Fatland v. Commissioner
| Decision Date | 12 September 1984 |
| Docket Number | Docket No. 9258-82. |
| Citation | 1984 TC Memo 489,48 TCM (CCH) 1107 |
| Parties | John L. Fatland and Donita V. Fatland v. Commissioner. |
| Court | U.S. Tax Court |
Paul M. Thielking, 2190 N.W. 82nd St., Des Moines, Iowa, for the petitioners. Jack Forsberg, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in petitioners' joint Federal income taxes for calendar years 1977, 1978, and 1979 in the amounts of $20,600.58, $14,142.74, and $15,144.61, respectively. The issue presented for determination is whether the income attributable to petitioner John L. Fatland's medical practice is taxable to him instead of his wholly owned professional corporation.
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,1 resided in Des Moines, Iowa. They filed their 1977, 1978, and 1979 joint Federal income tax returns with the Internal Revenue Service Center in Kansas City, Missouri.
John L. Fatland (petitioner) is a physician licensed to practice medicine in the State of Iowa. Prior to October 2, 1975, petitioner 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 1979.2 The corporation paid all required State and Federal taxes.
The corporation adopted corporate bylaws on October 2, 1975, a medical expense reimbursement plan on October 6, 1975, and an employee ownership plan covering professional employees (ESOP) on December 18, 1975. Petitioner was the only employee and, accordingly, was the only person eligible to participate in either the medical expense plan or the ESOP. All contributions by the corporation to the ESOP, during the respective years, were made by the transfer of corporate shares of stock. The corporation claimed deductions for contributions to the ESOP of $9,000 in 1977, $9,900 in 1978, and $11,378.43 in 1979.
Petitioner was the sole incorporator and sole director, and was the president and secretary-treasurer of the corporation. Petitioner and the ESOP were the corporation's only shareholders.
The partnership employed 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 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 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.
OpinionThe 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 4823 or 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 neither section 482 nor section 61 sanctions the allocations made by respondent. We agree with petitioner.
Section 4824 authorizes respondent to allocate gross income, deductions, and credits between any two 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 applying section 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 Dec. 38,351, 77 T.C. 881, 900 (1981); Jordan v. Commissioner Dec. 32,130, 60 T.C. 872, 882 (1973), affd. 75-1 USTC ¶ 9444 514 F. 2d 1209 (8th Cir. 1975); Marc's Big Boy-Prospect, Inc. v. Commissioner Dec. 29,756, 52 T.C. 1073, 1092 (1969), affd. 452 F. 2d 317 (7th Cir. 1971); Ballentine Motor Co.v. Commissioner 63-2 USTC ¶ 9680, 321 F. 2d 796, 800 (4th Cir. 1963), affg. Dec. 25,743 39 T.C. 348 (1962); Grenada Industries, Inc. v. Commissioner Dec. 18,468, 17 T.C. 231, 255 (1951), affd. 53-1 USTC ¶ 9271 202 F. 2d 873 (5th Cir. 1953), cert. denied 346 U.S. 819 (1953).
Section 482 properly applies to the one-man personal service corporation situation. Pacella v. Commissioner Dec. 38,937, 78 T.C. 604, 618 (1982); Keller v. Commissioner Dec. 38,401, 77 T.C. 1014, 1022 (1981), affd. 83-2 USTC ¶ 9740 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 618; Keller v. Commissioner, 77 T.C. at 1030.
In 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 43-1 USTC ¶ 9464, 319 U.S. 436 (1943). Further, the respondent does not contend that personal service corporations generally should not be treated as corporations for Federal income tax purposes.5 Petitioner agrees that the corporation is not a sham but contends that respondent may not challenge the tax treatment of the income received. However, the mere recognition of a corporation as a separate taxable entity does not automatically preclude respondent's use of section 482.6
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 our Pacella 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 618-619.
This Court has consistently held that section 482 may be applicable to the situation where a shareholder/employee "controls" his wholly owned professional corporation.7 Pacella v. Commissioner, supra at 618; Keller v. Commissioner, 77 T.C. at 1023-1024. This Court in Keller v. Commissioner, 77 T.C. at 1023-1024, found that, although there was a controlled corporation involved, two levels of operating the medical practice existed. The business at the...
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