                IN THE UNITED STATES COURT OF APPEALS
                        FOR THE FIFTH CIRCUIT



                            No. 95-60381
                         (Summary Calendar)




DONALD PALMER COMPANY, INCORPORATED

                                              Petitioner - Appellant,

                               versus


COMMISSIONER OF INTERNAL REVENUE

                                              Respondent - Appellee.




               Appeal from the United States Tax Court
                              (24901-92)


                            April 1, 1996




Before WIENER, PARKER and DENNIS Circuit Judges.

PER CURIAM:*

     In this federal income tax case, Petitioner-Appellant David



     *
      Pursuant to Local Rule 47.5, the court has determined that
this opinion should not be published and is not precedent except
under the limited circumstances set forth in Local Rule 47.5.4.
Palmer Company, Inc. (Petitioner) appeals a decision by the United

States Tax Court that a portion of the compensation paid to its

president    and   sole   shareholder   was     unreasonable    and    thus

nondeductible as an expense of the corporation.       Finding no error,

we affirm.

                                    I

                          FACTS AND PROCEEDINGS

     Petitioner is a Louisiana corporation engaged in the business

of buying and selling bags and packaging materials.         Incorporated

in 1979 by David Palmer with a capital contribution of $5,000,

Petitioner has consistently grossed several million dollars a year

in sales.    PalmerSQwho has worked in the plastic packaging business

for most of his lifeSQis Petitioner's sole stockholder, as well as

its president and only officer. Palmer is also the one responsible

for Petitioner's success: He works approximately seventy hours per

week, takes little time off, personally generates almost all of

Petitioner's sales, and manages its daily operations.

     In addition to Palmer, Petitioner employs a secretary, a

bookkeeper, and a cleaning person.         Petitioner also employed a

salesperson in 1985 and again in 1987.          In each of those years,

however,     the   individual   employed      accounted   for   only     an

insignificant portion of the total sales and both were discharged

after a short period of employment.

     For the tax year ended June 30, 1990 (1990), Petitioner paid

Palmer compensation of $1,259,979, consisting of $441,446 in salary

                                    2
and a bonus of $818,533.         This appeal concerns the determination,

for tax purposes, of the maximum amount of compensation that is

reasonable for Palmer's services in 1990.

     The following schedule reflects Petitioner's gross receipts,

gross profit, officer's compensation (Palmer's compensation), and

taxable income for most of its history.


Tax
Year         Gross            Gross          Palmer's             Taxable
Ended        Receipts         Profit         Compensation         Income


6/30/82      $2,469,535      $639,742         $150,000        $197,207
6/30/83       2,602,522       707,338          300,000          99,092
6/30/84       3,112,563       693,348          300,000          46,854
6/30/85       3,532,714       801,997          300,000          87,697
6/30/86       2,948,626       666,139          275,000          76,552
6/30/87       3,182,588       725,687          435,000         121,080
6/30/88       3,395,436       708,678          350,000         150,279
6/30/89       4,068,042       801,490          390,000         262,126
6/30/90       4,017,352     1,137,182        1,259,979        (339,417)
6/30/91       4,057,664       884,969          617,113          17,384


In addition to the compensation listed above, Petitioner also made

pension plan contributions for the benefit of Palmer during some of

these years.1       Petitioner has never paid dividends on its stock.

     In     1988,   Petitioner    and   Palmer   entered   into    a   Deferred

Compensation Agreement (Agreement) which provided that Palmer would

receive $16,666 per month for ten years.           These payments were to

begin on the later of the date on which Palmer (1) attained the age

        1
        These pension plan contributions were made during the tax
years ended June 30, 1982 through June 30, 1986 in the following
respective amounts:   $23,239; $90,675; $141,750; $114,300; and
$106,184.

                                        3
of sixty-five years or (2) actually retired. Although no deduction

was taken, Petitioner's federal income tax returns reflected the

accrual of this liability, as follows:




     Tax                  Deferred             Deferred
     Year                 Compensation         Compensation
     Ended                Expense              Liability

     6/30/88              $ 208,013            $ 208,013
     6/30/89                208,012              416,025
     6/30/90                208,012              624,038
     6/30/91                208,013              832,050


The Agreement further provided that Petitioner had no duty to set

aside funds for this obligation owed to Palmer, and payments have

never been made to Palmer pursuant to the Agreement.

