Exacto Spring Corp. v. Commissioner
United States Court of Appeals for the Seventh Circuit
196 F.3d 833 (1999)
William Heitz was the cofounder, principal owner, and chief executive of Exacto Spring Corp. (plaintiff), a closely held manufacturer of precision springs, personally filling the roles of CEO plus chief manufacturing, research-and-development, and sales-and-marketing officer. Exacto paid Heitz $1.3 million in 1993 and $1.0 million in 1994 and deducted those amounts as ordinary business salary expenses. The Commissioner of Internal Revenue (defendant) determined Heitz's reasonable salary was only about $381,000 and $400,000 for those years, treating the excess as a nondeductible disguised dividend. The Tax Court applied its traditional seven-factor reasonableness test, split the difference, and still found a portion of Heitz's pay unreasonable; Exacto appealed.
Whether, under federal tax law, a closely held corporation's salary payments to its executive are presumptively reasonable and fully deductible as an ordinary business expense when the company's investors received dividends far exceeding what they had reason to expect.