The responsibility of the citizen of a country it is to pay our taxes honestly without any acts of omission. The great nation of ours runs on a Federal structure where it allows its citizens necessary freedom to file their tax return voluntarily without any restriction. The agents of Internal Revenue Service, here in after to be called only as IRS for the sake of brevity of the document, is responsible for assessing and evaluating tax. It is often found that there is omission or commission on the part of the taxpayers to reduced overall tax burden of the person unethically. Using any unethical practices by the tax payer would make the person liable to different penal provisions relevant to unethical practices identified. However, the Federal structure of the country also allows us to file protest against the findings of an agent of IRS to fight on the facts of the case thus, if the tax payer beliefs that he / she has not used any unethical means to obtain undue advantage by paying less tax than what he / she was liable to pay.
According to the mail of IRS agent it has been alleged by that the defendant, PC in this case, has attempted to subvert the income earned to it by transferring the earnings to different individuals. The agent has mentioned the facts of Commissioner v. Culbertson, 337 U.S. 733 (1949) case where the judge has specifically adjudged that the income must be taxed at the hand of the earner. If any subverting tactics are used the same shall be defeated by adding the amount in the taxable income of the person to whom the earnings have been incurred before the subversion or diversion as the case may be.
In order to understand the facts of the case better to write an effective protest it would be very helpful to discuss the facts of the case in hand. This would be extremely helpful to the readers of the document to evaluate the facts and accordingly in writing an effective letter to protest the assessment of the IRS agent.
A professional corporation named PC is engaged in general practice of law with D, E and F as equal shareholders of the corporation, i.e. PC. These are along with the equal shareholders of the entity in question are also its principal officers and directors. Estate of John Smith appointed D as its attorney to fight its case in the wrongful death action against Interdistrict Telephone Company. After a long drawn legal process in the above case the parties to the Estate of Smith decide to enter into a settlement agreement in the year 2010. It was decided in the agreement that pertaining to the settlement the a lump sum payment will made to D which will include fee of D as well as the receipts for the Estate of Smith. Accordingly, a payment of $ 3,000,000 was made to D w3hich included his payment too. Subsequent to the receipt of $3,000,000 D distributed E and F $1,000,000 each and accordingly mentioned the receipt of $3,000,000 in C schedule of 2010 Form 1040 to claim deduction on the disbursed amount of $2,000,000. After disbursing the amount D issued forms 1099 in respect of miscellaneous receipts to E and F for the above amount. Following the due tax procedure E and F mentioned the receipts of $1,000,000 in their respective schedules C for the year 2010.
The IRS agent after the due verification of the above has decided to include the entire sum of $3,000,000 in the income of the PC as it has been considered the income of the organization. In case of the entire sum of $3, 0000,000 the decision of the agent is as follows. The agent has decided to characterize the entire amount as distribution of dividends in the hands of D, E and F. Based on the above let us explain the position of PC as well as the individual tax payers D, E and F respectively in regards to proposition made by the IRS agent.
While making the above propositions the agent of Internal Revenue Service has used the reference of Commissioner v. Culbertson, 337 U.S. 733 (1949). Thus, let us take an in-depth view of the above case to find out whether there is relevant grounds for the agent to use the above case reference in relation to the facts of the case in hand. In this case the facts of the case was based on the premise that the actual earner has diverted its income by using contractual agreement to reduce its income tax liability. Thus, the judge while making decision in relation to the above case mentioned, that using subversion or diversion measures to subvert or divert the earnings from the true earner to others by using contractual agreement would be considered deflection of income and thus, shall be dealt with accordingly. The judge further mentioned that using clever measures to deflect incomes away from organization to other organizations using contractual agreement would not be considered a valid practice and will thus, be included in the income of the true earner.
In Lucas v. Earl, 281 U.S. 111 (1930); U.S. v. Basye, 410 U.S. 441 (1973)” the above rule was further glorified as the judge seconded the verdict while making order in the case. The fact of the case in this document has similarities with the above cases from the point of view of the entity in question. Here D, E and F all are attorneys of PC and hence, they are working for the organization and all the incomes accrued to them from them being representing the organization will firstly be the income of the organization, i.e. PC and not their individual income as it has been shown by the individual attorneys in their Schedule C. The lump sum payment of $3,000,000 made by the party involved in the case between the Estate of Smith and the Interdistrict Telephone Company was made to PC and not to the individual attorneys thus, the income of $3,000,000 has firstly been accrued to the entity providing the general practice support in relation to law of the land in the country. Thus, as to the receipt of the above amount the question whether it is the income of the entity to which D, E and F are equal shareholders or their individual income is beyond any doubt. Thus, the agent has been quite correct while referring to the case of diversion of income in case of assessing the income of the organization in question. However, the second proposition of the agent of IRS as to including the amount $1,000,000 each received by the respective attorneys of PC D, E and F which will already be included in the income of the organization and thus accordingly to be taxed is a fact on which further discussion is necessary to evaluate whether the same is justified or not. The agent while asking to include the $1,000,000 each received by the attorneys of PC, D, E and F respectively trusted the judgment made in the case of Johnson v. Commissioner, 78 T.C. 882 (1982); IRC §301(c); Treas. Regs. §1.301-1.” According to the verdict in this case where the judge made the following observation in relation to the income received by the common shareholders of an organization.
