he Tax Court ruled that “royalties” paid to a C corporation’s officer were wages for which the corporation was liable for payroll (for example, Social Security, Medicare and unemployment) taxes ( Charlotte’s Office Boutique, Inc., 121 TC no. 6 (2003)). The case teaches CPAs how not to structure a self-employed client’s transfer of intangibles to a corporation.
On incorporation Odell purportedly did not transfer ownership interests in her customer lists and contracts. Instead, she entered into a “licensing and sale agreement” that set forth a royalty fee, based on gross receipts, stemming from the transfer of her “know-how,” “existing contracts” and “woman-owned-business status,” and also executed employment and rental agreements with the C corporation. She was to be paid $400 a month under the employment agreement.
The corporation paid Odell rent, wages and royalties, and sporadically filed employment tax returns. In 2001, after an employment tax audit, the IRS issued a notice reclassifying Odell as the corporation’s employee.
In Tax Court the IRS established that Odell, as a corporate officer, was performing significant services for the corporation and receiving remuneration. This is the definition of employee ( Veterinary Surgical Consultants, P.C., 117 TC 141 (2001)).
TAX COURT’S RULING
Employment tax relief. The next issue was the availability of section 530 relief under the Revenue Act of 1978. If such relief is granted, the employer is not liable for employment taxes on the amounts reclassified as wages. There are three requirements:
The taxpayer did not treat the individual as an employee for any period.
For all periods beginning after 1978, the taxpayer’s returns consistently treated the individual as a nonemployee.
There was a reasonable basis for not treating the individual as an employee.
The Tax Court held that the corporation failed to meet the last requirement; its cites did not support the proposition that it reasonably believed the payments to Odell were made to her as a nonemployee.
For more information, see the Tax Clinic, edited by Michael Koppel, in the December 2003 issue of The Tax Adviser.
—Lesli Laffie, editor