Watson v. U.S.

• Decision Date: 23 December 2010
• Docket Number: No. 4:08–cv–442.,4:08–cv–442.
• Citation: 757 F.Supp.2d 877
• Parties: DAVID E. WATSON, P.C., Plaintiff,v.UNITED STATES of America, Defendant.
• Court: U.S. District Court — Southern District of Iowa

757 F.Supp.2d 877

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

v.UNITED STATES of America, Defendant.

No. 4:08–cv–442.

United States District Court, S.D. Iowa, Central Division.

Dec. 23, 2010.

Ronald L. Mountsier, Schneider Stiles Serangeli & Mountsier PC, Des Moines, IA, for Plaintiff.Michael R. Pahl, U.S. Dept. of Justice Tax Division, Washington, DC, for Defendant.

ORDER ON BENCH TRIAL

ROBERT W. PRATT, Chief Judge.

On or about February 5, 2007, the United States of America (“Defendant” or “Government”) recharacterized dividend and loan payments from David E. Watson, P.C. (“DEWPC” or “Plaintiff”) to its sole shareholder and employee, David E. Watson (“Watson”), as wages. Compl. (Clerk's No. 1) ¶ 10. In light of this recharacterization, Defendant assessed additional employment taxes, interest and penalties against Plaintiff for each of the eight calendar quarters in 2002 and 2003. Id. DEWPC paid the fourth quarter 2002 assessment of $4,063.93 on or about April 14, 2007 and filed a claim for refund of that amount on or about June 27, 2007. Id. ¶¶ 12–13. Defendant denied Plaintiff's request for a refund on or about November 16, 2007. Id. ¶ 14.

Plaintiff filed the above-captioned action on October 31, 2008, contending that the assessments against it were illegal, and requesting a refund of the amount paid. Id. ¶ 3. Defendant filed an Answer and Counterclaim on February 12, 2009 (Clerk's No. 6), resisting Plaintiff's request for refund, and requesting Judgment against Plaintiff in the amount of $44,457.39 for additional assessments, penalties, and interest for the seven additional quarters in 2002 and 2003 for which Plaintiff did not make payment. The Court held a bench trial in the case on August 27, 2010. Clerk's No. 29. On September 27, 2010, the parties submitted proposed findings of fact and conclusions of law. Clerk's Nos. 33–34. The matter is fully submitted.

I. CONSIDERATIONS ON REVIEW

Federal Rule of Civil Procedure 52(a) requires that in all cases tried without a jury or with an advisory jury, “the court shall find the facts specially and state separately its conclusions of law thereon.” In determining the credibility of the witnesses and the weight to be accorded their testimony, the Court has taken into consideration: the character of the witnesses, their demeanor on the stand, their interest, if any, in the result of the trial, their relation to or feeling toward the parties to the trial, the probability or improbability of their statements as well as all the other facts and circumstances given in evidence. Clark v. United States, 391 F.2d 57, 60 (8th Cir.1968). With these considerations in mind, the Court finds facts and makes conclusions of law as articulated herein.

II. FINDINGS OF FACT

A. Stipulated Facts

The parties have stipulated to many of facts in this case. See Stip. Facts in Final Pretrial Order at 2–5 (Clerk's No. 19). Pursuant to the parties' stipulation, the Court finds the following facts in this case:

• David Watson (“Watson”) graduated from the University of Iowa in 1982, with a bachelor's degree in business administration and a specialization in accounting. Stip. Fact ¶ L.

• Watson became a Certified Public Accountant (“CPA”) in 1983, and received a master's degree in taxation from Drake University in 1993. Id. ¶ M.

• Between 1982 and 1992, Watson practiced accounting at two different accounting firms, one of which was Ernst & Young, where he began specializing in partnership taxation. Id. ¶ N.

• After leaving Ernst & Young, Watson became a 25% shareholder in an accounting firm called Larson, Watson, Bartling & Eastman (“LWBE”). Id. ¶ O.

• The remaining 75% of LWBE was owned by Tom Larson, Jeff Bartling, and Dale Eastman. Stip. Facts. ¶ P.

• On October 11, 1996, Watson incorporated DEWPC, an Iowa Professional Corporation. Id. ¶¶ A, Q.

• DEWPC is a validly organized and existing corporation, properly recognized as a separate entity for federal tax purposes. Id. ¶ B.

• Watson, at the times relevant to this action, and at all times generally, is the only individual who is or has ever been an officer, shareholder, director, or employee of DEWPC. Id. ¶¶ C, E, U, V.

• Watson's employment with DEWPC was, at all relevant times, governed by the terms and conditions of an Employment Agreement. Id. ¶ D.

• DEWPC has elected to be taxed as an S Corporation since the time of its inception. Id. ¶ I.

• After incorporating DEWPC in 1996, Watson caused DEWPC to become a 25% shareholder in LWBE, replacing Watson's own, individual shareholder status in DEWPC. Id. ¶ Q.

• The other partners in LWBE undertook similar action, such that LWBE became owned by DEWPC, Thomas E. Larson, P.C., Jeffrey T. Bartling, P.C., and Dale A. Eastman, P.C., rather than by Watson, Larson, Bartling, and Eastman individually. Id. ¶ R.

