Blossom Day Care Centers, Inc.

T.C. Memo. 2021-86UNITED STATES TAX COURT
BLOSSOM DAY CARE CENTERS, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 3868-12, 3869-12.1 Filed July 13, 2021.
Steven P. Flowers and Nathalie M. Cornett, for petitioner.
William F. Castor and Vassiliki Economides Farrior, for respondent.
1
These cases were consolidated for trial, briefing, and opinion. The subject
of this opinion will pertain to those issues arising out of docket No. 3869-12.
Those issues arising out of docket No. 3868-12 are addressed in Blossom Day
Care Ctrs., Inc. v. Commissioner, T.C. Memo. 2021-87, filed today.
Served 07/13/21
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[*2] MEMORANDUM FINDINGS OF FACT AND OPINION
PARIS, Judge: This case is before the Court on a petition for
redetermination of employment status filed pursuant to section 7436.2 In a notice
of determination of worker classification dated November 14, 2011, respondent
determined that Blossom Day Care Centers, Inc. (petitioner or Blossom), had not
classified its corporate officers as employees for all taxable periods of calendar
years 2005 through 2008. Respondent determined that Barry A. Hacker and
Celeste Hacker (Hackers) were to be legally classified as petitioner’s “employees”
for all taxable periods of calendar years 2005 through 2008 and that petitioner is
not entitled to relief under the Revenue Act of 1978, Pub. L. No. 95-600, sec. 530,
92 Stat. at 2885. Respondent also determined that petitioner is liable for
employment taxes, penalties under section 6656 for failure to deposit tax, and
accuracy-related penalties under section 6662(a) for negligence. Attached to the
notice are schedules setting forth petitioner’s liabilities for (1) Federal Insurance
Contribution Act (FICA) pursuant to sections 3101 and 3111, (2) Federal
Unemployment Tax Act (FUTA) taxes pursuant to section 3301, (3) penalties for
2
Unless otherwise noted, all section references are to the Internal Revenue
Code in effect at all relevant times. All Rule references are to the Tax Court Rules
of Practice and Procedure.
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[*3] failure to deposit tax pursuant to section 6656, and (4) accuracy-related
penalties under section 6662(a) for negligence, summarized as follows:
Penalties
Tax periods Type of tax Amount Sec. 6656 Sec. 6662(a)
3/31 to
12/31/2005 941 $80,686.80 $1,419.36 $16,137.36
2005 940 868.00 86.80 173.60
3/31 to
12/31/2006 941 84,800.20 1,487.38 16,960.03
2006 940 868.00 86.80 173.60
3/31 to
12/31/2007 941 88,852.20 1,545.12 17,770.44
2007 940 868.00 86.80 173.60
3/31 to
12/31/2008 941 93,372.00 1,618.60 18,674.40
2008 940 868.00 86.80 173.60
After concessions,3 the issues for decision are whether: (1) the Hackers
should be legally classified as employees of petitioner such that petitioner is liable
for employment tax (FICA) and unemployment tax (FUTA) relating to wages paid
to the Hackers for all tax periods in 2005, 2006, 2007, and 2008; (2) petitioner is
3
Petitioner does not assert it is entitled to relief under the Revenue Act of
1978, Pub. L. No. 95-600, sec. 530, 92 Stat. at 2885, given the Hackers’ corporate
officer status.
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[*4] liable for FICA and FUTA taxes on the basis of respondent’s determination
that the Hackers had additional wage income from petitioner in 2005, 2006, 2007,
and 2008 of $209,200, $220,210, $231,800, and $244,000, respectively;
(3) petitioner is liable for a failure to deposit penalty under section 6656 with
respect to the FICA and FUTA tax liabilities respondent determined for the
taxable periods from 2005 through 2008; and (4) petitioner is liable for accuracy-
related penalties under section 6662(a) with respect to the FICA and FUTA tax
liabilities determined by respondent for the taxable periods from 2005 through
2008.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The parties filed a
first stipulation of facts and six supplemental stipulations of facts with
accompanying exhibits that are incorporated herein by this reference.
Background
Petitioner was an Oklahoma corporation, originally incorporated in 1986,
with its principal place of business in Tulsa, Oklahoma, at the time the petition
was filed in this case. Petitioner was a valid corporation in the State of Oklahoma
during all periods at issue.
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[*5] Petitioner did business as Blossom Day Care Centers and operated five
child care centers in the Tulsa metropolitan area from 2004 through May 2005 and
six child care centers from May 2005 through December 2008.
