Horn v. Commissioner, Docket No. 6025-76

• Decision Date: 28 December 1982
• Docket Number: Docket No. 6025-76,6028-76.,6026-76,6027-76
• Citation: 45 TCM (CCH) 413,1982 TC Memo 741
• Parties: Louis G. Horn III, and Joanne F. Horn, et al. v. Commissioner.
• Court: U.S. Tax Court

45 TCM (CCH) 413

1982 TC Memo 741

T.C. Memo. 1982-741.

Louis G. Horn III, and Joanne F. Horn, et al.¹ v. Commissioner.

Docket Nos. 6025-76, 6026-76, 6027-76, 6028-76.

United States Tax Court.

Filed December 28, 1982.

L. Bruce Ables, for the petitioners. Vallie C. Brooks, for the respondent.

Memorandum Findings of Fact and Opinion

CHABOT, Judge:

Respondent determined deficiencies in Federal income taxes against the individual and corporate petitioners as follows:

                                                            Taxable
                                           Docket No.     Year Ended       Deficiency
                  Louis G. Horn, III and    6025-76    December 31, 1972    $2,589.11
                   Joanne F. Horn                      December 31, 1973     5,370.58
                  Robert J. Hornsby and     6026-76    December 31, 1972     1,787.88
                   Florence W. Hornsby                 December 31, 1973     4,150.59
                  H. Donald Beck and        6027-76    December 31, 1973     3,461.10
                   Katherine A. Beck
                  Huntsville Orthopedic     6028-76    June 30, 1972         2,214.18
                   Associates, P.A.                    June 30, 1973         8,884.92
                                                       June 30, 1974         5,999.16
                

These cases have been consolidated for trial, briefs, and opinion. Petitioners have conceded certain adjustments made in the notices of deficiency. The issues remaining for decision are as follows:

(1) Whether Madison Medical Services, Inc. (hereinafter sometimes referred to as "Services"), was for tax purposes an entity separate from the corporate petitioner and, if so, whether respondent's determination to allocate all of Services' income and expenses to the corporate petitioner under section 482² was unreasonable, arbitrary, or capricious; and

(2) Whether petitioner-husbands must include in their respective gross incomes amounts paid by Services to the children of the individual petitioners during the years in issue.

Findings of Fact

Some of the facts have been stipulated; the stipulations and the stipulated exhibits are incorporated herein by this reference.

When the petitions in the instant cases were filed, petitioners Louis G. Horn, III (hereinafter sometimes referred to as "Horn") and Joanne F. Horn, husband and wife, resided in Huntsville, Alabama; petitioners Robert J. Hornsby (hereinafter sometimes referred to as "Hornsby") and Florence W. Hornsby, husband and wife, resided in Jackson, Tennessee; petitioners H. Donald Beck (hereinafter sometimes referred to as "Beck") and Katherine A. Beck, husband and wife, resided in Huntsville, Alabama; and petitioner Huntsville Orthopedic Associates, P.A. (hereinafter sometimes referred to as "Associates"), a corporation, had its principal office in Huntsville, Alabama.

General

Associates is a professional association incorporated by Horn and Hornsby under Alabama law in July 1970, to engage in the practice of orthopedic surgery.

From July 1970 until about July 1972, Horn and Hornsby were the equal owners of all of Associates' stock. In July 1972, Beck became a shareholder of Associates and from July 1972 until July 1974, Horn, Hornsby, and Beck were the equal owners of all of Associates' stock.³

Horn, Hornsby, and Jerry W. Bevil (hereinafter sometimes referred to as "Bevil") were the directors of Associates from July 1970 until July 21, 1972. From July 21, 1972, through the remaining years in issue, Horn, Hornsby, and Beck were the directors of Associates. During the years in issue, Horn, Hornsby, and Beck (for the period that he was a shareholder) controlled Associates as directors and shareholders.

From July 1970 through the years in issue, Horn and Hornsby were employed by Associates as physicians.⁴ From about January 1, 1972, through the years in issue, Beck was employed by Associates as a physician.⁵

Before Associates was incorporated, Horn and Hornsby did their residency together, in orthopedic surgery, at the Campbell Clinic in Memphis, Tennessee. The first place they practiced orthopedic surgery was in Huntsville as employees of Associates.

Orthopedic surgery is the surgical sub-specialty concerned with the diagnosis and treatment of skeleton deformities, and diseases of and injuries to the bones, joints, and soft tissue adjacent to bones and joints in the human body. X-rays of a patient's body are considered an essential diagnostic tool by orthopedic surgeons. Some patients with fractures must first have their casts removed before X-raying is done. Since fractures are quite moveable, care must be taken in X-raying these patients. For these patients, it is more reasonable to have the X-ray facilities near the cast-setting facilities.

