                               T.C. Memo. 2017-51



                        UNITED STATES TAX COURT



          HOME TEAM TRANSITION MANAGEMENT, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 26590-15.                        Filed March 28, 2017.



      Richard S. Avellone, for petitioner.

      Karen O. Myrick, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      GERBER, Judge: Respondent determined income tax deficiencies of

$50,282, $9,951, and $12,310 for petitioner’s 2011, 2012, and 2013 taxable years,

respectively. Respondent also determined accuracy-related penalties of
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[*2] $10,056.40, $1,990.20, and $2,462 under section 6662(a)1 for petitioner’s

2011, 2012, and 2013 taxable years, respectively. Finally, respondent determined

late filing additions to tax of $12,664.83 and $3,284.43 under section 6651(a)(1)

for petitioner’s 2011 and 2013 taxable years, respectively. After concessions by

the parties,2 the issues remaining for our consideration are: (1) whether petitioner

is entitled to deduct management fees for 2011, 2012, and 2013; (2) whether

petitioner is liable for accuracy-related penalties under section 6662(a) for each

taxable year; and (3) whether petitioner is liable for the late filing addition to tax

for the 2011 taxable year.

                                FINDINGS OF FACT3

      Petitioner, a corporate home healthcare service provider, had its principal

place of business at St. Louis, Missouri, at the time the petition was filed.


      1
      Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
      2
       Respondent conceded that petitioner did not fail to report $8,843 of gross
income for 2011 and that it is not liable for the late filing addition to tax for 2013.
Petitioner on brief presented no argument as to the remaining sec. 6662 penalties
and sec. 6651 addition to tax and conceded that its liability for the penalties and
addition to tax depends upon the Court’s holding with respect to the deductibility
of the management fees.
      3
        The parties’ stipulation of facts and the attached exhibits are incorporated
by this reference.
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[*3] Petitioner provides at-home aid services to assist clients in their daily living

tasks such as bathing, eating, cooking, and grocery shopping. Petitioner also

offers brief visits from a nurse to set out regular medications, monitor vital

statistics, and conduct a range of body exercises with a client.

      Petitioner reports its income and expenses on the cash method of accounting

and filed its 2011 Form 1120, U.S. Corporation Income Tax Return, on March 11,

2013. During the years at issue petitioner’s clientele was 65%-70% Medicaid

funded, 10% Veterans Affairs funded, and 20%-25% privately funded. During the

years at issue petitioner was wholly owned by Sacer Cor Enterprises, Inc. (Sacer

Cor). Sacer Cor purchased petitioner through a combination of owner

contributions, interest-bearing loans funded by the owners, and a corporate loan

from Union Bank.

      Sacer Cor is a Missouri for-profit corporation that was incorporated by

Charles N. Honigfort. Sacer Cor’s shares were held in equal percentages by

Charles and Mary Honigfort and Sean and Ruth Ann Noonan. When Sacer Cor

was incorporated, it was the intention of the four shareholders to acquire in-home

healthcare companies. On October 1, 2010, Sacer Cor acquired petitioner, which

had been an ongoing business since 1994 and had the same four shareholders

(owners) as Sacer Cor. When the owners acquired petitioner, it was owned and
                                        -4-

[*4] operated by an individual who lived in New York State and had an existing

contract with Medicaid. During 2011 through 2013 petitioner was Sacer Cor’s

only holding and no other healthcare companies were acquired.

      After Sacer Cor’s acquisition of petitioner, Mr. Honigfort performed its

daily administrative duties, including operations, payroll, bill payment, monitoring

cash flow, and bookkeeping. Ms. Noonan handled petitioner’s healthcare

management responsibilities. For the three years at issue Mr. Honigfort and Ms.

Noonan received wages from petitioner for the work performed. Mr. Honigfort

and Ms. Noonan provided marketing services to petitioner, for which neither

received additional compensation. Likewise, neither Mr. Honigfort nor Ms.

Noonan received additional compensation from Sacer Cor. During the three years

at issue Sacer Cor did not pay wages or compensate any of the four

shareholder/directors for work performed. Sacer Cor’s four owners (including Mr.

Honigfort and Ms. Noonan) periodically received director’s fees, each receiving

an equal amount. After 2013 Mr. Honigfort and Ms. Noonan received

compensation from petitioner when there was sufficient cashflow to enable

payment.

