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Tax Court Pokes Holes in Leasing Scheme

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Generally, if a company officer is paid for services, the amount is subject to payroll taxes as compensation, you can’t avoid tax liability simply by “dressing things up” as something else. A new Tax Court case has something to say on the matter.

 

Sep 7th 2021
Columnist
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In a new case, Bell Capital Management, Inc., TC Memo 2021-74, 6/14/21, payroll taxes were imposed on the sole shareholder of a corporation for lease payments he received from the company.

This is a new twist on an old theme (or scheme). Taxpayers have often concocted clever ways to avoid liability for payroll taxes. This may involve disguising compensation, purporting to be an independent contractor rather than an employer or using other payment methods, including certain leasing arrangements.

The stakes are high. Currently, payroll taxes can take a big bite out of an employee’s paycheck. For 2021, a 6.2 percent Social Security tax applies to a “wage base” of the first $142,800 of compensation. The 1.45 percent Medicare tax applies to all wages.

If the amounts paid are treated as compensation, both the employer and the employee are responsible for their share of the payroll taxes. In addition, employers must withhold taxes on amounts paid to employees.

Facts of the new case: A corporation was formed in 1984 by the taxpayer. He owned 100 percent of the stock and was its sole director. The corporation provided investment services to individual clients and their financial planners in exchange for quarterly fees.

For a number of years, the taxpayer was paid regular salary as an employee. The annual amounts ranged from slightly less than $600,000 to close to $1 million.

However, around 1998, the corporation changed the taxpayer’s compensation structure. It began leasing his services through “offshore employee leasing transactions” (OEL transactions).

As part of the arrangement, the corporation agreed to furnish space on its premises for the taxpayer’s use while he performed personnel services. It also provided an automobile for business use and health, medical and dental insurance as fringe benefits at its sole and exclusive cost. The company then subsequently agreed to similar OEL transactions.

During the following six years, the corporation deducted amounts for the taxpayer’s services through the lease arrangements that typically reached into six figures and topped out at more than $2.4 million in one year.

The Tax Court noted that the corporation continued to list the taxpayer as its president and also treated him as such on its tax returns and other legal documents. In all respects, the Court determined that the leasing arrangements lacked legal substance.

Tax outcome: The amounts paid to the taxpayer constitute compensation that is subject to payroll taxes and withholding.

No matter how creative taxpayers get, the IRS remains on the lookout for disguised compensation schemes. Advise your clients accordingly.  

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