     Following an examination of Petitioner's 1990 income tax

return, the Internal Revenue Service (IRS) disallowed the deduction

for the entire $818,533 bonus paid to Palmer, insisting that his

salary   of    $441,446    is   reasonable   compensation    for   his   1990

services.     Petitioner sought relief in Tax Court.        After a trial on

this issue, the Tax Court found that, in addition to Palmer's

salary, $220,723 of the bonusSQan amount equal to one-half of

Palmer's salarySQis reasonable compensation and thus deductible.

     Petitioner now appeals to us, arguing that the Tax Court erred

in its determination of reasonable compensation, as well as in

disposing of two evidentiary issues related to this determination.

                                      II


                                         4
                                   ANALYSIS

A. STANDARD   OF   REVIEW

     The determination of what is reasonable compensation is a

question of fact that is reviewed under the clearly erroneous

standard.2    A finding is clearly erroneous when "although there is

evidence to support it, the reviewing court is left with the

definite and firm conviction that a mistake has been committed."3

     A trial court's admission of evidence is reviewed for abuse of

discretion.4         Challenges   to   rulings   on   expert   testimony   are

reviewed under the manifestly erroneous standard.5

B. REASONABLE COMPENSATION

     A taxpayer is permitted to deduct "a reasonable allowance for

salaries or other compensation for personal services actually

rendered."6 The regulations explain that bonuses paid to employees

are deductible "when such payments are made in good faith and as

additional compensation for services actually rendered by the

employees, provided such payments, when added to the stipulated


      2
        Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d 1315,
1323 (5th Cir. 1987).
      3
        United States v. United States Gypsum Co., 333 U.S. 364,
395, 68 S. Ct. 525, 542, 92 L.Ed. 746 (1948).
      4
        EEOC v. Manville Sales Corp., 27 F.3d 1089, 1092-93 (5th
Cir. 1994), cert. denied, __ U.S. __, 115 S. Ct. 1252, 131 L.Ed.2d
133 (1995).
      5
        Edmonds v. Illinois Cent. Gulf R.R., 910 F.2d 1284, 1287
(5th Cir. 1990).
     6
          26 U.S.C. § 162(a)(1).

                                        5
salaries, do not exceed a reasonable compensation for the services

rendered."7

     The amount of compensation that is reasonable depends on the

facts and circumstances of each case.8         When making this inquiry,

a court must consider a number of factors, including:

     (1)          the employees qualifications;
     (2)          the nature, extent, and scope of the employee's work;
     (3)          the size and complexities of the business;
     (4)          a comparison of salaries paid with gross income and net
                  income;
     (5)          the prevailing general economic conditions;
     (6)          comparison of salaries with distributions to
                  stockholders;
     (7)          the prevailing rates of compensation for comparable
                  positions in comparable concerns;
     (8)          the salary policy of the taxpayer as to all employees;
     (9)          in the case of small corporations with a limited number
                  of officers the amount of compensation paid to the
                  particular employee in previous years.9

No single factor is determinative.10         Rather, the trial court must

consider and weigh the totality of the facts and circumstances in

a particular case when determining reasonable compensation.11

     The taxpayer has the burden to show that it is entitled to a

larger compensation deduction than that allowed by the IRS.12


     7
                Treas. Reg. § 1.162-9.
            8
                 Rutter v. Commissioner, 853 F.2d 1267, 1271 (5th Cir.
1988).
        9
                Id. at 1271; accord Owensby & Kritikos, Inc., 819 F.2d at
1323.
     10
                Owensby & Kritikos, Inc., 819 F.2d at 1323.
     11
                Rutter, 853 F.2d at 1271.
     12
                Owensby & Kritikos, Inc., 819 F.2d at 1324.

