Assign income from sole proprietor to corporation

[Bees Knees]

I can’t believe this. Are you serious?

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?

Did you get a private letter ruling for your specific case telling you what you did was OK?

Did you get any kind of response letter back from IRS with the name of the IRS employee who said you can assign income to a corporation without the payer's consent?

I doubt it.

This is no different than having a client call the IRS with a tax question and having a less than 50% chance the IRS idiot on the other end of the phone will give your client a correct answer. And then have the client tell you that you are wrong because the IRS phone person said they could do something stupid.

Common, people!

In this day and age of IRS penalties against tax preparers, you all should know better.
Please read Regulation § 1.6694-2 http://www.thetaxbook.com/updates/th...eg1.6694-2.pdf. Writing a letter to the IRS in response to their letter and then having them do nothing is NOT Substantial authority!

[Bees Knees]

Btw

Reg. § 1.6694-2(b)(2)

(2) Authorities. The authorities considered in determining whether a position satisfies the more likely
than not standard are those authorities provided in §1.6662–4(d)(3)(iii) (or any successor provision)

An IRS employee voicing an opinion over the phone on any tax matter is not included in the list of authorities provided in §1.6662-4(d)(3)(iii).

An IRS employee voicing an opinion in a letter on any tax matter is not included in the list of authorities provided in §1.6662-4(d)(3)(iii), unless it is a Private Letter Ruling or Technical Advice Memoranda

The IRS accepting your letter of explanation is not included in the list of authorities provided in §1.6662-4(d)(3)(iii).

An IRS auditor's opinion is not included in the list of authorities provided in §1.6662-4(d)(3)(iii).

An IRS appeals officer's opinion is not included in the list of authorities provided in §1.6662-4(d)(3)(iii).

In short, other than a published position, the IRS is simply not an authority in which you can take a position and avoid the $1,000 penalty for screwing up your client's tax return.

[BHoffman]

Did you get a private letter ruling for your specific case telling you what you did was OK?

Did you get any kind of response letter back from IRS with the name of the IRS employee who said you can assign income to a corporation without the payer's consent?

I doubt it.

This is no different than having a client call the IRS with a tax question and having a less than 50% chance the IRS idiot on the other end of the phone will give your client a correct answer. And then have the client tell you that you are wrong because the IRS phone person said they could do something stupid.

Common, people!

In this day and age of IRS penalties against tax preparers, you all should know better.
Please read Regulation § 1.6694-2 http://www.thetaxbook.com/updates/th...eg1.6694-2.pdf. Writing a letter to the IRS in response to their letter and then having them do nothing is NOT Substantial authority!

Well, I'll certainly be be sure to read Regulation § 1.6694-2 while soaking my burning behind in ice water after THAT spanking

[BHoffman]

Glutton for punishment

Here goes:

I am looking at IRC Sec 482.

This seems to me to be the substantial authority if the tax effect will be same whether the income is reported on Sch C or on 1120S.

If the salary taken by the shareholder is reasonable and in excess of the amount reported to him on 1099-MISC, but always at least the amount reported on 1099-MISC, then I think Sec 482 applies.

...and I could be wrong, but if you disagree please accept that I'm making an honest mistake here and appreciate patience.

Thanks

[solomon]

Here goes:

I am looking at IRC Sec 482.

This seems to me to be the substantial authority if the tax effect will be same whether the income is reported on Sch C or on 1120S.

If the salary taken by the shareholder is reasonable and in excess of the amount reported to him on 1099-MISC, but always at least the amount reported on 1099-MISC, then I think Sec 482 applies.

...and I could be wrong, but if you disagree please accept that I'm making an honest mistake here and appreciate patience.

Thanks

§482 regulations cover a controlled group transfer pricing with their affiliates as well as the appropriate methodologies to use. I do not believe §482 has any bearing on the assignment of income as suggested in the original post as well as in the Arnold case.

[geekgirldany]

I also found TC Memo 2007-168 relating to the same case.

