OPINION
This case stems from a bonus-characterized by the taxpayer itself as “unusually high”-paid to the president of a closely held, single-shareholder corporation. The taxpayer, LabelGraphics, Inc., (“Label-Graphics”) appeals the Tax Court’s decision that only $406,000 of the $878,913 paid to its president, Lon D. Martin (“Martin”), in fiscal year 1990, was reasonable compensation and therefore deductible as an ordinary and necessary business expense. We must determine whether the Tax Court appropriately applied the five-factor test established in
Elliotts, Inc. v. Commissioner,
BACKGROUND
LabelGraphics is an Oregon corporation that produces pressure-sensitive identification materials such as product labels and graphic overlays. The company specializes in sales to electronics and high-technology companies, but also offers retail typesetting services.
Martin, LabelGraphics’s president, started the company as a sole proprietorship in 1978 and incorporated it in 1980. During the tax year in question (fiscal year ending June 30, 1990), Martin was the corporation’s sole shareholder. Two years later Martin sold all of his shares to his son.
Despite its relatively small size, Label-Graphics has been very successful and has enjoyed a strong reputation as an innovator in the industry. During the company’s first eight fiscal years (1981-88), its annual gross receipts increased significantly each year. Receipts declined slightly over the next two years, but this was expected due to market conditions. Fiscal year 1990 was the first year that the company sustained a net loss after taxes. Specifically, the company had a negative return on equity for that year (6.19%), although its cumulative return on equity was still impressive (36.05%).
During 1989 and 1990, LabelGraphics developed its Micro Clean 100 proprietary process (“MC 100 process”) for producing labels meeting the “clean room” production facility standards of its electronics industry customers. Martin played a leading role in the substantial research and development that led to the creation of the MC 100 process. With this process, La-belGraphies became the first company to produce contaminant-free labels. By June 1990, the company’s directors anticipated that the MC 100 process would be highly successful and their prediction ultimately proved to be correct.
At that time, LabelGraphics employed 58 people. The board of directors consisted of Martin, Joan Martin (Martin’s wife), and Jerry Crispe. Joan Martin and Crispe were also LabelGraphics’s other two officers (secretary and executive vice president, respectively). Neither had substantial experience in the label and printing industry before working for Label-Graphics. Martin’s son, Mike, also worked for the company.
In short, Martin was the “heart” of this company. During 1990, his duties included: (1) setting corporate policy; (2) establishing and monitoring quality control and authorizing resources to ensure compliance; (3) maintaining external relationships; (4) directing the investment of funds; (5) directing employee policies; (6) establishing mission statements; (7) coordinating relationships with competitors, suppliers, and consultants to establish cor *1094 porate goals; (8) chairing all board meetings; (9) approving departmental strategy; and (10) reviewing and approving all capital expenditures. From 1988 to 1990, Martin also devoted some of his time to an unrelated printing venture in Puerto Rico.
Martin’s compensation consisted of a salary and bonus. He received no stock options or royalties. In contrast to the board-adopted formulas for determining the bonuses of Crispe and Mike Martin, the company had no fixed formula for determining Martin’s bonus; rather, the directors generally considered the company’s performance over the past year.
For fiscal year 1990, the year the MC 100 process was developed, Martin’s salary was $156,000 and he received a bonus of $722,913, a figure that was substantially higher than all previous bonuses:
Year Salary Bonus Total Compensation
1985 $154,000 $150,000 $304,000
1986 156,600 125,000 281,600
1987 156,600 125,000 281,600
1988 185,000 250,000 435,000
1989 158,200 200,000 358,200
1990 156,000 722,913 878,913
1991 156,000 156,000
In this regard, the board minutes reflected a
[bjonus to Lon D. Martin. Once again, the corporation has enjoyed a successful and profitable fiscal year. The Directors recognize that this success continues to be due in large part to the efforts and expertise of President, Lon D. Martin. In light of this recognition and the fact that Mr. Martin’s base salary has been continued at the same level for several years, the Directors unanimously agreed to pay Mr. Martin a total bonus of $722,913.00. This bonus is to be paid by the corporation’s forgiving a debt of $82,566.00 due from Mr. Martin to the corporation and by paying the balance of $640,347.00 in cash to Mr. Martin.
