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Exacto Spring Corp. v. Commissioner

United States Court of Appeals for the Seventh Circuit
196 F.3d 833 (1999)


Facts

Exacto Spring Corp. (Exacto) (plaintiff) was a closely held corporation in the business of manufacturing precision springs. Exacto paid one of its cofounders a salary of $1.3 million in 1993 and $1 million in 1994. This cofounder, in addition to being the principal owner of Exacto, also operated as the chief executive officer, chief manufacturing executive, chief research and development officer, and chief sales and marketing executive. Exacto’s investors received larger dividends than anticipated during 1993 and 1994, expecting a 13 percent return but actually receiving a return of more than 20 percent. Exacto deducted the cofounder’s salaries as business expenses on its 1993 and 1994 federal tax returns. The commissioner of internal revenue (commissioner) (defendant) determined that the salaries were too high and that a large portion was actually a dividend taxable to Exacto. Exacto filed a petition challenging the commissioner’s determination in the United States Tax Court. The tax court applied a seven-factor test and held that a large portion of the salaries was reasonable, but that the remaining portion was still a dividend. Exacto appealed.

Rule of Law

Issue

Holding and Reasoning (Posner, C.J.)

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