John Menard is Worth More than CEOs of Home Depot and Lowes…

The case of John Menard and the Tax Court’s finding that his compensation was not reasonable in T.C. Memo. 2004-207 has been troubling to many for quite a while, since the Court found that since Mr. Menard was paid more than the CEOs for Home Depot and Lowe’s, his compensation was unreasonable even though, even after his salary was paid, the return to shareholders on the value of their investments was greater than either of those publicly traded companies. John’s argument that he was worth more because he objectively did better didn’t sit well with the Tax Court.

It turns out that the Seventh Circuit Court of Appeals found John’s argument much more convincing, and had some rather caustic comments about the Tax Court’s original opinion, in the end finding that the Tax Court had committed clear error in finding that the $20.6 million salary paid to John Menard was excessive. The Seventh Circuit specifically ridculed the hoops the Tax Court jumped through trying to come up with the reasonable salary in trying to find some rhyme or reason for the amounts paid to the CEOs of Home Depot and Lowes, eventually describing the process to include “arbitrary as well as dizzying” adjustments.

The Court noted that the Tax Court had failed to include the entire compensation packages of the publicly traded company CEOs when making its comparison. The Circuit also rejected the Tax Court’s theory that Mr. Menard, as the owner o the company, had “all the incentive he needs to work hard, without the spur of a salary” siding with the Fifth Circuit’s view on this matter in two cases, and commenting unfavorably on a Tenth Circuit case that suggested support for the Tax Court’s position.

The Seventh Circuit specifically noted that a failure to pay a dividend in and of itself does not show that part of the salary must have been a concealed dividend. The Court noted that the bonus arrangement the company had in place (and from which most of the $20 million plus in compensation arose from) that paid a flat 5% of profits would have caused John’s salary to be substantially less than that paid to the other CEOs if the company lost money, and the fact it was paid at year end was simply when it had to be paid—once earnings were known.

While not necessarily giving us the final word on reasonable compensation for C corporation shareholders, this does bolster the view that a showing of a strong return to “pure” equity holders is a strong defense against IRS reasonable compensation attacks.