At all relevant times and since 1986, the Hackers were petitioner’s only
corporate officers. Mr. Hacker has always served as petitioner’s vice president,
secretary, and treasurer. Mrs. Hacker has always served as petitioner’s president.
There were no other corporate officers. In addition, the Hackers were petitioner’s
sole shareholders, Mrs. Hacker owning 51% and Mr. Hacker owning 49% of
petitioner’s stock.
In October 2002 the Hackers, as sole shareholders, incorporated Hacker
Corp. and had it elect to be taxed as a small business corporation (S corporation)
pursuant to section 1362. Petitioner was not a shareholder in Hacker Corp. In
May 2005 petitioner conveyed to Hacker Corp. by quitclaim deed certain real
estate locations of Blossom Day Care Centers. The Hackers have asserted that the
purpose of Hacker Corp. was to provide property and services management to
petitioner, the only client of the S corporation. On its returns petitioner claimed
deductions of management fees paid to Hacker Corp. in the following amounts in
the years at issue: $342,650 in 2005, $378,484 in 2006, $0 in 2007, and $204,514
in 2008.
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[*6] There is no written agreement as to the purpose of the management fees, but
Hacker Corp. did pay total salary to the Hackers from 2005 through 2008 of
$73,848, $40,000, $53,847, and $58,462, respectively, for services provided to
Hacker Corp., which were arguably for management of petitioner. Petitioner
asserts that whatever services the Hackers performed for Blossom Day Care
Centers were actually provided under a purported oral management agreement
between petitioner and Hacker Corp. for the benefit of Blossom Day Care Center,
and it was not petitioner’s responsibility to provide reasonable compensation to its
corporate officers, the Hackers, for services provided to petitioner.
Involvement of the Hackers
Before petitioner was incorporated, Mrs. Hacker, having received an
associate’s degree in child development, opened her own day care center which in
turn became the basis for the incorporation of Blossom Day Care Centers. From
1986 and through the years at issue, Mrs. Hacker served not only as petitioner’s
president but also as the director of curriculum and education for the 90
employees, students, and six locations for Blossom Day Care Centers. She served
as Blossom’s top manager, personally overseeing and supervising employees,
including hiring and firing and managing Blossom’s six day care directors, with
all of petitioner’s employees ultimately reporting to her.
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[*7] Mr. Hacker, also since 1986 and through all the years at issue, served not
only as petitioner’s corporate vice president but also as its secretary and treasurer.
During the years at issue Mr. Hacker also served as the director of the Blossom
Day Care Centers and as director of accountability and finance for petitioner. Mr.
Hacker had authority over all of petitioner’s bank accounts, and his daily
responsibilities included, but were not limited to, depositing parents’ payments for
child care into petitioner’s bank accounts and personally writing all of the payroll
checks to petitioner’s 90 employees.
Both Mr. and Mrs. Hacker were members of the Oklahoma Child Care
Association, and Mr. Hacker was a member of its board from 2004 through 2008.
This State organization focused on child care issues, working with the Oklahoma
Department of Human Services (ODHS) regarding comments on regulations,
training, and education. Petitioner’s daycare locations were licensed by ODHS,
and the Hackers were responsible for ensuring the programs and employees met
ODHS standards.
During the tax periods at issue, 2005 through 2008, the Hackers controlled
all of petitioner’s child care policies and education, and coordinated all physical
location and program maintenance decisions. Both actively participated in
petitioner’s daily operation, frequently working 50 to 60 hours per week at all
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[*8] levels, including those duties described above, as well as paperwork and front
office duties, classroom teaching and supervision of teachers, purchasing and
delivering food for petitioner’s child care programs, and even maintenance and
custodial duties, if needed.
Wages, Salary, or Other Compensation of Mr. and Mrs. Hacker
Petitioner did not report paying a salary or wages to either Mr. or Mrs.
Hacker on its Forms 1120, U.S. Corporation Income Tax Return, for tax years
2005 through 2008. It did report paying compensation to officers of $100,000 in
2006, but not for the other years at issue.4 In addition, petitioner maintained
vehicles titled in the Hackers’ names including loan payments and maintenance for
a 2000 Lexus and a 2003 Hummer. Petitioner claimed depreciation for those autos
on its corporate tax returns for 2005 through 2008. In addition, petitioner
maintained vehicles it did not own, for the benefit of the Hackers’ children and a
parent and a sibling. Petitioner provided multiple credit cards in the names of Mr.
Hacker and Mrs. Hacker and for their children. Petitioner paid personal
expenditures for their benefit that were not petitioner’s business expenses.