Also, for the first time, the board paid a bonus to Joan Martin and paid an additional bonus (in excess of the formula) to Mike Martin. LabelGraphics deducted these bonuses on its FY 1990 corporate tax return as reasonable compensation for services rendered.
The Commissioner sent a deficiency notice to LabelGraphics that, in pertinent part, disallowed $633,313 of Martin’s total compensation as a deductible reasonable business expense. On appeal, the Tax Court found that the Commissioner correctly determined that the full amount was not reasonable compensation, but that the Commissioner overstated the excess. Accordingly, the court held that LabelGraph-ics was entitled to a $406,000 deduction ($156,000 as salary and $250,000 as a bonus) as reasonable compensation to Martin. La
belgraphics, Inc. v. Commissioner,
STANDARD OF REVIEW
This case turns on the standard of review applicable to the Tax Court's decision. Although we review de novo the Tax Court’s definition of the factors for determining the reasonableness of compensation,
Elliotts,
DISCUSSION
This case presents the classic tension between characterization of payments as employee compensation, which is deductr ible, and characterization of payments as a dividend, 2 which is not deductible. As we noted in Elliotts,
[i]t is likely to be in the interests of both the corporation and the shareholder-employee to characterize any payments to the shareholder-employee as compensation rather than dividends. For this reason, a taxpayer’s characterization of such payments may warrant close scrutiny to ensure that a portion of the purported compensation payments is not a disguised dividend.
The question here is whether the Tax Court clearly erred in finding that $406,000 of Martin’s 1990 salary and bonus was reasonable, deductible compensation and excluding the remaining $472,913 of his bonus. We hold that the Tax Court’s finding was not clearly erroneous.
Under section 162(a)(1) of the Internal Revenue Code, a corporation may deduct “a reasonable allowance for salaries or other compensation for personal services actually rendered.” I.R.C. § 162(a)(1). “When payments are made to an individual who is both a corporate employee and a principal shareholder, a two-prong test is applied to determine whether the distribution is truly compensatory. First, the amount of compensation must be reasonable; second, the payment must be purely for services, or have a purely compensatory purpose.”
O.S.C. & Assocs., Inc. v. Commissioner,
In
Elliotts,
we set out five broad factors that are relevant to the reasonableness inquiry: (1) the employee’s role in the company; (2) a comparison of the employee’s salary with those paid by similar companies for similar services; (3) the character and condition of the company; (4) potential conflicts of interest; and (5) evidence of an internal inconsistency in a company’s treatment of payments to employees.
During the relevant time period, Martin was the sole shareholder of LabelGraphics. This makes the compensation/dividend determination especially difficult. As explained in
Elliotts,
“[n]ot only is a sole shareholder likely to have complete control over the corporation’s operations, he will also be the only recipient of its dividends.”
We turn now to the Tax Court’s application of the Elliotts factors.
1. The employee’s role in the company
When looking at this factor, “[r]ele-vant considerations include the position held by the employee, hours worked, and duties performed, as well as the general importance of the employee to the success of the company. If the employee has received a large salary increase, comparing past duties and salary with current responsibilities and compensation also may provide significant insights into the reasonableness of the compensation scheme.”
Elliotts,
The Tax Court recognized Martin’s pivotal position in the corporation. Martin played multiple management roles ranging from plant design to marketing. 3 He was instrumental in the development of the MicroClean 100 process. The court concluded, however, that Martin’s role as the “driving force” in the company did not weigh in favor of a bonus almost three times greater than previous bonuses. 4 Indeed, the Tax Court found that except for the earliest years (1980 and 1981), Martin was very well compensated. Prior to the striking spike in 1990, Martin’s total compensation between 1984 and 1989 ranged between $281,600 and $435,000. The year following the 1990 bonus, which Label-Graphics itself characterized as “unusually high” and an “extraordinary one time” bonus, Martin was paid $156,000 in salary and no bonus:
Year Total Compensation
1984 $352,200
1985 304,000
1986 281,600
1987 281,600
1988 435,000
1989 358,200
1990 878,913
1991 156,000
As illustrated above, 1990 was truly “off the charts.”
