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JOHN L. FATLAND AND DONITA V. FATLAND, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentFatland v. CommissionerDocket No. 9258-82.
United States Tax Court T.C. Memo 1984-489; 1984 Tax Ct. Memo LEXIS 182; 48 T.C.M. (CCH) 1107; T.C.M. (RIA) 84489; 5 Employee Benefits Cas. (BNA) 2442;September 12, 1984. Paul M. Thielking ,Jack Forsberg ,GERBERMEMORANDUM FINDINGS OF FACT AND OPINION
FINDINGS OF FACT
All of the facts have been stipulated, and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference.
At the time the petition in this case was filed, petitioners John L. Fatland and Donita V. Fatland, *184 was a general partner in a partnership (partnership) organized to conduct a medical practice specializing in urology. As a general partner in the partnership, petitioner provided medical services to the partnership's clients and received his proportionate share of the partnership's net income.
On October 2, 1975, petitioner incorporated a professional corporation, John L. Fatland, M.D., P.C. (corporation), under the State laws of Iowa. The corporation kept minutes of the organizational meeting, annual stockholders' and board of directors' meetings, and special meetings. The corporation had a separate checking account through which all cash expenditures were made. The corporation subscribed to periodicals and paid costs for petitioner's attendance at seminars. In addition, the corporation purchased tangible assets consisting of two calculators, an adding machine, a tape player, office furniture, and medical equipment.
The corporation filed corporate income tax returns reporting the distributive share of the partnership's income attributable to the interest which petitioner held in the partnership in the amount of $104,387.79 in 1977, $98,183.52 in 1978, and $105,561.72 in 1979. *185 *186 the nonprofessional employees and paid the office, lab, and medical expenses. The partnership paid the rent expenses for the partnership office which was also the office of the corporation. The corporation paid no rental expenses. The partnership purchased malpractice insurance during the respective calendar years insuring itself, petitioner, and the other physicians in the partnership's practice. Neither petitioner nor the corporation purchased any malpractice insurance.
The partnership adopted an employee profit-sharing plan covering nonprofessional employees (profit-sharing plan) effective October 2, 1975.The corporation claimed deductions for contributions to the profit-sharing plan of $2,844.30 in 1977, $2,997.19 in 1978, and $2,892.76 in 1979.
A written employment contract and an assignment of interest in the partnership were prepared for the corporation and petitioner contemporaneously with the formation of the corporation, although no documents were executed until sometime after 1979 and subsequent to the commencement of the examination of the petitioner's tax returns. Petitioner rendered no services other than those performed in the partnership's practice. Per the*187 corporate books and records, petitioner received a salary of $60,000 in 1977, $66,000 in 1978, and $75,856.23 in 1979. The corporation withheld Federal and State income taxes from the amounts paid to petitioner and remitted it to the appropriate taxing authorities.
The corporation declared no dividends during the respective years but made nine loans to petitioner totaling $38,532 and evidenced by promissory notes with a stated interest rate of 5-percent per annum. Except for an amount less than $4,000, the loans were not repaid prior to the end of 1979. The corporate books and records reflected these unpaid balances, however, as "notes receivables and loans to officers" and "accrued interest receivable."
During the years in issue, the corporation reported the distributive share of partnership income on its corporate tax return and petitioner reported only the corporate wages on his personal income tax return as income and deducted certain employee business expenses. In the statutory notice of deficiency, the respondent allocated the distributive share of the partnership income reported by the corporation to the petitioner except for certain interest and dividend income reported*188 by the corporation. The respondent took into account the amount reported on petitioner's return as salary received from the corporation but otherwise allocated the corporate deductions, credits, and allowances to the petitioner.