What I am getting that neither taxpayers had their s-corps pay them a payroll. Any money they got out was classified as loans. Seems to me as long as taxes are paid on the income received then reassignment is possible. If the S-Corp is in control of the employee or a contract exsists between the S-Corp and employee then the Corporation earned the income.

Just my opinion in reading it.
====

From the case:
"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).

Petitioners admitted that there was no contract between Mr. Arnold and PCI recognizing the right of PCI to control Mr. Arnold's performance of services. There is no credible evidence that Mrs. Arnold contracted with EAPC to perform real estate services or that EAPC controlled Mrs. Arnold in some meaningful sense.

We conclude that EAPC did not control Mrs. Arnold's performance of real estate services and that PCI did not control Mr. Arnold's performance of accounting or return preparation services. Accordingly, we sustain respondent's determination that petitioners are subject to self-employment tax in 2002 and 2003 on income from their accounting/return preparation and real estate activities.

[BHoffman]

§482 regulations cover a controlled group transfer pricing with their affiliates as well as the appropriate methodologies to use. I do not believe §482 has any bearing on the assignment of income as suggested in the original post as well as in the Arnold case.

Text from IRC Sec 482:

"Sec. 482. Allocation of income and deductions among taxpayers

In any case of two or more organizations, trades, or businesses
(whether or not incorporated, whether or not organized in the
United States, and whether or not affiliated) owned or controlled
directly or indirectly by the same interests, the Secretary may
distribute, apportion, or allocate gross income, deductions,
credits, or allowances between or among such organizations, trades,
or businesses, if he determines that such distribution,
apportionment, or allocation is necessary in order to prevent
evasion of taxes or clearly to reflect the income of any of such
organizations, trades, or businesses. In the case of any transfer
(or license) of intangible property (within the meaning of section
936(h)(3)(B)), the income with respect to such transfer or license
shall be commensurate with the income attributable to the
intangible."

I'm reading this to be the reason why IRS chooses not to disallow the transfer of income from the Sch C sole proprietor to the SCorp as long as the Scorp is paying salary of the greater of the amount reported on the 1099-MISC or what would be considered reasonable compensation.

Dany posted information that indicates the reason the income was recharactized by the tax court was because it was proven to be tax evasion where NO Soc Sec or Medicare tax was paid, and I totally agree. I believe this is the deciding factor.

If sufficient amounts of SS and Med tax are paid in accordance with either the reasonable salary requirements for SCorp shareholders or in accordance with the amount reported on 1099-MISC, whichever is higher, then there is no tax evasion. IRC Sec 482 was the cite I found that seemed to support this.

Very grateful for your attention and comments.

[Snaggletooth]

The Secretary

Plenty of divided opinion amongst knowledgeable people. BHoffman, arise from your whelps and bruises and hang in there. You are among our best.

However, I think your cite is the result of knocking on the wrong door. I believe this section is to apply to "controlled groups" - a different environment entirely than the channeling of revenue into an obvious phony entity created by an individual. The "controlled group" issue is hardly the same.

But even this cite has a ring of reality check when it portends that "The Secretary" has the right to allocate or reallocate as seen fit to properly represent the income. Usually this kind of language refers to the Secretary of the Treasury and not the Secretary of the Corporation, and allows the IRS (in the name of "fairness" of course) to rearrange income in such manner as to maximize tax collections.

I'm thinking the best support available to this insurance agent would be to find an economic reason for the creation of his corporation OTHER than this obvious dodge of the SE tax.

For purposes of the central issue involved, I support Bees, especially the reliance upon IRS personnel. However, I do disagree with him that this provides fodder for preparer penalties. The issue has broad disagreement on this board, and were it presented to the entire tax prep community-at-large there would be considerable disagreement. Far from obvious, and not the blatant disregard and abuse that the IRS should be looking for when assessing penalties.

Even though I think Bees is correct, there is enough grey area here that, as a preparer, I would not be acting as an IRS collections officer against this client.