One rationale often advanced for an extraordinary increase in compensation is that the compensation “makes up” for past undercompensation. This remedy, it is argued, is a factor to be considered in the reasonableness of compensation. Here, however, no evidence suggested that the compensation package was intended to remedy prior undercompensation or that Martin had taken on any additional roles or duties in 1989 or 1990. LabelGraphics correctly maintains that prior undercom-pensation is not the sine qua non of a significant increase in compensation. The Tax Court did not, however, treat it as such. Rather, the court properly recognized that when relevant, an intention to remedy prior undercompensation can weigh in favor of reasonableness.' This is not such a case and the Tax Court gave little weight to the conclusory claim of undercompensation offered by Martin’s expert because no analysis or explanation supported the claim.
5
Finally, the Tax
*1097
Court noted that “any possible earlier un-dercompensation by petitioner of Mr. Martin was likely remedied long before 1990.”
Labelgraphics,
Neither the Board’s minutes nor any other evidence indicates that the uncharacteristically large bonus was directly tied to the development of the MC 100 process (which at that point had yet to prove successful). Although a closely held corporation’s failure to document actions is neither uncommon nor generally looked upon dis-favorably,
see Levenson and Klein, Inc. v. Commissioner,
2. A comparison of the employee’s salary with those paid by similar companies for similar services
“It is, in general, just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises under like circumstances.” Treas. Reg. § 1.162 — 7(b)(3). The Tax Court was well within its authority as fact-finder in giving little weight to LabelGraphics’s two experts regarding the comparable companies factor.
See Alpha Medical, Inc.,
LabelGraphics maintains that there is a “dearth of comparable companies” and that this presents a question of first impression in this Circuit, namely how to apply this factor in such a situation. We hold that, to the extent this factor favors neither party, it is treated as neutral.
See Alpha Medical, Inc.,
Finally, the Tax Court also found that “[ajlthough Mr. Martin may have performed some of the duties and functions of four ... executives, he did not perform work equal to the full-time services of four such executives.”
Labelgraphics,
3. The character and condition of the company
“The focus under this category may be on the company’s size as indicated by its sales, net income, or capital value. Also relevant are the complexities of the business and general economic conditions.”
Elliotts,
*1099 4. Potential conflicts of interest
Elliotts instructs that
[t]he primary issue within this category is whether some relationship exists between the taxpaying company and its employee which might permit the company to disguise nondeductible corporate distributions of income as salary expenditures deductible under section 162(a)(1). Such a potentially exploitable relationship may exist where ... the employee is the taxpaying company’s sole or controlling shareholder....
Because Martin was the sole shareholder, “the sort of relationship existed that warrants scrutiny.... In such a situation ... it is appropriate to evaluate the compensation payments from the perspective of a hypothetical independent shareholder.” Id. at 1246-47. Considering that LabelGraphics suffered a net loss of $98,639 in fiscal year 1990, resulting in a negative return on equity of 6.19%, the Tax Court concluded that an independent investor would not be satisfied with the bonus paid to Martin. The court rejected the argument that such an investor would be satisfied because the company still boasted a cumulative return on equity of 36.05%. 10
Pointing to a footnote in
Elliotts,
Label-Graphics argues that a negative return on equity for the year in question should not always be accorded so much weight: “It should be noted that there are. situations in which the compensation paid to employees is reasonable and yet the corporation may suffer a loss or an inadequate return on equity.”
Elliotts,
But this statement in
Elliotts
is merely dicta and simply underscores the fact-specific nature of the reasonableness inquiry. Construed in context, the focus in this portion of the
Elliotts
opinion was on the Tax Court’s failure to
consider
the rate of return on equity during the years that the challenged compensation was paid.
See
5. Evidence of an internal inconsistency in a company’s treatment of payments to employees
Elliotts
cautions that “[b]onuses that have not been awarded under a structured, formal, consistently applied program generally are suspect.... Similarly, salaries paid to controlling shareholders are open to question if, when compared to salaries paid to non-owner management, they indicate that the level of compensation is a function of ownership, not corporate management responsibility.”
