Reasonable compensation disputes are usually described as valuation fights. In practice they are documentation fights. The side holding contemporaneous evidence of duties, hours, and market comparables tends to win; the side reconstructing a rationale after the notice arrives tends to lose. The controlling regulation builds this timing into the legal standard itself, which is why the single most important fact about compensation documentation is when it is created.
The regulation puts a clock on it
The circumstances to be taken into consideration are those existing at the date when the contract for services was made, not those existing at the date when the contract is questioned.
Reasonableness is measured as of the date compensation was set. A file assembled at examination time is not just weaker as evidence; it is answering a different legal question than the one the regulation asks. The compliant workflow is therefore prospective: determine the number when you set compensation for the year, write down how you got it, and refresh the determination when the underlying facts or data change.
What the file needs to contain
The factor tests courts apply are public, and they tell you exactly what evidence will be examined. Build the file to answer them in advance.
1. A duties and hours inventory
The nine-factor test that governs most circuits begins with the person and the work: qualifications, and “the nature, extent and scope of the employee’s work” (Mayson Mfg. Co. v. Commissioner, 178 F.2d 115 (6th Cir. 1949)). The Ninth Circuit’s framing opens the same way, with “the employee’s role in the taxpaying company [position, hours worked, duties performed, general importance]” (Elliotts, Inc. v. Commissioner, 716 F.2d 1241 (9th Cir. 1983)). Concretely: list what you actually do, in what proportions, for how many hours a year. An officer who manages, sells, keeps books, and produces is performing several jobs, and a defensible file prices each of them rather than borrowing the title of whichever one sounds cheapest.
2. Market comparability evidence
The standard is what “like enterprises” pay for “like services” under “like circumstances” (Treas. Reg. § 1.162-7(b)(3)), so the core exhibit is occupational wage data matched to your actual duties, industry, and scale. Public Bureau of Labor Statistics Occupational Employment and Wage Statistics series exist for this, publish percentile wage distributions by occupation, and can be aged forward with the Employment Cost Index when the reporting period and the compensation year differ. Data with a citation beats an opinion without one.
3. The corporate and distribution context
The factor lists reach beyond the individual: company size and complexity, salary versus gross and net income, “comparison of salaries with distributions to stockholders,” salary policy toward other employees, and compensation history (Mayson; see also the IRS’s own factor list in Fact Sheet FS-2008-25, which includes dividend history and payments to non-shareholder employees). Keep the financial statements, the distribution record, and the payroll history alongside the wage analysis, because that is the context in which the number will be judged.
4. A multi-framework stress test
Which framework applies depends on where a dispute would be heard. Most circuits weigh multi-factor tests descended from Mayson; the Fifth Circuit applies them through Owensby & Kritikos, with the instruction that “no single factor is decisive”; the Seventh Circuit has replaced factor-counting with the independent investor test outright (Exacto Spring Corp. v. Commissioner, 196 F.3d 833 (7th Cir. 1999)). A position checked against all of the recognized frameworks, including the investor’s-return perspective, is venue-proof in a way that a single-framework rationale is not.
What happens without the file
The Tax Court’s Glass Blocks decision is the cautionary tale in miniature. The owner performed substantial services for no salary, took distributions, and then argued the withdrawals were repayments of shareholder loans. The transfers were undocumented, and the court disposed of the argument on the evidence:
Applying the above factors, we find that the transfers in question were capital contributions and not bona fide loans.
With no loan papers, no wage analysis, and no factor evidence, every characterization question resolved against the taxpayer, and the distributions were deemed wages. The absence of a file is itself a fact, and it is never a helpful one.
Keep it current
Documentation decays. Duties shift, the business grows, and the wage data underneath the analysis is revised on a publication cycle. A determination built on identified data vintages can be refreshed when those sources update; a determination built on “what we did last year” compounds whatever error it started with. The habit that survives scrutiny is the same one the regulation describes: set the number prospectively, on market evidence, and keep the work.