OPINION
The issue for decision is whether the income of petitioner's wholly owned professional corporation is includable in petitioner's tax returns for the taxable years 1977, 1978, and 1979. Respondent argues that, either under
section 482 section 61 , the income received by the professional corporation for petitioner's services to patients should be allocated from the professional corporation to petitioner. Petitioner, on the other hand, contends that neithersection 482 norsection 61 sanctions the allocations made by respondent. We agree with petitioner.Section 482 AllocationSection 482 *189 or more organizations, trades, or businesses which are owned or controlled by the same interests, where it is necessary to prevent evasion of taxes or to reflect the income of each taxpayer's business. The respondent has broad discretion in applyingsection 482 . His determination must be upheld unless petitioner proves respondent abused that discretion, i.e., that the determination is arbitrary, capricious, or unreasonable.Achiro v. Commissioner, 77 T.C. 881">77 T.C. 881Jordan v. Commissioner, 60 T.C. 872">60 T.C. 872514 F.2d 1209">514 F.2d 1209 (8th Cir. 1975);Marc's Big Boy-Prospect, Inc. v. Commissioner, 52 T.C. 1073">52 T.C. 1073452 F.2d 317">452 F.2d 317 (7th Cir. 1971);Ballentine Motor Co. v. Commissioner, 321 F.2d 796">321 F.2d 79639 T.C. 348">39 T.C. 348 (1962);Grenada Industries, Inc. v. Commissioner, 17 T.C. 231">17 T.C. 231202 F.2d 873">202 F.2d 873 (5th Cir. 1953), cert. denied346 U.S. 819">346 U.S. 819 (1953).*190
Section 482 properly applies to the one-man personal service corporation situation.Pacella v. Commissioner, 78 T.C. 604">78 T.C. 604Keller v. Commissioner, 77 T.C. 1014">77 T.C. 1014723 F.2d 58">723 F.2d 58 (10th Cir. 1983).Section 482 will not be sanctioned, however, simply because one purpose for the incorporation was to obtain the benefits of a medical reimbursement plan and pension plan so long as the corporation engages in business activity.Pacella v. Commissioner, supra at 618Keller v. Commissioner, 77 T.C. at 1030In the instant case, respondent does not contend that the corporation is a sham or that it should not be recognized as a separate taxable entity under the doctrine in
Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436section 482 . *192 The rationale of respondent's argument is that, although the corporation is a viable taxpaying entity, petitioner should be taxed on all the income generated by his services because petitioner controlled his wholly owned professional corporation. The facts in this case are substantially identical to those in ourPacella opinion. Accordingly, we reject respondent's argument because the control issue is resolved by our finding that the corporation is engaged in business activity.Pacella v. Commissioner, supra at 618-619This Court has consistently held that
section 482 may be applicable to the situation where a shareholder/employee "controls" his wholly owned professional corporation.Pacella v. Commissioner, supra at 618Keller v. Commissioner, 77 T.C. at 1023-1024Keller v. Commissioner, 77 T.C. at 1023-1024Pacella v. Commissioner, supra at 619Foglesong v. Commissioner, 77 T.C. 1102">77 T.C. 1102691 F.2d 848">691 F.2d 848 (7th Cir. 1982), on remand from621 F.2d 865">621 F.2d 865 (7th Cir. 1980), revg. a Memorandum Opinion of this Court;Rubin v. Commissioner, 56 T.C. 1155">56 T.C. 1155460 F.2d 1216">460 F.2d 1216 (2d Cir. 1972), on remand from429 F.2d 650">429 F.2d 650 (2d Cir. 1970), revg.51 T.C. 251">51 T.C. 251 (1968).As we stated in
Pacella v. Commissioner, supra at 619Foglesong, Foglesong v. Commissioner, 691 F.2d at 852 and621 F.2d at 872 .*196 Second, respondent argues that we must allocate the income to Dr. Fatland because the corporation made loans to Dr. Fatland. We point out, however, that promissory notes were signed and the corporate records reflect any unpaid balances as "notes receivable" and "accrued interest receivable." We believe the actions of the parties in this case accurately reflect the actions of two unrelated parties in making loans.