The Tax Court found that Martin’s 1990 bonus “represented a departure from [Taxpayer’s] normal annual bonus practice,”
Labelgraphics,
CONCLUSION
The Tax Court carefully applied the five factor
Elliott
analysis and found that Martin’s total compensation for fiscal year 1990 was unreasonable. In so doing, the court fulfilled its obligation to “spell out its reasoning and to do more than enumerate the factors and leap to a figure intermediate between petitioner’s and the Commissioner’s.”
Leonard Pipeline Contractors, Ltd.,
AFFIRMED.
Notes
. Notably, from its incorporation through January 1, 1992, the company paid no formal dividends.
. LabelGraphics’s expert testified that "[i]t's not uncommon to see a combination of VP of sales and marketing. It's very uncommon to see the breadth and skill set both strategically and tactically that we identified in the case of Lon Martin. He basically has been able to keep a very lean organization at the executive level in place over a sustained period of time.”
. This conclusion was well-founded. As the Fifth Circuit explained in a case involving two executives who filled a variety of roles and who were directly responsible for the "remarkable growth and profitability” of their companies, “limits to reasonable compensation exist even for the most valuable employees.”
Owensby & Kritikos, Inc. v. Commissioner,
. Because this case does not turn on the need to remedy prior undercompensation, Label-Graphics’s heavy reliance on the Sixth Circuit’s decision in
Alpha Medical, Inc. v. Commissioner,
.The Tax Court rejected LabelGraphics's argument that the compensation was reasonable in part because Martin did not receive any stock options. As the court explained, "[mjoreover, even if he were not petitioner's sole shareholder, we are skeptical that Mr. Martin, prior to and during the 1990 fiscal year, in addition to the salary and bonus he had already received, would also have been compensated by petitioner with stock options .... Mr. Martin generally does not appear to have been undercompensated in prior years. Also, we have no way of knowing the specific stock options petitioner’s experts believed Mr. Martin, hypothetically, should have otherwise received, as they provided no further elaboration in connection with this point.” Labelgraphics, 76 T.C.M. (CCH) AT 526.
We recognize the role that options have come to play in executive compensation, especially in the high technology sector.
See
Randall S. Thomas and Kenneth J. Martin,
The Determinants of Shareholder Voting On Stock Option Plans,
35 Wake Forest L. Rev. 31, 34-35 (2000); Calvin H. Johnson,
Stock Compensation: The Most Expensive Way to
Pay
Future Cash,
52 S.M.U. L. Rev. 423, 424 (1999);
see also Kennedy v. Commissioner,
. We also recognize that in certain circumstances royalties are an appropriate form of executive compensation.
See PMT, Inc. v. Commissioner,
. Specifically, the Tax Court found that:
Culbertson and Jones failed to offer any details concerning the specific high-technology companies upon which they based their *1098 opinions. They also offered no specifics on the particular executives involved, nor pertinent information on their particular qualifications and skills and the exact compensation they received. We thus are unable to determine: (1) How similar these other unidentified companies and their businesses are to petitioner; and (2) how similar the services their executives rendered are to the services Mr. Martin performed.
Labelgraphics,
. The Tax Court also declined to accept the opinion of the Commissioner's expert (Clau-sen), explaining that he used companies that were not reasonably comparable to Label-Graphics and failed to take into account stock options granted to the chief executive officers of two of those companies. Contrary to La-belGraphics’s assertion, the Tax Court’s recognition that Clausen failed to look at stock options does not reflect an internal inconsistency in its treatment of stock options. The court simply concluded that: (1) there was not sufficient evidence that Martin would have received options, and (2) when comparing Martin’s compensation with that of other CEOs who did receive options, the options must be considered as part of the compensation packages being used for comparison.
. LabelGraphics also points out the success that it has enjoyed since 1990, due in large part to the MC 100 process. The Tax Court did recognize this later success: “In years after 1990 and 1991, the labels were probably the single most important factor in spurring petitioner to even greater sales and profitability.”
Labelgraphics,
.
Cf. Donald Palmer Co. v. Commissioner,
. The Tax Court did not consider the salaries of the other executives. Had the court done so, its conclusion likely would have been bolstered.
See Owensby & Kritikos, Inc.,