Clary Hood, Inc. v. Commissioner of Internal Revenue, No. 22-1573 (4th Cir. 2023)
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Clary Hood, Inc. (“Hood, Inc.”), a South Carolina corporation engaged in land excavation and grading, with revenue of $44 million in 2015 and $69 million in 2016, paid its CEO a $5 million bonus in both of those years, deducting the payments on its income tax returns as reasonable business expenses under 26 U.S.C. Section 162(a)(1). The Internal Revenue Service (“IRS”) contended that the bonuses were excessive, with the excess amount actually representing a disguised payment of dividends from profits, which could not be deducted. The Tax Court mostly agreed with the IRS and determined that Hood, Inc. could only deduct roughly $3.7 million for 2015 and $1.4 million for 2016 as reasonable amounts for total compensation to its CEO. Accordingly, it assessed tax deficiencies for both years in the total amount of roughly $1.96 million, as well as a penalty for 2016 in the amount of $282,398.
The Fourth Circuit affirmed the Tax Court’s findings with respect to the amount of reasonable deductions and consequent tax deficiency but vacated the imposition of the penalty. The court explained that because the record indicates that Hood, Inc. anticipated remedying Mr. Hood’s past under compensation in installments over multiple years and discussed that plan with its tax advisors, who approved it as reasonable, the court concluded that the Tax Court’s finding regarding the reasonable-cause defense for the 2015 tax year should also have applied to the 2016 tax year. Further, Hood, Inc. used a consistent methodology to determine the amount of Mr. Hood’s bonuses for both 2015 and 2016 with the advice of independent accountants.
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