Third, respondent notes that the corporation's offices were also the offices of the medical partnership and Dr. Fatland's corporation did not pay rent. We recognized in
Keller, as we do here, that the absence of a separate office is not fatal.Keller v. Commissioner, 77 T.C. at 1032Finally, respondent points out that neither petitioner nor his professional corporation purchased malpractice insurance. The partnership purchased the*197 insurance. Under State law, a professional is not insulated from personal liability arising from the performance of professional services even though a professional corporation is formed. *198 and the corporation are separate taxable entities.
We now must consider whether respondent abused his discretion in allocating the income, deductions, and credits from the corporation to petitioner under
section 482 . The relevant inquiry undersection 482 is whether petitioner's professional corporation and petitioner would have entered into their financial relationships had they been unrelated parties dealing at arm's length.Pacella v. Commissioner, supra at 619Keller v. Commissioner, 77 T.C. at 1025Achiro v. Commissioner, supra at 897Ach v Commissioner, 42 T.C. 114">42 T.C. 114358 F.2d 342">358 F.2d 342 (6th Cir. 1966), cert. denied385 U.S. 899">385 U.S. 899 (1966);Foglesong v. Commissioner, 77 T.C. at 1104section 1.482-1(b)(1), Income Tax Regs. If the professional corporation's gross receipts continued to be on par with petitioner's gross receipts in the pre-incorporation years, it is reasonable to assume that petitioner, in an arm's-length transaction with an unrelated party, would have bargained for a total compensation package*199 that would approximate the amounts he previously received as a partner in the partnership.Pacella v. Commissioner, supra at 620Keller v. Commissioner, 77 T.C. at 1025Prior to the years at issue, the corporation's distributive share of partnership income was $97,686.48 in 1976 and $91,250.96 *200 would have received approximately $20,000 more in cash than he received after incorporation.
As recognized in
Pacella v. Commissioner, supra at 621Keller v. Commissioner, 77 T.C. at 1028section 482 allocation as being arbitrary.Pacella v. Commissioner, supra ; Ballentine Motor Co. v. Commissioner, 321 F.2d 796">321 F.2d 796Section 61 Assignment of IncomeRespondent next argues that if we decline to allocate any of the professional corporation's income to Dr. Fatland under
section 482 , we must assign income to petitioner undersection 61 . We decline to do so. *202 The effect of assigning income undersection 61 is to hold that the personal service corporation is a sham.section 482 and notsection 61 applies to the professional medical service corporation situation. In addition, two circuits have reversed this Court where we have sought to apply the common law doctrine of assignment of income. Keller v. Commissionersection 269A . *203Decision will be entered for the petitioners. Footnotes
*. By order of the Chief Judge, this case was reassigned from Judge Darrell D. Wiles to Judge Joel Gerber↩ for disposition.
1. Donita V. Fatland is a petitioner solely because she filed joint returns with her husband. Therefore, reference to petitioner in the singular will be to Dr. John L. Fatland.↩
2. Minor inconsistencies exist between the numbers used in the stipulation of facts, statutory notice of deficiency, and attached exhibits. We assume that the numbers used in the stipulation of facts are transposed for 1979 and 1977. These inconsistencies do not affect the outcome of this case.↩
3. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years in question.↩
4. SEC. 482.ALLOCATION OF INCOME AND DEDUCTIONS AMONG TAXPAYERS.
In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businessess, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.↩
5. Respondent announced in
Rev. Rul. 70-101, 1 C.B. 278">1970-1 C.B. 278 , that professional corporations organized and operated under the State professional corporation statutes enumerated therein would be recognized as corporations for Federal income tax purposes. See alsoRev. Rul. 70-455, 2 C.B. 297">1970-2 C.B. 297 , that makesRev. Rul. 70-101 applicable to corporations organized under the Iowa Professional Corporations Act.Rev. Rul. 70-101↩ states that its holding is limited to the issue of the proper classification of professional corporations and that nothing therein "is to be construed as waiving the assertion of any issues against such organizations other than that of classification."6. Some commentators question whether it is appropriate to apply
sec. 482 in the case of a sole shareholder who renders services to his corporation where the shareholder could perform the services as a single business without the corporation. Fuller,Section 482 Revisited, 31 tax L. Rev. 475, 480 (1976); Seieroe & Gerber,Section 482 --Still Growing at the Age of 50,46 Taxes 893">46 Taxes 893 , 896 (1968). For the proposition thatsec. 482 may represent the end of the professional service corporation, see McFadden,Section 482 and the Professional Corporation: The Foglesong Case,8 J. Corp. Tax 35 (1981) ; Feuer,Section 482 , Assignment of Income Principles and Personal Service Corporations,59 Taxes 564">59 Taxes 564 (1981); Burdett, Foglesong'sSec. 482 Approach May Threaten Closely-Held Personal Service Corporations,53 J. Tax 330↩ (1980) .7. The issue usually revolves around whether "two organizations, trades, or businesses" exist to warrant application of
sec. 482 . This Court inKeller v. Commissioner, 77 T.C. 1014">77 T.C. 1014723 F.2d 58">723 F.2d 58 (10th Cir. 1983), noted that the legislative history of the predecessor ofsec. 482 suggests that the terms "trade," "business," and "organization" are to be broadly construed, and that "the regulations promulgated undersection 482 are broadly written so as to cover any type of entity or enterprise which has independent tax significance." See cases, regulations, and legislative history cited inKeller v. Commissioner, 77 T.C. at 1023-1024↩8. This Court in
Keller noted thatWhipple v. Commissioner, 373 U.S. 193">373 U.S. 193Rubin v. Commissioner, 56 T.C. 1155">56 T.C. 1155460 F.2d 1216">460 F.2d 1216 (2d Cir. 1972), on remand from429 F.2d 650">429 F.2d 650 (2d Cir. 1970), revg.51 T.C. 251">51 T.C. 251 (1968), did not require a contrary view. The issue inWhipple was whether an individual shareholder's devoting of time and effort to his corporation as an investor (and not as an employee) constitutes a business for purposes of the bad debt deduction. Here, as inKeller, part of petitioner's expected financial return was as an employee and was not "income, profit or gain in the form of dividends or enhancement in the value of an investment."Whipple v. Commissioner, supra at 202Borge v. Commissioner, 405 F.2d 673">405 F.2d 673395 U.S. 933">395 U.S. 933 (1969); andAch v. Commissioner, 42 T.C. 114">42 T.C. 114358 F.2d 342">358 F.2d 342 (6th Cir. 1966), cert. denied385 U.S. 899">385 U.S. 899 (1966). This Court inRubin v. Commissioner, 56 T.C. at 1161Borge v. Commissioner, supra , andAch v. Commissioner, supra ,↩ for the proposition that principles may be used to the limited extent of supporting the existence of a trade or business on the part of a shareholder who purportedly acts as a corporate employee in conducting his business affairs.9. The Seventh Circuit in
Foglesong v. Commissioner, 77 T.C. 1102">77 T.C. 1102691 F.2d 848">691 F.2d 848 (7th Cir. 1982), on remand from621 F.2d 865">621 F.2d 865 (7th Cir. 1980), revg. a Memorandum Opinion of this Court, held that the Tax Court improperly appliedsec. 482 (in77 T.C. 1102">77 T.C. 1102↩ ).However, because of the decision we reach in this case, we need not decide whether to follow the decision of the Seventh Circuit.10. The Seventh Circuit in
Foglesong v. Commissioner, 691 F.2d at 852, distinguished the Second Circuit'sRubin v. Commissioner decision (460 F.2d 1216">460 F.2d 1216 ) with respect to the exclusivity issue because the taxpayer inRubin↩ performed more than $25,000 worth of other work unrelated to the work for his controlled corporation.11.
