                              T.C. Memo. 2016-238



                        UNITED STATES TAX COURT



                 RYAN M. FLEISCHER, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 8685-14.                         Filed December 29, 2016.



      Howard N. Kaplan, for petitioner.

      Randall L. Eager, Jr., for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      PARIS, Judge: Respondent determined deficiencies of $14,189, $13,985,

and $13,389 in petitioner’s Federal income tax for 2009, 2010, and 2011,
                                         -2-

[*2] respectively. The only issue for decision is whether petitioner or his S

corporation must report the income earned for the years in issue.1

                                FINDINGS OF FACT

      Some of the facts have been stipulated and are so found. The stipulated

facts and the facts drawn from stipulated exhibits are incorporated herein by this

reference. Petitioner resided in Nebraska when he timely filed his petition.

I.    Petitioner’s Occupation

      Petitioner is a financial consultant, developing investment portfolios for

clients. After graduating from the University of Nebraska with a degree in

business administration, petitioner obtained his series 6, 7, 24, 63, and 65 licenses

so that he could purchase and sell securities under the Securities Exchange Act of

1934 (Act), Ch. 404, 48 Stat. 881 (codified as amended at 15 U.S.C. secs. 78a to

78pp (2006)), and the Financial Industry Regulatory Authority (FINRA) and the

      1
        Respondent also disallowed deductions for certain expenses reported on the
Forms 1120S, U.S. Income Tax Return for an S Corporation, determining that
“certain business expenses that were previously reported on the S Corp return, are
allowed on Schedule C to the extent of ($38,046.00), ($45,019.00), and
($60,844.00) for taxable years 2009, 2010, and 2011, respectively, since the
related expenses were expended and paid for ordinary, [sic] and necessary
business purposes.” The notice of deficiency reflects the parties’ partial resolution
of the deductions for business expenses on Schedules C, Profit or Loss From
Business, and Schedules E, Supplemental Income and Loss (From rental real
estate, royalties, partnerships, S corporations, estates, trusts, REMICs, etc.), for the
years in issue, subject to the resolution of the income issue.
                                         -3-

[*3] North American Securities Administration Association (NASAA) rules.2 He

is also a certified financial planner, a registered financial consultant, and a

licensed seller of variable health and life insurance policies under Nebraska law.

      Petitioner started his career with Waddell & Reed, Inc., an investment firm

that sold proprietary products and performed financial planning. He left Waddell

& Reed, Inc., to work for First National Bank of Omaha, where he again sold

proprietary products to clients. The clients of Waddell & Reed, Inc., and First

National Bank of Omaha were not petitioner’s; he provided advice and services to

his employers’ clients. Wanting to have his own clients and accounts on which to

work--and to provide his clients with varying investment opportunities--petitioner

struck out on his own.




      2
        Pursuant to FINRA and NASAA, the series 6 license allows the licensee to
sell mutual funds, variable annuities, and insurance premiums. The series 7
license is the general securities representative license, which allows the licensee to
sell almost any type of individual security. The series 24 license allows the
licensee to supervise and manage a general securities broker-dealer. The series 63
license is the Uniform Securities Agent License, which allows the licensee to
transact business within a State and is required by every State. The series 65
license is required to provide financial advice or services on a noncommission
basis.
                                        -4-

[*4] II.     Petitioner’s Agreements and Contract

       On February 2, 2006, petitioner entered into a representative agreement with

Linsco/Private Ledger Financial Services (LPL). The agreement expressly states

that petitioner’s relationship with LPL is that of an independent contractor.

Petitioner signed the agreement in his personal capacity.

       After consulting both his business attorney and his CPA, petitioner

incorporated Fleischer Wealth Plan (FWP) and caused it to elect S corporation

status. The Court takes judicial notice of the fact that FWP was incorporated in

the State of Nebraska on February 7, 2006. See Fed. R. Evid. 201. Petitioner was

the sole shareholder and the president, secretary, and treasurer of FWP. On

February 28, 2006, petitioner entered into an employment agreement with FWP.

The agreement expressly states that petitioner’s term of employment with FWP

began on February 28, 2006.