4
The parties agree that petitioner made no actual cash payments to its
corporate officers as compensation during 2006.
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[*9] Petitioner did pay salaries and wages to its other employees and did file
timely Forms 941, Employer’s Quarterly Federal Tax Return, for all calendar
quarters from 2005 through 2008. Petitioner also filed timely Forms 940,
Employer’s Annual Federal Unemployment (FUTA) Tax Return, for tax years
2005 through 2008. Petitioner, consistent with its assertion that the Hackers
provided services pursuant to an oral management agreement with Hacker Corp.,
did not issue to Mr. Hacker or Mrs. Hacker or file with the Internal Revenue
Service (IRS) Forms W-2, Wage and Tax Statement, nor did it issue to them or file
with the IRS Forms 1099-MISC, Miscellaneous Income.
In addition, petitioner did not include either Mr. Hacker or Mrs. Hacker on
the Forms 941 or 940, nor make on their behalf any deposit of employment taxes
into any Federal depository for any calendar quarter or annual return for tax years
2005 through 2008.
OPINION
I. Burden of Proof
The determinations set forth in the Commissioner’s notice of determination
of worker classification are presumed correct, and the taxpayer bears the burden of
proving those determinations are in error. See Rule 142(a); Welch v. Helvering,
290 U.S. 111, 115 (1933); Ewens & Miller, Inc. v. Commissioner, 117 T.C. 263,
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[*10] 268 (2001). Petitioner bears the burden of proving that its officers, the
Hackers, were not its employees as determined in the notice of determination for
the tax periods in issue. Petitioner, a corporation, also bears the burden of proving
that it is not liable for the penalties under section 6656 for failure to deposit tax
and accuracy-related penalties under section 6662(a) for negligence. See NT, Inc.
v. Commissioner, 126 T.C. 191, 194-195 (2006).
II. Worker Classification
For the purposes of respondent’s determination, “employee” is defined for
FICA and FUTA purposes to include “any officer of a corporation”. See secs.
3121(d)(1) and (2), 3306(i). For purposes of income tax withholding under
section 3402, the term “employee” also includes “an officer of a corporation”. See
sec. 3401(c). FICA and FUTA impose “employment taxes” that employers must
pay and are obligated to withhold in addition to income tax withholding under
section 3402. Employers are required to make periodic deposits of amounts
withheld from employees’ wages and amounts corresponding to the employer’s
share of FICA and FUTA tax. Secs. 6302, 6157; secs. 31.6302-1, 31.6302(c)-3,
Employment Tax Regs.
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[*11] III. Petitioner’s Corporate Officers
An officer of a corporation who performs more than minor services and
receives remuneration for such services is a “statutory” employee for employment
tax purposes. See Joseph M. Grey Pub. Accountant, P.C. v. Commissioner, 119
T.C. 121, 126 (2002), aff’d, 93 F. App’x 473 (3d Cir. 2004); Central Motorplex,
Inc. v. Commissioner, T.C. Memo. 2014-207; Glass Blocks Unlimited v.
Commissioner, T.C. Memo. 2013-180; Nu-Look Design, Inc. v. Commissioner,
T.C. Memo. 2003-52, 85 T.C.M. (CCH) 927, 931 (2003), aff’d, 356 F.3d 290 (3d
Cir. 2004); secs. 31.3121(d)-1(b), 31.3306(i)-1(c), 31.3401(c)-1(f), Employment
Tax Regs. An officer can escape statutory employee status only if he performs no
services (or only minor services) for that corporation and neither receives nor is
entitled to receive any remuneration, directly or indirectly, for services performed.
See Veterinary Surgical Consultants, P.C. v. Commissioner, 117 T.C. 141, 144-
145 (2001), aff’d sub nom. Yeagle Drywall Co. v. Commissioner, 54 F. App’x 100(3d Cir. 2002); secs. 31.3121(d)-1(b), 31.3306(i)-1(e), 31.3401(c)-1(f),
Employment Tax Regs.
Petitioner has stipulated that the Hackers were corporate officers during all
of the calendar quarters and years 2005 through 2008. Both provided substantial
services far beyond minor services, and both directly and indirectly received
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[*12] remuneration for their services. Mrs. Hacker was petitioner’s 51%
shareholder and acted as president of the corporation and director of curriculum
and education for all six child care locations and supervised over 90 employees
and students of those centers. See Nu-Look Design, Inc. v. Commissioner, 85
T.C.M. (CCH) at 931-932 (characterizing as statutory employee S corporation
shareholder who served as corporation’s president). Mr. Hacker was 49%
shareholder and acted as vice president, secretary, and treasurer; as director of
Blossom Day Care Centers; and as director of accounting and finance for
petitioner. Both Mr. and Mrs. Hacker had check-signing authority over
petitioner’s bank accounts and credit card authorization in their corporate capacity.