Iowa Code Ann. sec. 496A.1↩ et seq. (West 1962).12. This figure results from multiplying $22,812.74 by 4. The $22,812.74 represents the partnership's distributive share from Oct. 2 to Dec. 31, 1975 (i.e., one-fourth of the year).The record does not reflect what Dr. Fatland's distributive share was before Oct. 2, 1975.↩
13. This Court in
Pacella v. Commissioner, 78 T.C. 604">78 T.C. 604Keller v. Commissioner, 77 T.C. at 1028↩14. A footnote in
Keller v. Commissioner, 77 T.C. at 1028Section 482 and the Aftermath of Foglesong: The Beginning or the End for the Personal Service Corporation,15 Ind. L. Rev. 639">15 Ind. L. Rev. 639 , 664↩ (1983).15. While respondent argues that a finding that a corporation is not a sham does not preclude reallocation under the assignment of income doctrine citing
Wilson v. United States, 530 F.2d 772">530 F.2d 772W.D. Mo. 1974, 34 AFTR 2d 74-5719, 74-2 USTC par. 9646), that case is distinguishable because the issue involved inWilson was not whether assignment of income applied to a viable professional corporation but rather whether there was sufficient evidence to overcome a directed verdict. But seeRoubik v. Commissioner, 53 T.C. 365">53 T.C. 365Roubik↩ was a sham.16.
Pacella v. Commissioner, supra ; Keller v. Commissioner, supra.↩ 17.
Foglesong v. Commissioner, 621 F.2d 865">621 F.2d 865Rubin v. Commissioner, 429 F.2d 650">429 F.2d 650↩18.
Sec. 61 has been used to attribute income to a controlling shareholder where corporate formalities have not been observed and the corporation was not treated as a separate taxable entity that carried on a business activity.Roubik v. Commissioner, supra ; Bailey,supra at 671; McFadden,supra at 36. As McFadden,supra at 40, stated: "there is no way to carry out the logic ofLucas v. Earl [281 U.S. 111">281 U.S. 111sec. 61 still has some viability in the personal service context after the reversal inFoglesong v. Commissioner, 691 F.2d 848">691 F.2d 848Section 269A ,10 J. Corp. Tax 65, 66 (1983) ↩.19. In a footnote, Judge Wilbur's dissent in
Keller v. Commissioner, 77 T.C. at 1045sec. 482↩ will be inadequate, and the decision today to so lightly discard the assignment of income doctrine will come home to roost."20. Although not effective for the taxable years in question, sec. 250 of the Tax Equity and Fiscal Responsibility Act of 1982 (Pub. L. 97-248, 96 Stat. 324) enacted
sec. 269A .Sec. 269A provides:SEC. 269A . PERSONAL SERVICE CORPORATIONS FORMED OR AVAILED OF TO AVOID OR EVADE INCOME TAX.(a) General Rule.--If--
(1) substantially all of the services of a personal service corporation are performed for (or on behalf of) 1 other corporation, partnership, or other entity, and
(2) the principal purpose for forming, or availing of, such personal service corporation is the avoidance or evasion of Federal income tax by reducing the income of, or securing the benefit of any expense, deduction, credit, exclusion, or other allowance for, any employee-owner which would not otherwise be available,
then the Secretary may allocate all income, deductions, credits, exclusions, and other allowances between such personal service corporation and its employee-owners, if such allocation is necessary to prevent avoidance or evasion of Federal income tax or clearly to reflect the income of the personal service corporation or any of its employee-owners.↩
Document Info
Docket Number： Docket No. 9258-82.
Citation Numbers： 48 T.C.M. 1107, 1984 Tax Ct. Memo LEXIS 182, 5 Employee Benefits Cas. (BNA) 2442, 1984 T.C. Memo. 489
Filed Date： 9/12/1984
Precedential Status： Non-Precedential
Modified Date： 11/20/2020