Watson v. United States

• Decision Date: 21 February 2012
• Docket Number: No. 11–1589.,11–1589.
• Citation: 668 F.3d 1008,2012 USTC P 50203,109 A.F.T.R.2d 2012
• Parties: DAVID E. WATSON, P.C., Plaintiff/Appellant, v. UNITED STATES of America, Defendant/Appellee,United States of America, Counter-plaintiff/Appellee, v. David E. Watson, P.C., Cross-defendant/Appellant.
• Court: U.S. Court of Appeals — Eighth Circuit

109 A.F.T.R.2d 2012-1059

2012-1 USTC P 50,203

668 F.3d 1008

DAVID E. WATSON, P.C., Plaintiff/Appellant,

v.UNITED STATES of America, Defendant/Appellee,United States of America, Counter-plaintiff/Appellee,

v.David E. Watson, P.C., Cross-defendant/Appellant.

No. 11–1589.

United States Court of Appeals, Eighth Circuit.

Submitted: Nov. 15, 2011.Filed: Feb. 21, 2012.

Ronald Leigh Mountsier, argued, Des Moines, IA, for appellant.

Damon Taaffe, argued, Bruce R. Ellisen, on the brief, U.S. DOJ, Civil Division, Washington, DC, for appellee.

Before RILEY, Chief Judge, BEAM, and BYE, Circuit Judges.

BEAM, Circuit Judge.

This case concerns the Federal Insurance Contribution Act (FICA), 26 U.S.C. (I.R.C.) § 3101 et seq., and certain employment taxes FICA imposes upon employers. After a bench trial on the merits, the district court ¹ rendered a tax deficiency judgment against David E. Watson, P.C. (DEWPC) for unpaid FICA tax. DEWPC appeals, and we affirm.

I. BACKGROUND

In 1982, David Watson (Watson) graduated from college with a bachelor's degree in business administration and a specialization in accounting. In 1983, Watson became a Certified Public Accountant (CPA) and later obtained a master's degree in taxation. In his first ten years of practice, Watson worked at two accounting firms, one of which was Ernst & Young. While at Ernst & Young, Watson began specializing in partnership taxation.

After leaving Ernst & Young, Watson obtained a 25% interest in an accounting firm located in West Des Moines, Iowa, known as Larson, Watson, Bartling & Eastman. At trial, Watson testified that he received no salary when the firm first began operations because the entity did not have money to pay him. Eventually, one partner exited and the firm added a new partner, reemerging as Larson, Watson, Bartling & Juffer, LLP (LWBJ ²).

In 1996, Watson incorporated a business entity known as David E. Watson, P.C. Watson transferred his individual 25% interest in LWBJ to DEWPC, and thereafter DEWPC replaced Watson as a partner in LWBJ. Watson served as DEWPC's sole officer, shareholder, director, and employee. Through an employment agreement, DEWPC employed Watson, but Watson exclusively provided his accounting services to LWBJ for the period relevant to this dispute. From its inception, DEWPC elected to be taxed as an S Corporation.

In both 2002 and 2003, DEWPC distributed $24,000 to Watson as employment compensation. Watson testified that the LWBJ partners made the determination that LWBJ had sufficient cash flow where it could distribute $2,000 a month to each partner, regardless of the seasonality of the business. There were no documents reflecting these salary discussions, and no other LWBJ partner testified at trial. Ultimately, DEWPC is the entity that authorized and paid Watson's salary. In addition to salary, Watson, through DEWPC, received $203,651 from LWBJ as profit distributions for 2002. In 2003, Watson, through DEWPC, received $175,470 as profit distributions from LWBJ. Thus, in 2002 and 2003, after DEWPC paid Watson's salary and other expenses, it distributed all remaining cash to Watson as dividends.

The Internal Revenue Service (IRS) investigated DEWPC and determined that it underpaid certain employment taxes pursuant to FICA, see I.R.C. § 3111(a), (b), in 2002 and 2003. The IRS assessed additional tax and penalties against DEWPC for the eight quarters covering 2002 and 2003. On April 14, 2007, DEWPC paid the delinquent tax, penalty, and interest for the fourth quarter of 2002 and sought a refund from the IRS.³ The IRS denied DEWPC's refund claim, and DEWPC sued the United States in district court. The United States counterclaimed, seeking to recover employment taxes, penalties, and interest that remained unpaid for 2002 and 2003.

