Originally published on Passive Activities and Other Oxymorons on December 29, 2010.
JAMES A. HILL, JR. v. COM TC Memo 2010-268
There were a number of issues in this case, not all of them interesting. For example, you have to report your share of S corporation income even though you don't receive any distributions. One issue was of some interest though. M. Hill and his wife had formed an LLC to purchase property that they intended to develop. The LLC was treated as an S corporation. (This gets me a little suspicious of the quality of the advice they were getting. One of my themes is that the partnership form is generally superior, particularly in real estate, but I don't have enough facts to second guess them here.) Mr. Hill also filed a schedule C for his real estate brokerage business.
Mr. Hill found a likely property for Parkwood and contracted to buy it. At the closing things got a little complicated::
Petitioner attended the real estate closing on February 7, 2003, in his dual capacity as broker and as the purchaser's representative. At the closing, Robert Garrison (Mr. Garrison), the closing attorney, credited to Real Estate North's account $10,000 in earnest money that Real Estate North had been holding in escrow from Parkwood. Mr. Garrison also tendered a check to petitioner, payable to Real Estate North, for $90,000. Petitioner informed Mr. Garrison that he did not want to accept a commission on the sale, and he asked Mr. Garrison to redraft the closing agreement to eliminate Real Estate North's commission. Mr. Garrison refused to redraft the closing documents. Instead, he asked petitioner to endorse the $90,000 check to Mr. Garrison's escrow account. Mr. Garrison then applied the $90,000 to the purchase price of the Huntington Park property. A February 7, 2003, closing statement signed by petitioner indicates that Real Estate North received a $100,000 commission in the transaction. Petitioner, however, did not report the $100,000 commission on his 2003 Form 1040, U.S. Individual Income Tax Return.
The IRS determined that Mr. Hill should recognize the $100,000 commission as income on his schedule C. Mr. Hill argued that he should be able to treat it as having been used to reduce his cost of the property purchased.
The Court sided with the IRS :
First, the record is clear that petitioner did, in fact, realize the commission. Petitioner testified that he asked Mr. Garrison to redraft the closing documents to eliminate the commission, but Mr. Garrison refused. Whatever discussions occurred at the closing, the fact remains that petitioner was tendered a $90,000 commission check and signed the closing statement affirming that Real Estate North received a $100,000 commission in the transaction. The commission was not subject to any limitations or restrictions. Thus, the commission was income when tendered. .....The fact that petitioner did not deposit the check into his or Real Estate North's bank account is immaterial. Petitioner cannot alter the tax consequences of the transaction by claiming, after the fact, that he did not want to accept the commission. ....
Second, both this Court and the U.S. Court of Appeals for the Eleventh Circuit have rejected the argument that a commission paid to a broker or agent who is purchasing for his own account is a purchase price reduction and is not income to the recipient. ..... Thus, even if petitioner had not received the $100,000 commission but instead transferred his rights to the money to Parkwood, the transfer would constitute an anticipatory assignment of income. ......
Finally, we note that “the Commissioner may bind a taxpayer to the form in which the taxpayer has cast a transaction.” ........Petitioner deliberately structured the purchase of the Huntington Park property so that Real Estate North would receive a $100,000 commission. Petitioner cannot avoid paying tax on the income by attempting, after the fact, to recharacterize the commission.
The moral of the story is to not wait till closing to do the tax structuring of a transaction.