Monday, May 8, 2017

The Taxation of LLC Member Distributions for Broker Dealers | Bethesda Tax Lawyer

In today’s blog, I’d like to look at another case, Fleischer v. Commissioner (2016), that deals with the reporting of income.  In this case, Ryan Fleischer, a financial advisor with various securities-trading licenses, had left his prior employment with an investment firm to work on his own.  To this end, he secured a contract with Linsco Financial Services, which he signed in his personal capacity. Shortly thereafter, Fleischer incorporated his own business, Fleischer Wealth Plan (FWP), as an S corporation. He then entered into an employment agreement with this entity, entitling him to an annual salary in exchange for various services rendered.  Shortly thereafter, he personally entered into a broker agreement with Mass Mutual, but neglected to include Fleischer Wealth Plan in that agreement.

When he filed his taxes in 2009, Fleischer reported wages of $34,851 and nonpassive income of $11,924 from FWP (which, the company’s returns stated, had $147,617 against expenses of $135,693).  In 2010 and 2011, he reported a similar $34k salary, but the S-corp generated nonpassive income of $147,642 and $115,327, respectively.  The IRS later responded by issuing notices of deficiency for all three of these years, noting that the gross receipts or sales reported by FWP should have been classified as self-employment income by Fleischer.

Fleischer challenged this determination, requiring that the court sort out who earned the income:  the corporate entity or Fleischer himself.  In the case of sole proprietors or employees of companies who are paid salaries or commissions, this is easy enough--the individual earns the income.  But here, the presence of a corporation makes the analysis more challenging.  Fleischer, operating under the assumption that his S-corp had earned these large amounts of nonpassive income, had filed taxes related to FWP asserting that this was so.  

In order to ascertain who earned the income, the court evaluated “who controlled the earning of the income.”  This test, more complicated than a simple examination of “who earned the income,” necessitated that two elements be proven true for Fleischer’s earlier assessment of his S-corporation’s tax status to stand:  first, “the individual providing the services must be an employee of the corporation whom the corporation can direct and control in a meaningful sense”; and second, “there must exist between the corporation and the person or entity using the services a contract or similar indicium recognizing the corporation’s controlling position.”  

In this instance, the fact that Fleischer contracted without mentioning FWP in the documents, including his contract with Mass Mutual after FWP had been formed, indicated that Fleischer, not FWP, controlled the earning of the income (in fact, Fleischer specifically omitted mention of FWP in his contract with Mass Mutual because he hoped to enter another side of the insurance sales business in the future).   Fleischer contended that he had to assign the income to FWP while contracting in his personal capacity because the S-corp did not have the same securities-trading licenses he did, and acquiring them would be financially ruinous, but the court gave no weight to this argument.  

In short, Fleischer was assessed deficiencies because he structured his business contracts improperly and then assigned income to his S-corp that he should have paid taxes on himself.  Had Fleischer actually wished to avoid this situation, he likely could have done so with better advice about tax and contract law.

For a free phone consultation regarding assignment of income to a corporation, the self-employment tax, or other tax matters, please contact the Law Office of Aaron P Richter, a Bethesda-based tax law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.