I. Judy and Bob own 80% and 20%, respectively, of Plum Company stock.

Thanks to their
hard work, Plum’s software sales have sky rocketed. In its first year of operation, Plum’s
earnings were minimal, but four years later, Plum grossed $10 million. Plum
compensated Judy and Bob as follows: Judy received a bonus of 76% of net profits and
Bob received a bonus of 19% of net profits at the end of each year. Plum never paid any
dividends. Can Plum deduct any or all of the “salaries” paid to Judy and Bob.

Answer:

Plum can deduct any or all of the “salaries” paid to Judy and Bob because it is qualified as
reasonable and ordinary compensation paid during taxable year in connection with the services
performed by both in carrying on any trade or business of company , under sec 162(a)(1).
Plum can deduct = $10 million*95%=9.5 million dollar.

Section 162
(a)There shall be allowed as a deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or business, including-
(1) a reasonable allowance for salaries or other compensation for personal services actually
rendered;
(2) traveling expenses (including amounts expended for meals and lodging other than amounts
which are lavish or extravagant under the circumstances) while away from home in the pursuit of
a trade or business; and
(3) rentals or other payments required to be made as a condition to the continued use or
possession, for purposes of the trade or business, of property to which the taxpayer has not taken
or is not taking title or in which he has no equity.