                                         6
Moreover, in a situation in which shareholders of a closely held

corporation set their own level of compensation, the reasonableness

of this compensation is subject to close scrutiny.13

     1.    Termination of Deferred Compensation Agreement

     At    trial,   Palmer   testified   that   the   Agreement    had   been

terminated in 1990 to make the corporation more attractive to

potential buyers.      Thus, Petitioner contends, much of the bonus

paid to Palmer in 1990 was not compensation earned in that year,

but rather was payment for deferred compensation earned in 1988 and

1989 but lost when the Agreement was terminated.             Accordingly,

argues Petitioner, the reasonableness of this compensation must be

analyzed with regard to the facts and circumstances of the years in

which it was actually earned.      As the only testimony regarding the

purported termination of the Agreement was Palmer's uncontradicted

testimony, Petitioner insists that the Tax Court's finding that the

Agreement had not been terminated in 1990 is clearly erroneous

because a court may not arbitrarily disregard testimony that is

competent, relevant, credible, and uncontradicted.14

     The only testimony on this issue was Palmer's.               Petitioner

offered no other evidence documenting the alleged termination of

the Agreement in 1990. Moreover, Petitioner concedes that its 1990

federal income tax return did not reflect a termination of the

     13
           Id.
      14
            See Banks v. Commissioner, 322 F.2d 530, 537 (8th Cir.
1963).

                                    7
Agreement.       In fact,      Petitioner's subsequent income tax return

(1991) showed an increase in the deferred compensation liability.

Petitioner's sole effort to explain this incongruence is the

contention that the entries on the tax returns were simply made in

error.      The Tax Court's opinion, however, makes clear that it did

not find this explanation persuasive.                   We therefore conclude that

the Tax Court did not arbitrarily disregard Palmer's testimony.

       Petitioner also contends that the payment of Palmer's bonus

left it      financially     unable     to       meet   its   obligation   under   the

Agreement.       Thus, argues Petitioner, this payment supports its

position that the Agreement was in fact terminated in 1990.                        The

terms of the Agreement, however, did not require any funds to be

set aside for this obligation.               Thus, we are unconvinced that the

payment of this bonus is probative that the Agreement had been in

fact terminated in 1990.            We therefore conclude that the Tax Court

did   not    clearly   err     in    finding       that   the   Agreement    was   not

terminated in 1990.

       2.    Return on Investment of Hypothetical Investor

       In its analysis, the Tax Court also noted that an important

factor      in   determining    reasonable          compensation     is    whether   a

hypothetical investor would have been willing to pay Palmer the

same amount of compensation that he was paid by Petitioner.15                      The

corporation's rate of return on equity is relevant in making this

      15
       See Elliots, Inc. v. Commissioner, 716 F.2d 1241, 1245 (9th
Cir. 1983).

                                             8
assessment.16     As the large bonus paid to Palmer resulted in

negative retained earnings, a taxable loss, and a negative return

on   investment   for   its   shareholders   for   1990,   the   Tax   Court

concluded that an independent investor would not have been pleased

with his investment if he had to compensate Palmer so handsomely.

      Petitioner challenges the Tax Court's analysis by contending

that it had positive "earnings and profits."           Petitioner insists

that the liability for accrued deferred compensation is in the

nature of a reserve for future expenses and thus would not reduce

its earnings and profits.17

      This argument misses the mark.       Earnings and profits is a tax

concept that generally relates to the determination of whether a

distribution from a corporation to its shareholders is properly

treated as a dividend or a return of capital.18         That earnings and

profits may have been positive, however, in no way impugns the Tax

Court's analysis regarding a hypothetical investor's return on

investment.

      Petitioner also insists that a hypothetical investor would

have paid Palmer compensation equal to what he actually received

because otherwise Palmer could have quit. As Petitioner's earnings



      16
           Id.
      17
          See BORIS I. BITTKER & JAMES S. EUSTICE, FEDERAL INCOME TAXATION   OF
CORPORATIONS AND SHAREHOLDERS ¶ 8.04, at 8-31 (6th ed. 1994).
     18
       See 26 U.S.C. §§ 301(c), 316(a); see also Mazzocchi Bus Co.
v. Commissioner, 14 F.3d 923, 927 (3rd Cir. 1994).

                                     9
depend almost exclusively on the services of Palmer and not on

invested capital, a decision by Palmer to quit would have rendered

the corporation virtually worthless.

      Although       these     facts    might      support     a     high    level    of

compensation for Palmer's services, we have made clear that "limits

to   reasonable      compensation       exist     even   for   the    most    valuable

employees."19       We therefore are unconvinced that the Tax Court's

analysis regarding a hypothetical investor is clearly erroneous.

      3.    Application of Factors

      Finally, Petitioner argues that the Tax Court failed to

consider the following factors: the employee's qualifications; the

nature, extent, and scope of the employee's work; the size and

complexities of the business; and Petitioner's financial condition.

Petitioner maintains that these factorsSQas well as the others,

which it concedes were consideredSQfavor its position that all of

Palmer's     compensation        is    reasonable.         Petitioner        therefore

maintains     that     the     Tax    Court's     determination       of    reasonable

compensation for Palmer is clearly erroneous.                  We disagree.