In addition, Mr. Hacker’s daily responsibilities included but were not
limited to depositing parents’ payments for child care and personally writing all of
the payroll checks to petitioner’s 90 employees. Both Mr. and Mrs. Hacker
provided numerous services to petitioner, any one of which could be considered
substantial. Both received direct and indirect remuneration in the form of cars for
themselves, a Lexus and a Hummer; cars for their children and relatives; credit
cards; and access to all cash distributions.
Petitioner has asserted that it operates under an oral management contract
and pays management fees to a related S corporation, Hacker Corp., to provide
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[*13] services, and that the Hackers, as employees of Hacker Corp., provide
services to petitioner and its day care centers. Whether a corporate officer is
performing services in his capacity as an officer is a question of fact. Joseph M.
Grey Public Accounting, P.C. v. Commissioner, 119 T.C. at 129-130; Rev. Rul.
82-83, 1982-1 C.B. 151, 152. The conclusion that a corporate officer is a statutory
employee may not apply to the extent that he or she performs services in some
other capacity. Nu-Look Design, Inc. v. Commissioner, 85 T.C.M. (CCH) at 931-
932.
Petitioner did pay Hacker Corp. money classified as management fees on its
general ledger for the years at issue in the following amounts: $382,650 in 2005,
$378,484 in 2006, $0 in 2007, and $204,514 in 2008. From these management
fees, Hacker Corp. paid Form W-2 wages to the Hackers for 2005 through 2008 of
$73,848, $40,000, $53,847, and $58,462, supposedly for the services the Hackers
were to render to petitioner under an oral management contract. Petitioner has
submitted no evidence of a management agreement, either written or oral, with
Hacker Corp. Likewise, petitioner has submitted no evidence, written or
otherwise, as to a service agreement directing the Hackers to perform substantial
services on behalf of Hacker Corp. to benefit petitioner, or even a service or
employment agreement between the Hackers and Hacker Corp. Therefore, there is
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[*14] no evidence in the record that Mr. Hacker or Mrs. Hacker performed
services in a capacity other than as a corporate officer.
The Court finds that the Hackers were both “statutory” employees of
petitioner for employment tax purposes for all calendar quarters and years of 2005
through 2008. Having made that determination, the Court is not required to
consider whether they would also be classified as “employees” under the common
law test. See Nu-Look Design, Inc. v. Commissioner, 356 F.3d at 293.
IV. Reasonableness of Compensation
Petitioner also contends that, even if the Court determines that its corporate
officers are statutory employees, the determination of additional wages paid to the
Hackers should be no more than the difference between what was paid to the
Hackers as Form W-2 employees of Hacker Corp. and the reasonable wage
determinations of respondent. Petitioner’s arguments are misguided in that wages
paid by Hacker Corp. do not offset reasonable compensation requirements for the
services provided by petitioner’s corporate officers to petitioner. Whatever wages
paid for whatever purposes by Hacker Corp. to the Hackers as employees of the S
corporation will be better addressed in relation to respondent’s notice of
deficiency for the Hackers’ individual income tax, in consideration that Hacker
Corp. is a wholly owned S corporation.
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[*15] Additionally, petitioner contends that the notice of determination is flawed
in that the determined compensation reflects requirements of higher educational
qualifications than either Mr. Hacker or Mrs. Hacker has achieved, since Mr.
Hacker did not graduate from college and Mrs. Hacker has only an associate’s
degree in child development. While petitioner has not further developed this
contention in its briefs and there was limited trial testimony on the topic, whatever
higher educational qualifications might be required have been far eclipsed by the
Hackers’ practical experience, professional qualifications, success in running day
care centers, and ownership prerogatives.
Reasonableness of compensation is a question determined by all the facts
and circumstances of the case. E.g., Glass Blocks Unlimited v. Commissioner,
at *13; Joly v. Commissioner, T.C. Memo. 1998-361, 1998 WL 712528, at *4,
aff’d without published opinion, 211 F.3d 1269 (6th Cir. 2000). Factors affecting
the reasonableness of compensation include the employee’s role in the company,
comparisons of the employee’s salary to those paid by similar companies for
similar services, and the character and condition of the company. Elliotts, Inc. v.
