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FLEISCHER --DOES THE SERVICE RECIPIENT KNOW YOUR S CORPORATION EVEN EXISTS?

02 / 20 / 2017

Fleischer v. Commissioner, T.C. Memo 2016-238 (December 29, 2016)

In this Tax Court decision, a financial consultant went out on his own, entered into financial consulting contracts with LP and MassMutual, and received 1099s from these companies.  However, because he had formed his own S corporation, he attempted to run the 1099 income through his S corporation.  The problem he runs into is that he failed to adhere to 2-part Johnson test.  Under that test, in order for one's corporation to be the recognized earner of income, two elements must be met:  (1) the individual providing the services must be an employee of the corporation whom the corporation can direct and control in a meaningful sense; and (2) there must exist between the corporation and the person or entity using the services a contract or similar indicium recognizing the corporation's controlling position.  Johnson v. Commissioner, 78 T.C. 882, 891 (1982).  See also Regs. 31.3121(d)-1(c)(2).  

It did not matter that one can claim that the entity could not legally operate under the securities laws , thereby prohibiting one from entering into a contract with one's own service corporation, this does not allow it to be assigned the income the consultant earned in his personal capacity.  See also Jones v. Commissioner, 64 T.C. 1066 (1975)(holding that court reporter improperly assigned income to his personal service corporation because a court reporter was legally required to be an individual, and although the corporation was a valid entity, it could not perform such services).  

Taxpayer's effort to rely on Sargent v. Commissioner, 929 F.2d 1252 failed because there, the two hockey players had formed personal service corporations that in turn had actually contracted with the hockey team for whom they played, and the team paid the corporations, and their corporations then paid them a salary and separately contributed funds to pension players set up for the players.  The court also did not find that taxpayer's effort to rely on Rev. Rul. 70-101 could work since the validity of the entity under Nebraska state law is not the issue; it is that the law does not permit a "reallocation" of income, such that there was no indicium for LPL to believe that the S corporation had any meaningful control over the financial consultant, where the LPL or MassMutual entities were not  even mentioned in the contracts entered into with the consultant.