       Petitioner was paid an annual salary to “perform duties in the capacity of

Financial Advisor.” Those duties consisted of: (1) acting in the clients’ best

interests in managing client investment portfolios; (2) expanding FWP’s client

base and the “overall presence” of FWP; (3) drafting and reviewing financial

documents; and (4) representing FWP “diligently and responsibly at all times.”

The agreement gives FWP the right to reasonably modify petitioner’s duties at its
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[*5] discretion. The agreement includes other common provisions found in

employment agreements, such as provisions for the reimbursement of expenses

and how to terminate the agreement, an arbitration clause, and a noncompete

clause. The agreement does not include a provision requiring petitioner to remit

any commissions or fees from LPL or any other third party to FWP. Petitioner

signed the agreement twice--once as FWP’s president and once in his personal

capacity. Outside of the employment agreement, FWP entered into no other

contracts during the years in issue.

      On March 13, 2008, petitioner entered into a broker contract with

MassMutual Financial Group (Mass Mutual). The contract is between petitioner

and MassMutual--there is no mention of FWP in the contract. The contract

explicitly states that there is no employer-employee relationship between

petitioner and MassMutual. Petitioner signed the contract in his personal capacity.

At the time petitioner entered into the contract, he was selling only fixed insurance

products.

      There are no addendums or amendments to either the LPL agreement or the

MassMutual contract requiring those entities to begin paying FWP instead of

petitioner or to recognize FWP in any capacity.
                                        -6-

[*6] III.    Petitioner’s Forms 1040 and FWP’s Forms 1120S

       A.    2009

       For 2009 petitioner reported taxable wage income of $34,851 from FWP on

his Form 1040, U.S. Individual Income Tax Return.3 He attached a Schedule E to

his Form 1040, reporting nonpassive income of $11,924 from FWP. No amount

was reported for self-employment tax, but petitioner did claim a self-employed

health insurance deduction of $1,351 on his Form 1040. There were no Forms

10994 from LPL or MassMutual and no Schedule C attached to petitioner’s 2009

Form 1040.

       For 2009 FWP reported gross receipts or sales of $147,617, total expenses

of $135,693, and ordinary business income of $11,924 on its Form 1120S. The

amount of gross receipts or sales was calculated from the Forms 1099 that LPL

and MassMutual issued to petitioner for 2009.5 The Schedule K-1, Shareholder’s


       3
       Petitioner filed a Form 1040X, Amended U.S. Individual Income Tax
Return, for 2009 to claim the first-time homebuyer credit. No other changes were
made to his 2009 Form 1040.
       4
       Generally, Form 1099-MISC, Miscellaneous Income, is the form used to
report nonemployee compensation. The Court will refer to the form as Form 1099
throughout.
       5
      Although no Forms 1099 are attached to the Federal income tax returns that
were admitted into the record, the parties stipulated that both LPL and
                                                                       (continued...)
                                        -7-

[*7] Share of Income, Deductions, Credits, etc., that FWP issued to petitioner

reported ordinary business income of $11,924.6

      B.     2010

      For 2010 petitioner reported taxable wage income of $34,856 from FWP on

his Form 1040. He attached a Schedule E to his Form 1040, reporting nonpassive

income of $147,642 from FWP. No amount was reported for self-employment tax,

but petitioner did claim a self-employed health insurance deduction of $1,356 on

his Form 1040. There were no Forms 1099 from LPL or MassMutual and only

page 2 of a Schedule C attached to petitioner’s 2010 Form 1040. Petitioner

reported in part V on page 2 of the Schedule C “other expenses” of $284,963.

“Reported by” was typed across from that amount followed by a redacted word or

phrase.



      5
       (...continued)
MassMutual issued Forms 1099 to petitioner in his individual capacity for the
years in issue.
      6
       Generally, an S corporation is not subject to income taxes. Sec. 1363(a).
The corporation’s income, losses, deductions, and credits are passed through to the
shareholders at their pro rata shares. Sec. 1366(a). Because petitioner was the
sole shareholder of FWP, 100% of these items was passed through to him. See
supra p. 4. An S corporation is required to file an information return. Sec. 6037.
Unless otherwise stated, all section references are to the Internal Revenue Code of
1986, as amended and in effect for the years in issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
                                        -8-

[*8] For 2010 FWP reported gross receipts or sales of $289,201, total expenses

of $141,559, and ordinary business income of $147,642 on its Form 1120S. The

reported gross receipts or sales were calculated from the Forms 1099 that LPL and

MassMutual issued to petitioner for 2010. See supra note 5. The Schedule K-1

that FWP issued to petitioner reported ordinary business income of $147,642.