Commissioner, 716 F.2d 1241, 1245-1246 (9th Cir. 1983), rev’g T.C. Memo.
1980-282; see also Pepsi-Cola Bottling Co. of Salina, Inc. v. Commissioner, 528
F.2d 176, 179 (10th Cir. 1975), aff’g 61 T.C. 564 (1974). The Court does not find
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[*16] persuasive petitioner’s evidence that the services provided by the Hackers
were worth something less than respondent’s determination. Once again, although
the issue was passingly addressed in evidence at trial, petitioner’s briefs have
failed to show why respondent’s determination is unreasonable and, accordingly,
petitioner has not carried its burden to show that the amounts respondent
determined are unreasonable compensation.
V. Penalties
Respondent determined that petitioner is liable for penalties for failure to
deposit tax pursuant to section 6656 and accuracy-related penalties pursuant to
section 6662(a) for all periods in issue. Section 6656(a) and (b) imposes a penalty
equal to 10% of the portion of an underpayment in tax that is required to be
deposited if the failure to deposit is more than 15 days beyond the prescribed
deadline, unless it is shown that such failure is due to reasonable cause and not to
willful neglect. Section 6662(a) and (b)(1) imposes an accuracy-related penalty
equal to 20% of the portion of an underpayment that is attributable to negligence.
Petitioner contends that respondent has not met his burden of production
with respect to the penalties because he has not introduced evidence that the initial
determination was approved in writing by the immediate supervisor of the
individual making the determination, as required by section 6751(b)(1).
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[*17] Petitioner’s argument is misplaced. Section 7491(c), which shifts the
burden of production to the Secretary in any court proceeding with respect to
liability for any penalty, addition to tax, or additional amount, applies only to
individuals. See Povolny Grp., Inc. v. Commissioner, T.C. Memo. 2018-37,
at *27. Respondent thus has no burden of production in this case. That burden
remains with petitioner.
Nevertheless, a nonindividual taxpayer may raise the lack of supervisory
approval as an affirmative defense to penalties. See, e.g., Palmolive Bldg. Inv’rs,
LLC v. Commissioner, 152 T.C. 75, 83 (2019); Endeavor Partners Fund v.
Commissioner, T.C. Memo. 2018-96, at *63-*64, aff’d, 943 F.3d 464 (D.C. Cir.
2019). Petitioner raised the question of supervisory approval for the first time on
brief. It did not raise the affirmative defense in its pleadings, as required under
Rule 40, nor has it sought leave to amend its pleadings pursuant to Rule 41.
Moreover, respondent has introduced into evidence a Civil Penalty
Approval Form signed on March 31, 2010, by the immediate supervisor of the
revenue agent who conducted the examination of petitioner’s employment tax
liabilities for the periods in issue.5 The Form reflects that the revenue agent’s
5
On October 6, 2017, respondent filed a motion to reopen the record to
submit additional evidence. Attached to the motion was, among other documents,
(continued...)
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[*18] immediate supervisor approved assertion of the failure to deposit penalties
under section 6656 and the accuracy-related penalties under section 6662(a) for
negligence. There is no evidence in the record to suggest, and petitioner does not
contend, that respondent communicated his initial penalty determination to
petitioner before the date the examining agent’s supervisor signed the penalty
approval form. See Clay v. Commissioner, 152 T.C. 223, 249 (2019), aff’d, 990
F.3d 1296 (11th Cir. 2021).
Petitioner does not contest the substance of the penalties, except insofar as it
disagrees with respondent’s classification of the Hackers as employees and his
determination of employment tax liabilities. The Court has sustained respondent’s
determinations. Petitioner does not claim reasonable cause for the failure to
deposit or for the underpayments, and the Court finds that petitioner had none.
Accordingly, the Court holds that petitioner is liable for the section 6656
penalty for failure to deposit tax and section 6662 penalty for negligence for all
periods in issue.
5
(...continued)
the declaration of Joe W. Cooper, the immediate supervisor of the revenue agent
who conducted the examination of petitioner’s worker classification and
employment tax liabilities for the periods in issue. Also attached to the motion
was a Civil Penalty Approval Form, signed by Mr. Cooper and approving the
assertion of the penalties at issue in this case. The Court has granted respondent’s
motion contemporaneously with the filing of this opinion.
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[*19] VI. Conclusion
The Court sustains respondent’s determination of worker classification,
Federal employment tax deficiencies, and penalties and additions to tax.
To reflect the foregoing,
Decision will be entered for
respondent in docket No. 3869-12.