[BHoffman]

Snags

This is a good and interesting conversation

Believe the insurance agent can recharacterize income from Sch C to 1120S provided that:

Salary is reasonable. AND Reasonable Salary is at LEAST the amount of what is reported on 1099-MISC.

This is the whole point of Sec 482: Income that is recharactized between two or more businesses that are controlled by one party (Sch C sole proprietor vs. SCorp sole shareholder) must not result in a lesser tax than would otherwise result. The sole proprietor and the SCorp are two businesses controlled by a common taxpayer and therefore, I believe, qualify as a "controlled group".

This is my interpretation, and I believe the IRS via the Secretary of the Treasury use this Code Sec to allow the recharacterization. Perhaps I'm naive, but I believe the IRS does have some method behind its madness, and does not indulge in arbitrarily allowing the illegal reporting of income. IRS consistently approves reporting 1099-MISC income as nominee income to an SCorp, and there must be a reason why. So, what is that reason? I say it's IRC Sec 482. That is the one which makes the most sense.

I believe if the SCorp pays no salary at all, then the IRS might rightly challenge the recharacterization as happened in the forementioned court cases. Otherwise, they may be content that no tax evasion is taking place and allow the income to be recharacterized.

The big reason to create a corporation is to limit liability. Does the agent employ others? Did the agent sign a lease agreement for office space? Does the agent rent or lease equipment? Does the agent intend to do so in the near future?

I guess I'm pursuing this is because the darned IRS seems to consistently approve the letters we write when questioned. Well, I wonder, why do they? They must have some direction from somewhere.

So, that sparks my curiosity and sometimes gets my butt spanked rosy red but this line of work requires a good measure of risk-taking and I refuse to approach it with a faint heart. We seemingly mild mannered accountants are vastly under-rated and under-represented in reality TV shows.

[Snaggletooth]

Controlled Groups

Beth, I still believe the context of "controlled groups" does not apply to an insurance salesman. (Refer to Solomon's post above)

A typical "controlled group" issue would be three commonly owned C-corps allocating one of the corps as being eligible for the surcharge exemption at lower tax rates. Or the transfer price of a sold commodity from one commonly owned corporation to another.

I'm not questioning your credibility, but are you telling us you have had this same (or similar) issue arise with clients more than once, and the IRS has repetitively allowed this on multiple occasions? Or have I misunderstood? I don't think this would happen to me more than once in fifty years...

[BHoffman]

Beth, I still believe the context of "controlled groups" does not apply to an insurance salesman. (Refer to Solomon's post above)

A typical "controlled group" issue would be three commonly owned C-corps allocating one of the corps as being eligible for the surcharge exemption at lower tax rates. Or the transfer price of a sold commodity from one commonly owned corporation to another.

I'm not questioning your credibility, but are you telling us you have had this same (or similar) issue arise with clients more than once, and the IRS has repetitively allowed this on multiple occasions? Or have I misunderstood? I don't think this would happen to me more than once in fifty years...

"In any case of two or more organizations, trades, or businesses
(whether or not incorporated, whether or not organized in the
United States, and whether or not affiliated) owned or controlled
directly or indirectly by the same interests"

Based on this language, I believe the business operations reported on Sch C and the business operations reported on 1120S qualify as a controlled group if the sole proprietor and the sole shareholder are one and the same person. I very respectfully disagree with solomon.

How many others have had the same experience? Geekgirldany, DaveO, and I all admit to at least one. Other forums prescribe to the nominee treatment. Local colleagues I asked when this issue first occurred advised me to report this as nominee income. This is not uncommon and I've seen it discussed on other forums. Always the same result: IRS either accepts without question, or accepts explanation that it was reported on 1120S or 1065 or 1120.

Big question: Why does the IRS allow this treatment? I believe Sec 482 is the answer. Because it's up to the Secretary to decide, and the Secretary decides to allow it in this case and Sec 482 allows the Secretary to deny it in that case depending on the circumstances.

[taxxcpa]

Since the IRS allows it....

Should you, as a tax preparer, be stricter than the IRS?