      C.     2011

      For 2011 petitioner reported taxable wage income of $34,996 from FWP on

his Form 1040. He attached to his Form 1040 a Schedule C, showing “Ryan

Fleischer” as both his principal business or profession and his business name and

reporting gross income of $266,292 and “other expenses” of $266,292 for a net

profit or loss of zero.7 Petitioner also attached a Schedule E to his Form 1040,

reporting nonpassive income of $115,327 from FWP. No amount was reported for

self-employment tax, but petitioner did claim a self-employed health insurance

deduction of $1,496 on his Form 1040. There were no Forms 1099 from LPL or

MassMutual attached to petitioner’s 2011 Form 1040.


      7
        Petitioner testified that he “zeroed out” Schedules C and reported all
income from LPL and MassMutual on Schedules E for the years in issue. The
only Federal income tax return from one of the years in issue that fully
corroborates petitioner’s testimony is the return for 2011. While not in issue,
petitioner’s return for 2006, the year he incorporated FWP, also corroborates his
testimony.
                                        -9-

[*9] For 2011 FWP reported gross receipts or sales of $266,292, total expenses

of $150,965, and ordinary business income of $115,327. The reported gross

receipts or sales were calculated from the Forms 1099 that LPL and MassMutual

issued to petitioner for 2011. See supra note 5. The Schedule K-1 that FWP

issued to petitioner reported ordinary business income of $115,327.

IV.   Notice of Deficiency

      Respondent issued petitioner a notice of deficiency, determining

deficiencies of $14,189, $13,985, and $13,389 for 2009, 2010, and 2011,

respectively. Respondent determined under sections 482 and 61 that the gross

receipts or sales FWP reported on its Forms 1120S should have properly been

reported by petitioner as self-employment income on Schedules C attached to his

Forms 1040 for the years in issue. Petitioner timely petitioned the Court

challenging respondent’s determination.

                                    OPINION

      Generally, the Commissioner’s determination of a deficiency is presumed

correct, and the taxpayer bears the burden of proving it incorrect. See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Under certain

circumstances the burden of proof as to factual matters may shift to the

Commissioner pursuant to section 7491(a). Petitioner did not argue for a burden
                                        - 10 -

[*10] shift under section 7491(a), and the record does not establish that he has met

the prerequisites for a burden shift; therefore, the burden of proof remains his.

I.    General and Longstanding Principles of Income Taxation

      It has long been held that the first principle of income taxation is that

income must be taxed to him who earned it. See United States v. Basye, 410 U.S.

441, 449 (1973); Commissioner v. Culbertson, 337 U.S. 733, 739-740 (1949);

Lucas v. Earl, 281 U.S. 111 (1930). While this principle is easily applied between

two individuals by simply asking who performed the services or created the goods,

the question of who earned the income is not so easily answered when a

corporation is involved. For almost as long as this first principle of income

taxation has been in place, the principle that a corporation is a separate taxable

entity has been, too. See Moline Props., Inc. v. Commissioner, 319 U.S. 436, 439

(1943) (citing New Colonial Ice Co. v. Helvering, 292 U.S. 435, 442 (1934), and

Deputy v. du Pont, 308 U.S. 488, 494 (1940)).

      Because it is impractical to apply a simplistic “who earned the income” test

when the Court’s choices are a corporation and its service-provider employee, the

question has evolved to one of “who controls the earning of the income.” Johnson

v. Commissioner, 78 T.C. 882, 891 (1982) (citing Vercio v. Commissioner, 73

T.C. 1246, 1254-1255 (1980)), aff’d without published opinion, 734 F.2d 20 (9th
                                       - 11 -

[*11] Cir. 1984). For a corporation, not its service-provider employee, to be the

controller of the income, two elements must be found: (1) the individual

providing the services must be an employee of the corporation whom the

corporation can direct and control in a meaningful sense, id. (citing Vnuk v.