      The     Tax    Court      specifically        recognized        Palmer's       many

contributions to Petitioner, including that he worked long hours,

generated     almost     all     of    the    sales,     and   managed      the   daily

operations. The Tax Court also considered Palmer's compensation in

prior years, as well as the relationship of such compensation to


      19
            Owensby & Kritikos, Inc., 819 F.2d at 1325.

                                             10
Petitioner's sales and gross profit. Although some of the relevant

factors might favor Petitioner's position, the fact that the Tax

Court did      not    conclude   that   the     entire   bonus   was   reasonable

compensation does not mean that these factors were ignored.                To the

contrary, these factors appear to have been not only considered,

but also accorded substantial weight in determining that a bonus

equal to fifty percent of Palmer's salary would be reasonable.

Moreover, the amount of compensation determined by the Tax Court to

be   reasonable      is   consistent    with    the   historical   relationship

between    Palmer's       compensation        and   Petitioner's   performance,

reflecting the fact that Petitioner had one of its best years in

1990.     Our review of the record convinces us that the Tax Court

properly considered all of the relevant factors and that its

determination of reasonable compensation for Palmer's services is

not clearly erroneous.

C. ADMISSION   OF   EMPLOYMENT CONTRACTS INTO EVIDENCE

      Petitioner also contends that the trial court abused its

discretion by admitting into evidence the employment contracts of

two former salespersons who were employed by Petitioner for short

periods of time.          Petitioner explains that these two individuals

performed different functions than Palmer and generated only an

insignificant amount of the total sales.                 Petitioner maintains

that, as the compensation of these two salespersons has little

bearing on the issue of reasonable compensation for Palmer, the

admission of this evidence was an abuse of discretion.                  Again we

                                         11
disagree.

     One of the factors to be considered in determining reasonable

compensation is "the salary policy of the taxpayer as to all

employees."20     Moreover, comparison of the compensation paid to

shareholder-employees with that paid to nonshareholder-employees is

relevant.21     Thus, even though the employment contracts with these

nonshareholder-salespersons might not be entitled to great weight,

they cannot be said to be irrelevant.      We therefore conclude that

the Tax Court did not abuse its discretion by admitting these

employment contracts into evidence.     We note gratuitously that the

Tax Court appears to have accorded little if any significance to

these contracts, and Petitioner has failed to show that it was

prejudiced by their admission.

D. EXPERT WITNESS

          Petitioner also insists that the Tax Court's decision not to

qualify Harold Mollere as an expert witness is manifest error.22

Petitioner maintains that Mollere is qualified to be an expert in

this case, given his experience as a practicing certified public

         20
              Rutter v. Commissioner, 853 F.2d 1267, 1271 (5th Cir.
1988).
     21
        Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d 1315,
1329 (5th Cir. 1987).
      22
         Rule 702 of the Federal Rules of Evidence provides that
"[i]f scientific, technical, or other specialized knowledge will
assist the trier of fact to understand the evidence or determine a
fact in issue, a witness qualified as an expert by knowledge,
skill, experience, training, or education, may testify thereto in
the form of an opinion or otherwise."

                                   12
accountant for thirty-eight years, during which time he reviewed

hundreds of federal income tax returns annually for businesses and

corporations,       and   advised     clients    on     their   compensation   in

connection with their year-end planning.              Petitioner goes further,

suggesting that the Tax Court disqualified Mollere because the IRS

had   no   expert    of   its   own   rather     than    because   of   Mollere's

qualifications.

      We are unpersuaded.       During voir dire, Mollere admitted that

he had not had any specific training in the field of executive

compensation, and that he had never been retained to evaluate a

company's executive compensation policy.                 In addition, the Tax

Court noted that Mollere's report was unhelpful as it merely

summarized his view of the evidence and did not provide sufficient

information to make an intelligent evaluation of his conclusion

that all of Palmer's compensation is reasonable.                   Furthermore,

Petitioner has absolutely no support for its speculation that the

Tax Court's ruling was based on the fact that the IRS had no expert

witness of its own.        Under these circumstances, we conclude that

the Tax Court did not commit manifest error by deciding not to

qualify Mollere as an expert.

                                        III

                                    CONCLUSION

  Based on the foregoing reasons, the judgment of the Tax Court is

AFFIRMED.



                                        13