As soon as Associates began its practice, it purchased its own X-ray equipment. This equipment was used by Associates from July 1970 until the incorporation of Services to take and develop X-rays of its patients prescribed by Horn and Hornsby. The X-ray equipment owned by Associates was operated by Jacob Jones (hereinafter referred to as "Jones"), an X-ray technician and full-time employee of Associates. When Jones was not performing his duties as an X-ray technician, he set casts for Associates, assisted the physicians in surgery, and performed other related duties.

Sometime in August 1971, Associates moved to a new office suite with a room with lead-lined walls and plumbing specially designed for X-ray work. Associates' X-ray equipment was housed in this room. This room, together with a storage area for the X-rays, occupied perhaps one-fifteenth of Associates' office suite.

Horn and Hornsby met with George A. Kronenberg (hereinafter sometimes referred to as "Kronenberg"), an attorney, and Bevil on a monthly basis to discuss the business operations of Associates. During these meetings, Horn and Hornsby discussed the advantages of forming a small business corporation under subchapter S of chapter 1 (hereinafter sometimes referred to as "a subchapter S corporation") to provide the X-ray services to Associates. Horn and Hornsby had the following reasons for forming such a corporation: (1) to accumulate funds for the education of their children; and (2) to act on the advice of Kronenberg and Bevil regarding the tax advantages of a subchapter S corporation.

Organization and Operation of Services

Services was incorporated on September 14, 1971, under Alabama law. Its certificate of incorporation appears to permit Services to engage in almost any type of service, management, construction, investment, manufacturing, or sales business. This certificate does not suggest that Services was expected to engage in X-ray laboratory work or in any particular related activity.

On October 1, 1971, Associates transferred its X-ray equipment to Services at its then book value ($3,630.45). Services borrowed from Associates' profit-sharing plan the funds it used to pay Associates for the X-ray equipment. The X-ray equipment remained in the same location in Associates' offices that it had previously occupied.

After this transfer, Jones continued to perform his X-ray duties in the same manner as he previously had. He also continued to set casts and assist in surgery as before. He was carried on Services' payroll for his duties as an X-ray technician and on Associates' payroll for his duties as a cast setter.⁶ Also, he was paid by Associates for his assistance in surgery. Jones was the only employee on Services' payroll until late 1973, when he voluntarily terminated his employment. Two technicians were hired to replace Jones. As was the case with Jones, these two technicians were on Services' payroll and also worked part-time for Associates. The decision to hire these employees was made by Horn, Hornsby, and Beck.

In September 1972, Services acquired additional X-ray equipment at a cost of $5,546.85.⁷ This amount, like the amount used to acquire Associates' X-ray equipment, was borrowed from Associates' profit-sharing plan. When a bank succeeded Bevil as trustee for Associates' profit-sharing plan, Bevil or Kronenberg advised Horn, Hornsby, and Beck to repay Services' loans from Associates' profit-sharing plan. Another bank lent Services an amount equal to the amount of Services' remaining debt to Associates' profit-sharing plan, and Services repaid this loan.

A typical X-ray transaction occurred as follows: When one of Associates' physicians determined that a patient needed an X-ray, the physician raised a flag outside the examining room to indicate that an X-ray was needed. The physician also wrote an order for the X-ray and placed it in the chart in the examining room door. On seeing the flag, one of Associates' employees usually took the patient, who was usually wearing an examining gown, to the room containing the X-ray equipment. The X-ray technician then took charge of the patient. After the X-ray technician completed the X-ray, the patient was escorted back to the examining room by one of the Associates' employees and, in some cases, by the X-ray technician. An employee of Associates or Services carried the X-ray to Associates' X-ray reading area. The physician read the X-ray and then went back to the examining room and consulted with the patient. Thereafter, the X-rays were stored in an X-ray file room next to the X-ray equipment room.

Services did not maintain any log of the X-rays taken or any patient cards. Associates maintained the patients' records which listed the type of X-ray made and the fee charged. In 1971, 40 to 50 X-rays were made each day. In 1972 and after, 70 to 80 X-rays were made each day.

Services did not bill, or collect anything from, the patients. Associates billed its patients for all X-ray services rendered and, on a monthly basis, remitted a percentage of the gross charges to Services. In the beginning, Associates remitted to Services an amount equal to 22 percent of the gross charges billed. Within a year, this was changed to 30 percent of the gross charges billed. These charges were paid by Associates whether or not Associates...