This post was originally published on Forbes Apr 3, 2015
If you viewed the Tax Court decision in the case of Midwest Eye Center as a wake-up call for people who have highly profitable professional practices inside C corporations, I think you would be mistaken. The wake-up call was in 1986. This decision is hitting them over the head with a two by four, particularly coming on top of the Vanney Associates, Inc decision late last summer.
Petitioner produced no evidence of comparable salaries. Instead, petitioner argues that there are no “like enterprises” under “like circumstances” from which to draw comparisons. Petitioner argues that Dr. Ahmad's large bonus was reasonable for several other reasons. Petitioner points to Dr. Ahmad's increased workload during 2007 and the various roles that Dr. Ahmad performed, such as CEO, CFO, and COO, and the corresponding managerial duties of those positions. However, petitioner did not provide any methodology to show how Dr. Ahmad's bonus was determined in relation to these responsibilities.
Petitioner did not explain how the amount of the bonus was determined and why it was divided into four payments. Dr. Goyal left in June, and Dr. Ahmad increased his surgeries and therefore billings as a result. Petitioner did not explain how the increased billings translated to bonus payments. Petitioner did not provide evidence to show that the full $2 million bonus was reasonable. Accordingly, petitioner did not meet its burden.
Because petitioner failed to show that the bonus constituted reasonable compensation, we do not reach the issue of whether it was paid or incurred for services actually rendered.
As in any two-front war, a victory on one front might cause problems on the other. A Tax Court victory yesterday for the IRS over an eye doctor who took “too much” compensation may give ammunition to S corporation professional practices that take corporate earnings out via their K-1s and distributions — free of Medicare taxes — rather than as salary and bonus.
Petitioner failed to provide any evidence about the identity of its tax return preparer, the information it provided to its tax return preparer, or whether it relied on the preparer's judgment. Moreover, the tax return preparer did not testify at trial. Petitioner has not shown that it had reasonable cause or acted in good faith.