Whenever a tax planner begins using jargon you don’t understand, you either ask for clarification or you move on to another professional who can explain things more clearly. In Robucci (T.C. Memo. 2011-19), the taxpayer did neither.
Dr. Robucci, a psychiatrist, went to his CPA-attorney-tax planner to find a way to minimize the self-employment tax he paid on income from his practice. The suggestion: Converting his sole proprietorship to two “alphabet” entities, an LLC and a corporation.
To effect the plan, Dr. Robucci formed legal corporations under Colorado law, signed various corporate documents including loans and business and medical reimbursement plans, and transferred some money into a corporate bank account. Then he proceeded to conduct business as usual.
The problem: Business as usual meant the corporations existed as “hollow shells.” The IRS said they served no significant purpose or function other than tax avoidance, and should be disregarded.
The court agreed. Disregarding the corporations put Dr. Robucci back to his tax status as a sole proprietorship, making all his income subject to self-employment tax–the very result he had intended to avoid. In addition, the court said Dr. Robucci had no reasonable cause for relying on his tax advisor and held him liable for accuracy-related penalties.
Even worse, the court stated the plan might have worked, at least in part, had Dr. Robucci’s new corporations created a “meaningful change.” (Despite the IRS position, the court points out that tax law in regard to self-employment taxation of profit distributions to members of professional service LLCs continues to be uncertain.)
Taxing Lesson: In tax, few things are as simple as ABC-123. In the words of the tax court:
“When a taxpayer is presented with what would appear to be a fabulous opportunity to avoid tax obligations, he should recognize that he proceeds at his own peril.”