Veterinary Surgical Consultants, P.C. v. Comm'r of Internal Revenue

• Decision Date: 15 October 2001
• Docket Number: No. 2500–99.,2500–99.
• Citation: 117 T.C. 141,117 T.C. No. 14
• Parties: VETERINARY SURGICAL CONSULTANTS, P.C., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

117 T.C. 141

117 T.C. No. 14

VETERINARY SURGICAL CONSULTANTS, P.C., Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 2500–99.

United States Tax Court.

Oct. 15, 2001.

Corporate taxpayer petitioned for redetermination of deficiencies in employment taxes. The Tax Court, Jacobs, J., held that: (1) sole shareholder who was officer and performed substantial services for corporation was an employee, and (2) corporation did not have reasonable basis for not treating sole shareholder of professional corporation as an employee.

Decision for IRS. P, an S corporation, distributed all of its net income to A, its sole shareholder and president. A performs substantial services for P. On his Forms 1040, A reported P's net income as nonpassive income from an S corporation.R issued to P a Notice of Determination Concerning Worker Classification Under Sec. 7436, determining that A was an employee of P for purposes of Federal employment tax.Held: A is an employee of P for purposes of Federal employment tax pursuant to sec. 31.3121(d)-(1)(b), Employment Tax Regs., because A is an officer who performs substantial services for P and receives remuneration for those services.Held, further, P is not entitled to relief pursuant to sec. 530 of the Rev. Act of 1978, Pub.L. 95–600, 92 Stat. 2763, 2885, because P did not have a reasonable basis for not treating A as an employee.Joseph H. O'Donnell, Jr., for petitioner.

Kathleen K. Raup, for respondent.

OPINION

JACOBS, J.

This case is before the Court on a petition for redetermination of a Notice of Determination Concerning Worker Classification Under Section 7436 (Notice of Determination). It was submitted to the Court fully stipulated under Rule 122. The sole issue to be decided is whether Kenneth K. Sadanaga, D.V.M. (Dr. Sadanaga), is an employee of petitioner for the period at issue (each of the four quarters of 1994, 1995, and 1996) for purposes of Federal employment taxes.¹

Rule references are to the Tax Court Rules of Practice and Procedure, and except as otherwise noted, section references are to the Internal Revenue Code in effect for the years at issue.

Background

The stipulation of facts and the attached exhibits are incorporated herein. The stipulated facts are hereby found.

Petitioner is an S corporation that was incorporated in Pennsylvania on May 22, 1991. At the time the petition was filed, petitioner's principal place of business was in Malvern, Pennsylvania. Petitioner's only business is providing consulting and surgical services to veterinarians. Dr. Sadanaga is petitioner's sole shareholder and serves as its president, petitioner's only officer.

Since petitioner's incorporation, all of its income has been generated from the consulting and surgical services provided by Dr. Sadanaga to Veterinary Orthopedic Services, Ltd. (Orthopedic). During the period at issue, Dr. Sadanaga spent at least 33 hours per week providing consulting and surgical services on behalf of petitioner. He performed surgeries at the Veterinary Referral Center in Frazer, Pennsylvania, and consulted with veterinarians in their offices or his home.

Dr. Sadanaga is the only person with signature authority on petitioner's bank account. Dr. Sadanaga handled all of petitioner's correspondence and performed all administrative tasks on behalf of petitioner. Petitioner did not make regular payments to Dr. Sadanaga; rather, Dr. Sadanaga withdrew money from petitioner's bank account at his discretion.

Petitioner received a Form 1099–MISC, Miscellaneous Income, from Orthopedic reporting “non-employee compensation” during each of the quarters at issue. The Forms 1099–MISC reported that Orthopedic paid petitioner $125,152.63 in 1994, $225,469.24 in 1995, and $212,863 in 1996. Petitioner reported the amount reflected on the Forms 1099–MISC as its total gross receipts on its Form 1120S, U.S. Income Tax Return for an S Corporation, for 1994, 1995, and 1996.

On Forms 1120S, petitioner reported net income from its trade or business for 1994, 1995, and 1996 in the respective amounts of $83,995.50, $173,030.39, and $161,483.35. Petitioner paid these amounts to Dr. Sadanaga, and reported these amounts as Dr. Sadanaga's share of its income on Schedules K–1, Shareholders' Shares of Income, Credits, Deductions, etc., of the Forms 1120S. Petitioner reported on Schedules M–2, Analysis of Accumulated Adjustments Account, Other Adjustments Account, and Shareholders' Undistributed Taxable Income Previously Taxed, of the Forms 1120S, that the amounts it paid to Dr. Sadanaga were distributions other than dividend distributions paid from accumulated earnings and profits.