After denying DEWPC's motion for summary judgment, the district court held a bench trial on the merits. At trial, the government's expert, Igor Ostrovsky, opined that the market value of Watson's accounting services was approximately $91,044 per year for 2002 and 2003. Ostrovsky is a general engineer with the IRS and has worked on approximately 20 to 30 cases involving reasonable compensation issues. In forming his opinion as to Watson's salary, Ostrovsky relied on several compensation surveys and studies particular to accountants. Primarily, Ostrovsky focused on the Management of an Accounting Practice (MAP) survey conducted by the American Institute of Certified Public Accountants, which contained adjustments for specific regions. Ostrovsky discovered that an owner—defined as an investor and an employee—in a firm the size of LWBJ would receive approximately $176,000 annually, which reflected both compensation and return on investment. Ostrovsky also discovered that a director—an employee with no investment interest—would receive approximately $70,000 in compensation alone. Because owners billed at rates 33% higher than directors, and because Ostrovsky viewed Watson as a de facto partner of LWBJ, Ostrovsky increased the director compensation by 33% to arrive at owner compensation or $93,000. Ostrovsky then made a downward adjustment to $91,044, accounting for untaxable fringe benefits. In reaching his conclusion, Ostrovsky used average billing rates rather than Watson's actual billing rates.

Ultimately, the district court adopted Ostrovsky's opinion and determined that the reasonable amount of Watson's remuneration for services performed totaled $91,044. Therefore, the district court rendered a tax deficiency judgment against DEWPC, which included unpaid employment taxes, penalties, and interest in the amount of $23,431.23. DEWPC now appeals.

II. DISCUSSION

This case presents two issues for our review. First, we must decide whether the district court erred in allowing Ostrovsky to testify as an expert witness on the issue of compensation. Second, we must determine whether the district court properly characterized $91,044 as “wages” for the purposes of assessing FICA tax in 2002 and 2003.

We apply the same standard of review in tax refund cases as we do in other bench trials. Townsend Indus., Inc. v. United States, 342 F.3d 890, 891 (8th Cir.2003). That is, we review the district court's findings of fact for clear error and its conclusions of law de novo. Id. We review the district court's decision to admit expert testimony for abuse of discretion, giving substantial deference to the district court. United States v. Roach, 644 F.3d 763, 763 (8th Cir.2011) (per curiam).

A. Ostrovsky's Expert Testimony

DEWPC argues that the district court erred in allowing Ostrovsky to testify as an expert witness on the issue of reasonable compensation because Ostrovsky was not competent to testify on that issue. Specifically, DEWPC asserts that Ostrovsky was not qualified, changed his opinion, relied on insufficient underlying facts, and used flawed methods in rendering his opinion.

Ostrovsky is a certified business valuation analyst, but because compensation is only one component of business valuation, DEWPC deems Ostrovsky incompetent to testify as to compensation. Federal Rule of Evidence 702 governs the admission of expert testimony in this case. A witness may qualify as an expert “by knowledge, skill, experience, training, or education.” Fed.R.Evid. 702. “Rule 702 does not rank academic training over demonstrated practical experience.” Roach, 644 F.3d at 764. Here, the record reveals that Ostrovsky, as a general engineer for the IRS, spends about 40% of his time dealing with compensation issues and has worked on about 20 to 30 reasonable compensation cases. Therefore, even if Ostrovsky's education and training was not specifically tailored to compensation issues, he certainly has “demonstrated practical experience” qualifying him as an expert in the field. See id. Accordingly, the district court did not abuse its discretion in determining Ostrovsky was qualified to render an expert opinion on Watson's compensation.

In addition to challenging his qualifications, DEWPC asserts that Ostrovsky was not a competent expert witness because his opinion as to the value of Watson's services changed over the course of the proceedings. It is true that Ostrovsky's opinion changed as the proceedings progressed. Before Watson's deposition, Ostrovsky's initial assessment was that Watson's salary in the disputed years should have been no less than $184,876. After discovering errors in his initial assessment and learning additional facts through Watson's deposition, Ostrovsky eventually revised his report and arrived at his final estimate. The district court made a specific finding on this point and found Ostrovsky competent. DEWPC fails to cite any authority supporting its contention that Ostrovsky's revised opinion rendered his testimony incompetent. In fact, it appears Ostrovsky properly updated his expert report, giving DEWPC ample notice of his revised opinions. See Fed.R.Civ.P. 26(a)(2)(B), (e)(2). Under these circumstances, we see no reason why Ostrovsky's revised opinion would be incompetent. Thus, we see no abuse of discretion.

DEWPC also argues that Ostrovsky failed to consider certain facts in rendering his opinion. Generally, “the factual basis of an expert opinion goes to the credibility of the testimony, not the admissibility, and it is up to the opposing party to examine the factual basis for the opinion in cross-examination.” Nebraska Plastics, Inc. v. Holland Colors Am., Inc., 408 F.3d 410, 416 (8th Cir.2005). However, “if the expert's opinion is so fundamentally unsupported that it can offer no assistance to the [fact-finder], it must be excluded.” Id. Previously, we have determined that when an expert “fail[s] to take into account a plethora of specific facts” his or her testimony is properly excluded. Id. at 417.

Here, DEWPC cross-examined Ostrovsky and questioned the factual basis for his opinion. The district court could take this into account when assessing Ostrovsky's credibility. Based on...