Commissioner, 621 F.2d 1318, 1320-1321 (8th Cir. 1980), aff’g T.C. Memo.

1979-164); and (2) “there must exist between the corporation and the person or

entity using the services a contract or similar indicium recognizing the

corporation’s controlling position”, id. (citing Pacella v. Commissioner, 78 T.C.

604 (1982), and Keller v. Commissioner, 77 T.C. 1014 (1981), aff’d, 723 F.2d 58

(10th Cir. 1983)). These elements can be found in the employment tax

regulations. Sec. 31.3121(d)-1(c)(2), Employment Tax Regs.; see Sargent v.

Commissioner, 929 F.2d 1252, 1256 (8th Cir. 1991) (“Accordingly, within

Regulation § 31.3121(d)-1(c)(2), two necessary elements must be met before the

corporation * * * may be considered the true controller of the service-provider.”),

rev’g 93 T.C. 572 (1989). Because both elements must be met before the

corporation will be considered to control the service-provider employee and

because the Court finds that there is no contract or other indicium that FWP

exhibited control over petitioner, the Court will discuss only the second element.
                                        - 12 -

[*12] II.    Whether FWP Entered Into a Contract or Other Indicium With LPL or
             MassMutual That Exhibited Its Control Over Petitioner

      On February 2, 2006, petitioner individually entered into a representative

agreement with LPL. There is no mention of FWP in the representative

agreement. Moreover, FWP was not incorporated until February 7, 2006, meaning

it did not exist as a separate entity when petitioner entered into the representative

agreement with LPL. Additionally, petitioner did not enter into an agreement that

purportedly created an employer-employee relationship with FWP until

approximately three weeks later. Therefore, there was no indicium that LPL was

aware that FWP controlled petitioner.

      There is also no mention of FWP in the broker contract petitioner signed

with MassMutual. Petitioner did enter into the broker contract after FWP was

incorporated on February 7, 2006, but he still signed the contract in his individual

capacity. The contract expressly states that there is no employer-employee

relationship between MassMutual and petitioner. There is no mention of FWP in

the contract and no evidence in the record that MassMutual was aware of whether

FWP had any degree of meaningful control over petitioner. Additionally,

petitioner testified that FWP could have signed the broker contract with

MassMutual because fixed insurance products were the only products that would
                                        - 13 -

[*13] be sold. He chose to sign the broker contract in his individual capacity

because of the possibility of selling variable insurance products in the future.

Although the contract with MassMutual allowed petitioner to sell variable

insurance products, he neither testified, nor offered any other evidence, that that

possibility had come to fruition.

III.   Petitioner’s Arguments

       A.    FWP’s Lack of Contracts With LPL and MassMutual

       Petitioner does not dispute that LPL and MassMutual never contracted

directly with FWP. He argues that it was impossible for those entities to do so

because FWP was not a registered entity under the securities laws and regulations.

To support his argument petitioner relies on section 78o, Registration and

Regulation of Brokers and Dealers, of the Act as evidence that FWP could not

enter into representative agreements and broker contracts. See 15 U.S.C. sec.

78o(a)(1) (2006).8 Section 78o(a)(1) of the Act provides:

       It shall be unlawful for any broker or dealer which is either a person
       other than a natural person or a natural person not associated with a
       broker or dealer which is a person other than a natural person (other
       than such a broker or dealer whose business is exclusively intrastate
       and who does not make use of any facility of a national securities

       8
        In 2010, one of the years in issue, Congress amended the Act. See Dodd-
Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124
Stat. 1376. Section 78o(a)(1) of the Act was not modified by that legislation.
                                        - 14 -

[*14] exchange) to make use of the mails or any means or instrumentality of
      interstate commerce to effect any transactions in, or to induce or
      attempt to induce the purchase or sale of, any security (other than an
      exempted security or commercial paper, bankers’ acceptances, or
      commercial bills) unless such broker or dealer is registered in
      accordance with subsection (b) of this section. [15 U.S.C. sec.
      78o(a)(1).]

