J.K. Lasser's Small Business Taxes 2013: Your Complete Guide to a Better Bottom Line

Disallowance Repayment Agreements

If you are an employee of a corporation you own and a portion of your salary is viewed as unreasonable, the corporation loses its deduction for the payment. You are taxed on the payment in any event—either as compensation or as a constructive dividend. However, there is a way you can ensure that the corporation does not lose out if the IRS later characterizes its compensation deduction as partially unreasonable: You can enter into a disallowance repayment agreement.

The repayment agreement provides that if certain payments to you by the corporation are disallowed by the IRS, you are required to repay such amounts to your corporation. The agreement must be in writing and enforceable under local law. The agreement should be reflected not only in a separate written agreement between you and your corporation, such as part of your employment contract with the corporation, but also in the corporate minutes as a resolution of the board of directors. The bylaws of the corporation should also reflect the ability of the board to enforce the agreement.

Effect of the Repayment Agreement

The repayment agreement is a way for you to offset dividend income you are required to report if the IRS considers payments to you to be constructive dividends. By virtue of the repayment agreement, you are entitled to deduct the amounts you are contractually required to repay to your corporation as a miscellaneous itemized deduction on your personal return in the year repayment ...