      Petitioner deducted $120,000, $36,000, and $42,000, claiming that it had

paid those deductions to Sacer Cor for management services for the 2011, 2012,
                                        -5-

[*5] and 2013 taxable years, respectively. Respondent disallowed these

deductions in full. On its corporate returns Sacer Cor reported the management

fees from petitioner as income.

      The $120,000 petitioner deducted as management fees for 2011 had initially

been classified on its books as loans and was reclassified at the end of the year

during the preparation of its return. Likewise, during the year 2011 petitioner

made transfers to Sacer Cor totaling $76,000 that initially were classified on

petitioner’s books as intercompany loans; later, a portion was reclassified as

management fees. At the end of the 2011 year journal entries were made on

petitioner’s books to reduce the balance of the intercompany loans account to

$63,149.

      During 2012 petitioner made transfers of $69,500 to Sacer Cor, which

initially were classified on petitioner’s books as intercompany loans and some of

which were claimed as a management fee deduction on petitioner’s return. The

management fee deduction for funds transferred to Sacer Cor was primarily

determined according to the amount of cash Sacer Cor needed to make outside

loan repayments and also to the amount of fiscal year operating profits of

petitioner and Sacer Cor.
                                         -6-

[*6] Sacer Cor’s board meeting minutes dated July 26, 2010, state that its

directors will periodically review and direct the operations of entities it controls.

The minutes also state that the board will “assess appropriate fees against its

entities for management services performed for them or on their behalf”. The

January 13, 2011, board meeting minutes state: “[D]ue to restricted cash flow

from operations [of petitioner], no member compensation or management fees

would at this point in time be approved or assessed.” Sacer Cor’s June 9, 2011,

board meeting minutes state that for day-to-day management services to petitioner

“it was determined that the amount of twenty-seven thousand dollars ($27,000)

was appropriate for its management services through June 11, 2011.” Likewise,

the December 15, 2011, board meeting minutes state that management fees of

$93,000 were approved for the period June through December 31, 2011. Board

meeting minutes for December 13, 2012, and December 12, 2013, state that the

board approved management fees of $36,000 and $42,000 for those respective

years. Other than those references to management fees in the board minutes there

were no written materials or agreements concerning management fees or

management duties performed.

      The amounts of the management fees deducted were not based upon the

number of hours worked or the particular services performed. Essentially, they
                                        -7-

[*7] were based on the amounts of cash required by Sacer Cor to make its loan

payments and the amounts of cash available from petitioner’s operating profits.

      Respondent examined Sacer Cor’s and petitioner’s returns and determined

that the management fees that had been deducted in reality were dividends to

Sacer Cor. On the basis of that determination respondent disallowed petitioner’s

management fee deductions, and Sacer Cor was entitled to and received refunds of

tax because of a reduction in the income it had reported as management fee

income. Sacer Cor did not protest or contest respondent’s determination that it

was entitled to refunds for the same years that deficiencies were determined for

petitioner.

                                     OPINION

      The seminal issue remaining for our consideration is whether petitioner is

entitled to its claimed deductions for management fees for 2011, 2012, and 2013.

Respondent determined that the management fees were disguised dividends and

not deductible. In support of that determination, respondent argues that no

management services were performed by Sacer Cor or its officers, there was no

written agreement between petitioner and Sacer Cor providing for management

services, and that, in effect, the payments from petitioner to Sacer Cor were

repayments of intercompany loans. Respondent also notes that petitioner remitted
                                         -8-

[*8] funds to Sacer Cor only as long as the intercompany loan was outstanding.

Petitioner disagrees, arguing that Sacer Cor’s board meeting minutes reflect that

management fees were intended and voted by the board for each of the years at

issue. Petitioner also argues that the amount of management fees varied each year

because there was no way of knowing, in advance, the amount of time needed to

manage petitioner.

      Management fees are deductible under section 162 if they are ordinary,

necessary and reasonable payments made for services rendered. See RTS Inv.

Corp. v. Commissioner (RTS), T.C. Memo. 1987-98, aff’d, 877 F.2d 647 (8th Cir.

1989) (RTS); sec. 1.162-7(a), Income Tax Regs. That case involved whether

amounts paid as salaries and management fees in closely held corporations were

reasonable compensation. The Court held that the salaries and management fees

that were paid by a subsidiary were not reasonable where, among other things, the

amount paid was equally distributed to shareholders according to ownership

percentages and was paid in direct relation to the subsidiary’s profitability.

