“Too Good to Be True” Arrangement Lacks Business Purpose

The Tax Court disregarded for tax purposes a multilevel-entity structure for a taxpayer’s psychiatry practice, holding the taxpayer liable for unpaid self-employment taxes on the practice’s net income.

Tony Robucci had conducted his practice in Colorado as a sole proprietorship until 2001, when, at his request to minimize his taxes, his attorney-accountant recommended an organizational structure involving an LLC and two corporations. Robucci adopted this arrangement without seeking additional advice. The LLC conducted the practice and had two members, Robucci and a professional corporation. A second corporation was formed to manage the business of the practice but was not involved in patient care. Robucci was the sole shareholder of both corporations. The LLC was 95% owned by Robucci and 5% by the PC as a limited partner. Robucci’s 95% ownership interest was further split between an 85% interest as a limited partner and a 10% interest as a general partner. The limited partner ownership percentage purportedly reflected Robucci’s capital contribution of intangibles (that is, his goodwill) to the LLC.

However, Robucci made no written assignment of assets from his practice to the LLC, nor did he have an employment agreement with any of the corporations, and none of them had any employees. Neither corporation paid a salary to Robucci nor to anyone else in subsequent years. The LLC deducted “management fees” for each year in question, but didn’t specify to whom they were paid or for what services. Furthermore, Robucci continued to bill Medicare and Medicaid as an individual practitioner under his own Social Security number, and the LLC and the corporations maintained the same business address as that of his previous sole proprietorship. The two corporations also did not have separate telephones or websites, nor did they advertise. Robucci’s Schedule SE, Self-Employment Tax, on his Form 1040 listed as earnings from self-employment only an amount corresponding to his 10% general partner interest in the LLC.

Upon examination, the IRS argued that the entities lacked legitimate business purposes and were created solely for the purpose of tax avoidance. Robucci argued that one of his corporations performed oversight and management services and that the other corporation managed and tracked expenses. He also stated that the organizational structure provided him with superior protection against personal liability. However, the Tax Court determined that neither corporation was formed for a valid business purpose. There was no evidence that either corporation performed any services for the LLC, and they had no employees or assets (other than the interest in the LLC). Instead, the overall facts of the case showed that Robucci’s practice was conducted in exactly the same manner after the formation of all three entities as it was before their formation.

The Tax Court’s disregarding the corporations rendered the LLC as a single-member LLC for which no protective election to be classified as an association under Treas. Reg. § 301.7701-3(a) had been made. As a result, the LLC was also treated as a disregarded entity, and Robucci was treated as a sole proprietor for tax purposes. The net income from the psychiatry practice during the years in issue, 2002 through 2004, (including the alleged management fees) was considered self-employment income and subject to self-employment tax at 15.3%.

An accuracy-related substantial understatement penalty also was assessed. Although Robucci argued he had relied on the advice of his attorney-accountant, the court held that such reliance wasn’t reasonable where the tax result was “too good to be true.” The fact that the entities were devoid of property, personnel to run them, or day-to-day activities should have warned Robucci that no meaningful change in the conduct of his practice had actually taken place, the court said. By not making further inquiries into the arrangement’s “efficacy,” Robucci failed to exercise the ordinary business care and prudence required of him under the circumstances, the court said.

• Tony L. Robucci v. Commissioner, TC Memo 2011-19

By Steven C. Thompson, CPA, Ph.D., McCoy Professor of Business, Texas State University, San Marcos, Texas.

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