Petitioner did not issue a Form 1099–MISC or a Form W–2, Wage and Tax Statement, to Dr. Sadanaga for 1994, 1995, or 1996. Nor did petitioner file a Form 941, Employer's Quarterly Federal Tax Return, or a Form 940, Employer's Annual Federal Unemployment Tax Return, for any quarter during the period at issue. On Schedules E, Supplemental Income and Loss, of Dr. Sadanaga's 1994, 1995, and 1996 Forms 1040, U.S. Individual Income Tax Returns, Dr. Sadanaga reported his share of petitioner's income (as indicated on the Schedules K–1) as nonpassive income from an S corporation.

Dr. Sadanaga was a full-time employee of Bristol–Myers Squibb Co. (Bristol–Myers). He reported wages from Bristol Myers of $91,212.18 in 1994, $95,891.15 in 1995, and $102,031.14 in 1996. In 1994, 1995, and 1996, Bristol–Myers withheld Social Security taxes from Dr. Sadanaga.

Respondent began an audit of petitioner's return for 1995 in May 1997. On October 22, 1997, Revenue Agent James Tepper, and petitioner's accountant, Joseph Grey, met to discuss the audit. Revenue Agent Orville Surla joined Revenue Agent Tepper and Mr. Grey to discuss whether Dr. Sadanaga was an employee of petitioner in 1995. Mr. Grey asserted that Dr. Sadanaga was not an employee of petitioner and that the distribution to him from petitioner represented his share of petitioner's net income. Mr. Grey objected to any assessment of Federal employment taxes against petitioner. Because Mr. Grey and Revenue Agent Tepper could not reach any agreement with respect to the Federal employment tax issue, the issue was referred to Revenue Agent Surla.

On March 16, 1998, respondent sent petitioner a 30–day letter, proposing adjustments to petitioner's Federal employment taxes for each of the four quarters of 1994, 1995, and 1996. On April 3, 1998, petitioner submitted to respondent a letter protesting the proposed adjustments.

On October 5, 1998, respondent sent petitioner a letter advising that there would be no change resulting from the audit of petitioner's Form 1120S for 1995. On November 17, 1998, respondent issued to petitioner a Notice of Determination, in which respondent determined that (1) Dr. Sadanaga was an employee of petitioner for purposes of Federal employment taxes, and (2) petitioner was not entitled to “safe harbor” relief from these taxes as provided by section 530 of the Revenue Act of 1978, Pub.L. 95–600, 92 Stat. 2885 (Section 530). Attached to the Notice of Determination was a schedule detailing the amount of the proposed Federal employment taxes. Thereafter, petitioner filed with the Court a timely petition seeking our review of respondent's Notice of Determination.

Discussion

Petitioner contends that Dr. Sadanaga was not its employee and that it properly distributed its net income to Dr. Sadanaga, as its sole shareholder, pursuant to section 1366. On the other hand, respondent contends that Dr. Sadanaga was an employee of petitioner because he was an officer of petitioner and performed substantial services on petitioner's behalf.

Sections 3111 and 3301 impose FICA (Social Security) and FUTA (unemployment) taxes on employers for wages paid to their employees. For Federal employment tax purposes, section 3121(d) defines an employee in part as any officer of a corporation. However, there is an exception to employee status for an officer who does not perform any services (or performs only minor services) and who neither receives nor is entitled to receive remuneration. Sec. 31.3121(d)-(1)(b), Employment Tax Regs. For Federal employment tax purposes, the term “wages” is defined as “all remuneration for employment”.² Secs. 3121(a), 3306(b). The form of payment is immaterial, the only relevant factor being whether the payments were actually received as compensation for employment. Secs. 31.3121(a)–1(b), 31. 3306(b)–1(b), Employment Tax Regs. Consequently, an officer who performs substantial services for a corporation and who receives remuneration in any form for those services is considered an employee, whose wages are subject to Federal employment taxes.

With respect to the case at hand, Dr. Sadanaga is an officer of petitioner, and therefore he is an employee of petitioner under the general rule of section 3121(d)(1). Additionally, Dr. Sadanaga performed substantial services for petitioner, working approximately 33 hours a week for petitioner. Indeed, he was the only individual working for petitioner. Tellingly, all of petitioner's income was generated from the consulting and surgical services provided by Dr. Sadanaga.

Petitioner contends that the amounts paid to Dr. Sadanaga were distributions of its corporate net income, rather than wages. Petitioner posits that as an S corporation it passed its net income to Dr. Sadanaga, as its sole shareholder, pursuant to section 1366. Petitioner's argument is flawed. Section 1366 only permits use of S corporation passthrough items in calculating tax liability under chapter 1, not tax liability under chapters 21 and 23—in which the Federal employment tax provisions for FICA and FUTA are located. Sec. 1366(a)(1); see also Ding v. Commissioner, 200 F.3d 587, 590 (9th Cir.1999), affg. T.C. Memo.1997–435; Catalano v. Commissioner, T.C. Memo.1998–447.

Dr. Sadanaga performed substantial services on behalf of petitioner. The characterization of the...