Assign income from sole proprietor to corporation

[PaulF]

I have a client who is an insurance agent for State Farm. He is currently a sole proprietorship, but wants to convert to an S-Corporation.

State Farm will not recognize his corporation and will continue to pay his commissions under his ss# based on how his contract is structured.

He was in contact with somebody from State Farm and they told him his accountant can assign the income from his sole proprietorship to his corporation to get around the fact that State Farm will not pay commissions to his corporation.

Does anybody have any experience with this?

[geekgirldany]

I have an artist that is frequently paid under his name and receives 1099s under his ss#. I put these 1099s on a Schedule C on the individual Gross Income... then on page two put in "these amounts have already been reported by S-Corporation Name , Fed #." Been doing this for several years and so far no problems. Not really the correct way but if they absolutely won't do it then the above would be the only way around.

[BHoffman]

I have a client who is an insurance agent for State Farm. He is currently a sole proprietorship, but wants to convert to an S-Corporation.

State Farm will not recognize his corporation and will continue to pay his commissions under his ss# based on how his contract is structured.

He was in contact with somebody from State Farm and they told him his accountant can assign the income from his sole proprietorship to his corporation to get around the fact that State Farm will not pay commissions to his corporation.

Does anybody have any experience with this?

Hi Paul and welcome to the message board

Sch C will show the 1099-MISC income with a corresponding "other" expense in Sch C Part V in the same amount. The description of the other expense is "Nominee" and the EIN. The Sch C will net to zero. I have seen where the Sch C actually issues a 1099-MISC to the SCorp, probably safest to do that.

[PaulF]

Thank you for the information!!

[veritas]

I don't think

assignment of income for personal services will fly under scrutiny.

Tell him to keep paying the self-employment tax since we baby boomers need a steady source of revenue to support us.

[Bees Knees]

I don't think assignment of income for personal services will fly under scrutiny.

I agree. There are many court cases where people tried to assign income to their corporation and the courts refused to recognize the corporation as the one earning the income. Especially in a case where the payer says it has to be the individual earning the income, not the corporation.

I would tell your client State Farm has to recognize the corporation as the payee before I would file a tax return as such.

[solomon]

Agree with Bees and Veritas. Normally the courts follow the fruit tree metaphor - i.e. the fruit of one tree can not be attributed to another tree.

[JoshinNC]

Bees

I agree. There are many court cases where people tried to assign income to their corporation and the courts refused to recognize the corporation as the one earning the income. Especially in a case where the payer says it has to be the individual earning the income, not the corporation.

I would tell your client State Farm has to recognize the corporation as the payee before I would file a tax return as such.

Can you provide one or two of these cases as references?

Thanks in advance!

[BHoffman]

I've always wondered about that....

Won't he be paying SE tax thru payroll as an SCorp officer by taking a reasonable salary? What if his reasonable salary comes out to be the amount of his drawings or less?

I'm wondering when SCorps with no employees, providing services only, will be taxed like Sch C sole proprietors.

Glad you are talking about this. Hope there is more discussion.

[solomon]

Can you provide one or two of these cases as references?

I believe the first was back in the twenties decided by the Supreme Court in Lucas (Commissioner) vs Earl. This gave rise to the substance over form because Earl had a valid contract with his wife. If you search legalbitstream.com I am sure you will find more current ones.

A pertinent part of Arnold ET AL vs Commissioner in TC Memo 2005-256 should clarify it.

[PaulF]

Thank you to everyone who has posted an opinion.

One of my concerns of assigning the income was how it would be viewed in the eyes of the IRS if it was challenged.

This is a problem with State Farm, not the regulations of the IRS.

I have several State Farm clients under older contracts who are incorporated and State Farm recognizes the corporation and pays commissions to the corporation.

The client in question is under State Farm's newest contract for agents.

[DaveO]

I work in a small firm unlike many here that are sole props. The assignment of income was a standard practice here when I started and I never thought to question it till this and similar discussions. I have only anecdotal evidence based on my experience here to offer.

We have a number of clients in various trades that we do this for. We attach a statment indicating the forms by name and ID# which have been reported by the corp, name and ID#. Several times a notice has been issued regrading non-reporting of the income. In every case a letter with the original list from the return has satisfied the service.