In summarizing the above specific points the judge while making decision in the case of Johnson v. Commissioner, 78 T.C. 882 (1982); IRC §301(c); Treas. Regs. §1.301-1″ said earnings which are corporate in nature and received by the shareholders directly including professional fees will be included in the gross total income of the entity.
The agent relying on I.R.C. §162(a) and Treas. Regs. § 1.162-7 for this position had declined the proposition of the shareholders of PC, D, E and F respectively that since the fees received by the attorney are corporate income they should be allowed as compensation payment for the services rendered by the shareholders.
On the basis of the above it seems that proposition of the IRS agent as far as it is concerned with the inclusion of the whole amount received by D from the settlement of case between the Estate of Smith and Interdistrict Telephone Company in the gross total income of PC. However, an in-depth analysis of few more cases in relation to the above would be even more helpful to the readers of the document along with the evaluation of the second proposition of the IRS agent. There it is contended that the individual receipts of $1,000,000 from the cases would have to be considered as dividend income in the hands of the recipient from PC.
In Charles Johnson, Petitioner v. Commissioner of Internal Revenue, Respondent case the petitioner was a professional basketball player entered into a contract with an entity which was not related to the petitioner at any levels. According to the agreement the professional basketball player agreed to provide his skills in basketball only for the organization for a limited period of time on the condition that the petitioner would be paid agreed monthly sum by the organization. According to the contract the professional basketball player provided his services to a club as asked by the entity with whom the player had signed the agreement. The club accordingly remitted the compensation to the corporation however there was no agreement between the club and the corporation. The judge held that the remittances of the amount by the club was the income of the professional basketball player and the corporation while receiving the amount from the club has only received the money as a trustee for the p[professional basketball player and is obligated to pay the sum to the player as provided in the contract. Taking clue from the above case it can be inferred that the amount received by D from the settlement of case between the two parties as mentioned in this document is the income of the corporation of which he, i.e. the attorney D is a shareholder. PC and thus the receipt is the income of the entity and accordingly shall be included in the gross total income of the entity to assess the tax liability of the entity.
In HOME JUICE COMPANY, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent, similar views was expressed by the judge in the above case to further solidified the already established rule that the income received by the shareholders on behalf of the company or an entity as the case may be irrespective of its application would first have to be included in the gross total income of the company or the entity as the case may be. There after according to the application of the income necessary treatment shall be carried out.
However the proposition of the agent in respect of treatment of the amount of $1,000,000 to the individual shareholders as receipt of dividend from the organization, i.e. PC is up for debate. Here the professional attorneys have received their fees from the settlement a case. The amount is not a distribution of the profit of the company to which they are shareholders after adjusting all necessary expenditures incurred by the organization in running the operations of the entity for a particular period. Thus, before even determination of profit of the entity how can the agent propose that the amount of fees received by the shareholders who are professional attorneys as distribution of profit. It is to be remembered that the cardinal rule in relation to the distribution of dividend is that dividend must be distributed only out of profits of an organization and generally the dividend is declared at the end of a financial year at the Annual General Meeting of an entity after considering the recommendations of the Board of Directors or such appropriate authority in case of an entity which is not a company. However, it is also to be understood though that dividends can also be declared before the end of the financial year, known as interim dividend. However, the fees paid to the shareholders who are also professional attorneys are in the nature of dividend or not has to be decide after considering all relevant aspects associated with the facts of the case. Here the settlement of a case has brought certain funds to the organization for the efforts of the attorneys. The lump sum amount of $3,000,000 has been received from the settlement which includes the fees for the attorneys. The above amount has been distributed by the shareholders equally amongst themselves as they are equal shareholders. There have been no decision in respect of the above to show that the above is distribution of profit and thus, the question of treating the above sums in the hands of the individual shareholders as dividend would not make any sense whatsoever. Thus, in this regard the proposition of the agent of Internal Revenue Service of country is seems not correct.
Conclusion:
Based on the above discussion it is clear that the option of protest that the shareholders have in front of them to contend the propositions of the IRS agent. The second proposition of the agent where he contends to include the individual receipt of $1,000,000 as dividend in the hands of the shareholders. However, protesting the proposition of the agent where he has contended that the lump sum amount of $3,000,000 from the settlement of the particular case should be included in the gross total income of PC is seems very much on the lines with decided case laws in this regards as mentioned throughout the document. Thus, the decision of protesting the propositions of the agent shall accordingly, be taken.
Reference
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