In an attempt to avoid some income from his psychiatric practice from being subject to federal self-employment tax, a Denver psychiatrist with the help of his CPA/attorney set up two corporations to perform certain management services. Trouble was neither corporation did anything. Neither had employees or assets and in the case of one, it didn’t even have a bank account. Nevertheless the psychiatrist operated his practice as if the companies were for real and thereby deflected some income away from his W-2.
The Tax Court, in Robucci v. Commissioner, T.C. Memo. 2011-19 (filed January 24, 2011) saw through this canard. The court first noted that “a corporation will be recognized as a separate taxable entity if (1) the purpose for its formation is the equivalent of business activity or (2) the incorporation is followed by the carrying on of a business by the corporation.” (citing Moline Props., Inc. v. Commissioner, 319 U.S. 436 (1943) and Achiro v. Commissioner, 77 T.C. 881 (1981). The court also quoted Judge Learned Hand (I love that name) who wrote in Nat’l Investors Corp. v. Hoey, 144 F. 2d 466 (2d Cir. 1944) that “to be a separate jural person for purposes of taxation, a corporation must engage in some industrial, commercial, or other activity besides avoiding taxation….”
As mentioned, the two corporations set up by Robucci didn’t do anything. They looked quite impressive on paper, but in fact, they couldn’t do anything. They didn’t have assets or employees in order to perform any “industrial, commercial, or other activity besides avoiding taxation.” Both were disregarded by the court for tax purposes and their income was allocated to the psychiatrist as a sole proprietor.
- Marc Ward