Under the independent investor test, all the other factors are examined from the perspective of an independent

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Under the independent investor test, all the other factors are examined from the perspective of an independent investor. This requires an analysis of the return on equity (ROE) of the taxpayer-corporation (where the employee-shareholder receiving the compensation in issue also controls that taxpayer) from the perspective of a hypothetical independent investor. The taxpayers expert contended that an independent investor would be satisfied with the 43.82 percent compounded annual rate of return he calculated was enjoyed through the year ended July 31, 1996, on that investors initial $10,000 investment in the corporation. The Court noted that under the independent investor test, a companys annual ROE usually examines that companys net income after taxes for that year. More importantly, the shareholders equity in the company, upon which an annual return is calculated, includes not just the shareholders initial invested capital but the companys prior accumulated earnings. The Court found that, regardless of which approach was used to calculate the taxpayers return on equity, for the 1996 fiscal year in issue, the taxpayer suffered a negative ROE even before consideration of the taxpayers deferred compensation obligation to Mr. and Mrs. Myers.

For that year, even before consideration of its future deferred payment obligation to Mr. and Mrs. Myers, the taxpayer had a $61,904 net loss after taxes, suffered a negative ROE (ranging from a negative 11.58 percent return to a negative 16.35 percent return), and experienced a $155,901 reduction in its equity or net asset value (i.e., its $534,443 of equity at the beginning of the 1996 fiscal year, less its $378,542 year-end equity). Therefore, the Court concluded that an independent investor would not be happy with the taxpayers financial performance for its 1996 fiscal year, especially where the total officer compensation paid to Mr. and Mrs. Myers for that year was almost three times the investors year-end equity in the company ($1,113,800, divided by $378,542). This factor favored the IRS.