• By 1998, Paul Juffer, P.C. had become a partner and Dale A. Eastman, P.C. had ceased being a partner, such that LWBE changed its name to Larson, Watson, Bartling, & Juffer, LLP (“LWBJ”). Id. ¶ S. DEWPC remained a partner in LWBJ after the name change. Id. ¶ G.

• Watson is not personally a partner or employee of LWBJ; rather, he provides accounting services to LWBJ and its clients as an employee of DEWPC. Id. ¶¶ H, J, K.

• In the relevant years, 2002 and 2003, Watson could not practice accounting other than through LWBJ.¹ Id. ¶ F.

• In 2002 and 2003, Watson received $24,000 designated as salary from DEWPC and paid employment taxes on that amount. Id. ¶ W.

• DEWPC's 2002 and 2003 cash income came exclusively in the form of distributions from LWBJ. Id. ¶ AA.

• Watson is the only person to whom DEWPC distributed money in 2002 or 2003. Id. ¶ X.

• There is no tax statute, regulation, or other rule that requires DEWPC to pay any minimum salary to Watson. Id. ¶ Y.

• There is no minimum amount of compensation that DEWPC was required to pay to Watson before it could declare and pay a dividend to Watson. Id. ¶ Z.

• On or about April 14, 2007, the United States received a payment of $4,063.93 from DEWPC, representing additional tax and related penalty and interest assessments made against DEWPC by the United States for the calendar quarter ending December 31, 2002. Id. ¶¶ BB, EE.

• Though DEWPC designated that the payment of $4,063.93 be applied to the tax liability for the fourth quarter of 2002, the IRS erroneously applied the payment to the first quarter of 2002. Id. ¶¶ CC–DD.

• The parties agree that the erroneous application of Plaintiff's tax payment to the first quarter of 2002, rather than the fourth quarter of 2002, does not operate to deprive this Court of subject-matter jurisdiction. Id. ¶¶ FF–GG.

B. Additional Findings of Fact

Though the facts to follow were not stipulated to by the parties, the Court finds that they have been amply proven or established by evidence and testimony at trial.

1. David Watson.

• DEWPC regularly held shareholder meetings, at which Watson (DEWPC's only shareholder, employee, and officer) was the only participant. See Exs. 5–9, 18–19.

• Watson testified that, when LWBE first started, he received zero salary due to the start-up nature of the company. Tr. at 18–19.²

• At the October 6, 1997 shareholder meeting, DEWPC authorized an annual salary for Watson of $12,000 for 1998. Ex. 8. DEWPC also approved payment to Watson of “dividends in the amount of available cash on hand after payment of compensation and other expenses of the corporation.” Id.

• Watson testified that the partners agreed to a $12,000 annual salary for each in 1998 because “we had determined as a group that, as a minimum, we should have enough cash flow on hand in any given period to pay $1,000 a month to each partner, whether it was good times or bad.” Tr. at 28.

• At the October 2, 2000 shareholder meeting, DEWPC authorized an annual salary for Watson of $24,000 for 2001. Ex. 19. DEWPC also approved payment to Watson of “dividends in the amount of available cash on hand after payment of compensation and other expenses of the corporation.” Id.

• DEWPC approved the same salary and dividend arrangement with respect to Watson ($24,000 salary plus dividends) at its October 1, 2001, October 7, 2002, and October 6, 2003 shareholder meetings. Exs. 5–7.

• Watson testified at trial that the reason his compensation was set at $24,000 for the years 2002 and 2003 was because the partners of LWBJ “got together and discussed what we felt that we could pay on a regular and continuous basis regardless of the seasonability of our business.” Tr. at 24. Watson further testified that the partners agreed that “regardless of whether it's a good economy or bad economy ... we felt that we'd grown to the point that, for each of the partners, that we could pay $2,000 a month for sure and then we'd have that cash available.” Id. at 24–25.

• Watson testified that his salary for the last several years (post-dating the tax years at issue in this case) has been $48,000, again because the partners of LWBJ agreed that the business' cash flow was sufficient to pay a “minimum of $4,000 per month whether it was good times or bad.” Tr. at 28.

• LWBJ maintained a “co-employer” relationship with Merit Resources, whereby twice a month, LWBJ submits funds to Merit Resources, and Merit Resources sends out payroll checks after accounting for relevant deductions. Id. at 28–29. Hence, Watson's paychecks and W–2s are issued by Merit Resources. Id. at 29.

• The gross revenues of LWBJ for 2002 were $2,349,556, and the gross revenues for LWBJ for 2003 were $2,949.739. Exs. 12–13; Tr. at 30.

• Watson's gross billings to clients were approximately $197,682.21 in 2002, and $200,380.36 in 2003. Exs. 14–15; Tr. at 31.

• Watson testified that LWBJ has approximately 30 employees, and that approximately 26–27 of those employees bill time to clients. Tr. at 33.

• Watson further testified that the partners of LWBJ incur substantially more of the expenses of the firm than any other employees, due to larger officers, more travel, and greater...