I realize this may not be correct and have no court case cites to back it up. Just adding my experience to the discussion.

[Bees Knees]

We have a number of clients in various trades that we do this for. We attach a statment indicating the forms by name and ID# which have been reported by the corp, name and ID#. Several times a notice has been issued regrading non-reporting of the income. In every case a letter with the original list from the return has satisfied the service.

Interesting court reasoning in T.C. Memo. 2005-256 cited by solomon:

http://www.ustaxcourt.gov/InOpHistoric/Arno5ld.TCM.WPD.pdf

Whether Petitioners Improperly Assigned Income From Accounting and Real Estate Services to Their Corporations

Petitioners contend that they did not improperly assign Mr.
Arnold’s accounting income to Pacific and Mrs. Arnold’s real estate commissions to EAPC. Petitioners contend that their corporations earned that income. Petitioners contend that the income at issue is not taxable to them under the assignment of income doctrine because the income was earned by their validly organized and operated corporations. We disagree.

The existence of a validly organized and operated corporation does not preclude taxation of income to the service provider instead of the corporation.

Wilson v. United States, 530 F.2d 772, 777-778 (8th Cir. 1976), Haag v. Commissioner, 88 T.C. 604, 610-611 (1987), affd. without published opinion 855 F.2d 855 (8th Cir. 1988); see also Commissioner v. Culbertson, 337 U.S. 733, 739-740 (1949).

Deciding whether the corporation or the service provider earned the income requires that we decide whether the corporation or its service-performing agent or shareholder controls the earning of the income.

Johnson v. Commissioner, 78 T.C. 882, 891 (1982) (and cases cited therein), affd. without published opinion 734 F.2d 20 (9th Cir. 1984).

A corporation earns the income if:

(a) The service provider is an employee of a corporation which has the right to direct or control that employee in some meaningful sense; and

(b) there exists a contract or similar arrangement between the corporation and the person or entity using the services which recognizes the corporation’s right to direct or control the work of the service provider.

Haag v. Commissioner, supra at 611; Johnson v. Commissioner, supra at 891; see also Leavell v. Commissioner, 104 T.C. 140, 151-152 (1995).

There is your proof. You cannot form a corporation and assign the income to the corporation unless the payer has an arrangement with the corporation to provide the services. Since State Farm specifically will not recognize the corporation as the one being paid and insists on using the individuals SSN rather than the corporation’s EIN, then you CANNOT zero the income out on Schedule C and nominee it to the corporation.

I don’t care how often you have done this in the past, or whether a letter to IRS seems to have solved the issue. Unless it passes the audit test, it is wrong to suggest to a client they can do this. Especially since we have clear evidence from the courts that you cannot do it.

[BHoffman]

"I don’t care how often you have done this in the past, or whether a letter to IRS seems to have solved the issue. Unless it passes the audit test, it is wrong to suggest to a client they can do this. Especially since we have clear evidence from the courts that you cannot do it."

I actually did resolve this very issue with the IRS with a letter. Why did they accept that explanation without question? If my experience shows that the governing body approves of the "nominee income" reporting thing, then how can I equate the obvious evidence presented by Bees AND solomon AND veritas, our Dream Team of very heavy hitters, with what came out of the IRS horse's mouth?

Perhaps it sometimes comes out of the other end?

This is so frustrating.

Thanks for clearing that up.

[DaveO]

I agree BHoffman, it's frustrating when the IRS is so contradictory. I respect and benefit from the knowledge of Bee and the other more learned contributors and certainly don't diagree with the facts presented. This duality of regulation and enforcement is one of the chief flaws (IMHO) of the tax code at all levels.

We have a county level personal property tax here that subjects all personal property held for the production of income to an annual tax of about 2% of its value based on a depreciation schedule that excludes any sort of expensing and differs from the federal rates as to term.

The county won't even trouble themselves to send forms out to the businesses affected by it but will instead levy big penalties on anyone failing to timely file their return. I've never seen audit or enforcement action of any sort other than to levy late filing penalties. Of course most small businesses don't want to file the return or pay the tax. What can I do other than inform them of the requirement and volunteer to complete the return? Some people get angry since "so and so" down the street never MADE them pay the tax.