       The Court noted in RTS that where a corporation is controlled by

officer/employees who set their own compensation, special scrutiny must be given

to such salaries, citing Charles Schneider & Co. v. Commissioner, 500 F.2d 148,

152 (8th Cir. 1974), aff’g T.C. Memo. 1973-130. The Commissioner’s
                                        -9-

[*9] determination is presumptively correct, and the taxpayer has the burden of

proving otherwise. Rule 142(a); Botany Worsted Mills v. United States, 278 U.S.

282 (1929).

      Section 1.162-7(b), Income Tax Regs., provides in pertinent part:

          (1) Any amount paid in the form of compensation, but not in fact
      as the purchase price of services, is not deductible. An ostensible
      salary paid by a corporation may be a distribution of a dividend on
      stock. This is likely to occur in the case of a corporation having few
      shareholders, practically all of whom draw salaries. * * *
          (2) The form or method of fixing compensation is not decisive as
      to deductibility. * * *
         (3) In any event the allowance for the compensation paid may not
      exceed what is reasonable under all the circumstances. It is, in
      general, just to assume that reasonable and true compensation is only
      such amount as would ordinarily be paid for like services by like
      enterprises under like circumstances. The circumstances to be taken
      into consideration are those existing at the date when the contract for
      services was made, not those existing at the date when the contract is
      questioned.

      In Friendly Fin., Inc. v. Commissioner, T.C. Memo. 1991-551, 1991 Tax Ct.

Memo LEXIS 599, this Court held that similar payments were distributions of

corporate earnings and profits and not compensation as the payments made were

not in relation to services provided. That case also involved the treatment of

payments made to shareholders of closely held entities. In reaching its conclusion,

the Court provided the following guidance:
                                       - 10 -

[*10] Thus, a taxpayer must show that the amount paid as compensation (1)
      is “reasonable” and (2) is for services actually rendered. Close
      scrutiny is given to deductions claimed for payments made by a
      corporation controlled by those to whom the payments are made. If
      the payments are distributions of earnings, rather than compensation
      for services rendered, they are not deductible. Charles Schneider &
      Co. v. Commissioner, 500 F.2d 148, 151-152 (8th Cir. 1974), aff’g
      T.C. Memo. 1973-130; Home Interiors & Gifts, Inc. v. Commis-
      sioner, 73 T.C. 1142, 1156 (1980). [Id., 1991 Tax Ct. Memo LEXIS
      599, at *35.]

      In this case, we have four individuals who were equal corporate

shareholders in a home care business, petitioner, that they had acquired in 1994.

During 2010 the same four shareholders incorporated another corporation, Sacer

Cor, in which they were equal shareholders, and Sacer Cor acquired ownership of

petitioner, the existing home healthcare business. Two of the shareholders were

employees of petitioner, and they were paid for their services, which included day-

to-day operation of petitioner. The other two shareholders were not employees of

petitioner. None of the four shareholders were employees of Sacer Cor, and no

one, including the four shareholders, was paid a salary for any services rendered to

or on behalf of Sacer Cor. Periodically, the four shareholders of Sacer Cor were

paid equal amounts as director’s fees. There is no credible evidence showing that

any management services were performed by the shareholders or other employees

of Sacer Cor for petitioner.
                                         - 11 -

[*11] Given those facts, petitioner has failed to meet its burden of showing that

the deducted management fees it paid to Sacer Cor were for services rendered

and/or “reasonable” within the meaning of section 162. Exacerbating those

circumstances are the facts that the alleged management fees were originally

booked as loan payments and that the amounts corresponded to petitioner’s ability

to pay; i.e., they varied depending on petitioner’s revenues. We accordingly hold

that respondent’s disallowance of the management fee deductions that petitioner

claimed for 2011, 2012, and 2013 is not in error and is sustained.

      Petitioner has conceded on brief that its liability for the section 6662

penalties and the section 6651 addition to tax depends on this Court’s holding

regarding the deductibility of the management fees. Because petitioner presented

no evidence showing that its actions were reasonable and not negligent or in

disregard of the rules or that its return was timely, the penalty issues are, to the

extent not conceded, decided for respondent.

      To reflect the foregoing,


                                                  Decision will be entered

                                        under Rule 155.