While section 78o(a)(1) of the Act clearly provides that neither “a natural person”

nor “a person other than a natural person” can effect any transactions in or induce

the purchase or sale of securities unless that person is properly registered to do so,

the section does not prohibit an entity from becoming registered to do so. Indeed,

petitioner did not offer and the Court has not found any substantive authority that

would prohibit FWP from registering to purchase or sell securities under the Act.

Petitioner testified that it would be overly burdensome and “would cost millions

and millions of dollars” for FWP to register under the Act, but he offered no other

evidence to corroborate his testimony. The fact that FWP was not registered, thus

preventing it from engaging in the sale of securities, does not allow petitioner to

assign the income he earned in his personal capacity to FWP. See Jones v.

Commissioner, 64 T.C. 1066 (1975) (holding that a court reporter improperly

assigned income to his personal service corporation because a court reporter was

legally required to be an individual, and although the corporation was a valid

entity, by law it could not perform such services).
                                        - 15 -

[*15] B.     Petitioner’s Reliance on Sargent and Rev. Rul. 70-101

      Petitioner argues that the Court should rule in his favor because Sargent v.

Commissioner, 929 F.2d 1252, is binding precedent and controls. Although

petitioner’s case is appealable to the Court of Appeals for the Eighth Circuit

absent a stipulation to the contrary, see sec. 7482(b)(1)(A), (2), his reliance on

Sargent is misplaced. In Sargent two hockey players formed personal service

corporations that in turn contracted with the hockey team for which they played.

Sargent v. Commissioner, 929 F.2d at 1255. The team paid the corporations, and

the corporations then paid the players a salary and contributed funds to pension

plans for the players. Id. The Court of Appeals held that the taxpayers met both

elements of the Johnson test. Petitioner’s case is distinguishable because, unlike

the taxpayers in Sargent, his corporation had no contractual relationship with LPL

or MassMutual. Moreover, FWP had no contractual relationships outside of the

employment agreement with petitioner.

      Petitioner also relies on Rev. Rul. 70-101, 1970-1 C.B. 278, which states

that the Internal Revenue Service will generally treat professional service

organizations formed under State professional association or corporation statutes

as corporations for tax purposes. Petitioner’s argument is that FWP is a validly

incorporated entity under Nebraska State law and must be recognized as a
                                       - 16 -

[*16] separate, taxable entity. The validity of FWP is not in issue here, and

moreover, the validity of the corporate entity “does not preclude reallocation under

the assignment of income doctrine.” Wilson v. United States, 530 F.2d 772, 778

(8th Cir. 1976).

IV.   Conclusion

      There was no indicium for LPL to believe that FWP had any meaningful

control over petitioner as FWP had not been incorporated and no purported

employer-employee relationship between FWP and petitioner existed at the time

petitioner signed the representative agreement with LPL. Moreover, there is no

evidence of any amendments or addendums to the LPL agreement after FWP was

incorporated. Although FWP had been incorporated before petitioner entered into

the broker contract with MassMutual, FWP is not mentioned in the contract, and

petitioner offered no evidence that MassMutual had any other indicium that FWP

had any meaningful control over him. See Roubik v. Commissioner, 53 T.C. 365

(1969) (holding income earned by individual taxpayers where corporation did not

enter into any agreements with third parties and agreements between physicians in

their independent capacities and third parties continued after corporation was

formed). For the reasons stated above, the Court finds that petitioner has failed to

meet the second element of the control test outlined in Johnson. Because
                                      - 17 -

[*17] petitioner does not meet the second element of the test enumerated in

Johnson, there is no need for the Court to analyze, and the Court makes no

decision as to, whether petitioner was an employee of FWP. Therefore, petitioner

individually, not FWP, should have reported the income earned under the

representative agreement with LPL and the broker contract with MassMutual for

the years in issue.

      The Court has considered all of the arguments made by the parties, and to

the extent they are not addressed herein, they are considered unnecessary, moot,

irrelevant, or without merit.

      To reflect the foregoing,


                                                     Decision will be entered

                                               for respondent.
