deduction,” an amount Congress allows each taxpayer to
deduct, if all itemized deductions are foregone. Furthermore, until 2010, item-
ized deductions that survive the above cuts are further limited for taxpayers
whose incomes are over $132,950 (the 2001 inf lation-adjusted amount). The
deductibility of Brad’s business expenses is, therefore, greatly in doubt.
Knowing all this, Brad would be well advised to request that Morris revise
his compensation package. Brad should request a cut in pay by the amount of
his anticipated business expenses, along with a commitment that the corpora-
tion will reimburse him for such expenses or pay them directly. In that case,
Brad will be in the same economic position, since his salary is lowered only
by the amount he would have spent any way. In fact, his economic position is