Since numerous instances have been cited indicating the IRS accepts deducting amounts on Schedule C and adding them to the Corporate income, I would not hesitate to adopt that approach. Several years ago, I had a client who had to do it that way and that's the way I did it.

Based on what I've read in this discussion, I would continue to do it that way. If the IRS continues to allow it, no harm done. If it begins disallowing it, then I would discontinue doing it that way.

[Bees Knees]

Based on what I've read in this discussion, I would continue to do it that way. If the IRS continues to allow it, no harm done. If it begins disallowing it, then I would discontinue doing it that way.

I had a new client say to me years ago that he has always deducted his hair cuts as a business expense because as a business man, he needs to look his best. The IRS never questioned that deduction on his tax return.

What would you say? Would you continue to allow him to deduct his hair cuts?

There is a difference between the IRS not challenging your return because they never officially examined your return, verses the IRS publishing a stated position for you to follow.

So far, there has been court cases cited where the assignment of income to a corporation is not allowed, unless the payer has an agreement with the corporation to render the services. Stating that the IRS never challenged the way you filed a return is not an equal counter to the court case cited. Not even an IRS audit where the position was never challenged equates to a cited court case, as is evident in the regulations I cited earlier.

I also disagree with Snag on the preparer penalties issue. The penalties apply when you shoot from the hip. That is, you have no substantial authority to back up your position. Cite a court case, a reg, a code section, an IRS Pub....anything published to support your position. IRS non-action is not a citation.

As to Section 482, it reads as follows:

In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. In the case of any transfer (or license) of intangible property (within the meaning of section 936 (h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible.

That is a nice try for a citation. However, there is one flaw. It supports my argument, not yours. It says the IRS (the Secretary) may do the assignment of income to another business entity, including a Schedule C to a corporation, or a corporation to a Schedule C. Nothing in that code section says the taxpayer can do this. Thus, when the IRS does in fact examine your client’s return and finds out you did this even though the payer had no agreement with the corporation to render the services, Code Section 482 gives the IRS the authority to disregard the corporation and make the individual pay the tax.

Nice try. But you will have to try again.

[Bees Knees]

What I am getting that neither taxpayers had their s-corps pay them a payroll. Any money they got out was classified as loans. Seems to me as long as taxes are paid on the income received then reassignment is possible. If the S-Corp is in control of the employee or a contract exsists between the S-Corp and employee then the Corporation earned the income.

That is a good observation. However, you have to be careful not to confuse the issue. Court cases always have a number of issues being discussed that interrelate to each other. The real issue in this case was the corporation set up by the taxpayer was not paying a wage to the shareholder. Those cases are always lost by the taxpayers.

However, the court, in making their argument against the taxpayer makes this one side issue comment:

"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.

The court says there is a requirement that there be a contract or similar arrangement between the corporation and the one paying for the services (in this case, State Farm). That requirement exists regardless of whether the service provider is an employee of the corporation or not. Notice the word “and” being used between requirement (a) and (b). If the court had said “or” between requirement (a) and (b), then I would agree with you that a corporation paying a wage to the shareholder is all that is required. But that is not what the court said. It says both requirements must be met before you can assign the income to the corporation.

[taxxcpa]

Drawing conclusions

I stand by my comment: Should we be stricter than the IRS?

Deducting a haircut is not a relevant comparison unless you can find situations where the IRS has allowed it after someone 'explained' it.

The previous comments have indicated that the IRS has accepted such treatment after it was explained to them. That is much different than getting by with something just because it slipped through.

1099s are often issued in error. Even if a non-owner employee of the corporation performed the services, a payer might issue a 1099 to the owner's SSN.

There might be some room for doubt in the situation under discussion if there was a contract with the individual and not with the corporation, but otherwise, I would think it would be appropriate to take a course of action to transfer the income to the corporation.

If the IRS does not follow the rule that has been cited it seems to be similar to the law of adverse possession in Real Estate. If you allow someone to use your property and don't object for several years, they have acquired it by adverse possession.