                               T.C. Memo. 2015-53



                         UNITED STATES TAX COURT



                MIDWEST EYE CENTER, S.C., Petitioner v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 14053-13.                          Filed March 23, 2015.



      Alan F. Segal, for petitioner.

      Kathryn E. Kelly and Mayah Solh-Cade, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      KERRIGAN, Judge: Respondent determined the following deficiencies and

addition to tax with respect to petitioner’s Federal income tax for tax years 2007

and 2008:
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                [*2]                                     Penalty
                Year             Deficiency            sec. 6662(a)
                2007             $313,062                $62,612
                2008                  7,608                 -0-

      Unless otherwise indicated, all section references are to the Internal

Revenue Code (Code) in effect for the years at issue, and all Rule references are to

the Tax Court Rules of Practice and Procedure.

      The issues for consideration are (1) whether the amount paid to petitioner’s

sole executive and shareholder in 2007 constituted reasonable compensation under

section 162(a)(1); and (2) whether petitioner is liable for an accuracy-related

penalty under section 6662(a). Other adjustments in the notice of deficiency are

either derivative or computational and will be resolved on the basis of the Court’s

disposition of the disputed issues.

                               FINDINGS OF FACT

      Some of the facts are stipulated and are so found. Petitioner was a

corporation in Illinois when the petition was filed.

      Petitioner was an ophthalmology surgery and care center during the tax

years at issue. Petitioner operated four locations and employed around 50

employees during the 2007 tax year. Of these 50 employees, 5 were physicians

who could perform surgery, 3 were optometrists, 3 were nurses, 2 were surgical
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[*3] technicians, 10 were nonsurgical technicians, and 15 were nonadministrative

employees. The remaining employees served administrative functions. Petitioner

had at least one manager at each of its four locations, a full-time billing specialist,

a number of front office staff, and a bookkeeper.

      Dr. Afzal Ahmad (Dr. Ahmad) was petitioner’s president, medical director,

and 100% shareholder. Dr. Ahmad was also petitioner’s chief executive officer

(CEO), chief operation officer (COO), and chief financial officer (CFO). These

positions required him to perform various managerial tasks. He was also an active

surgeon in the practice. Dr. Ahmad received a salary of $30,000 every two-week

pay period. He also received a substantial bonus at the end of each year. During

the tax years at issue his compensation was:

                                                             Total
        Year           Salary             Bonus           compensation
       2007          $780,000          $2,000,000           $2,780,000
       2008           690,000           1,100,000            1,790,000

      Dr. Ahmad’s bonus for 2007 was paid out via four separate checks totaling

$500,000 each. The dates of these payouts were: November 8, November 21,

December 5, and December 20, 2007.
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[*4] In 2007 Dr. Ahmad’s workload increased because of two events. First, one

of petitioner’s busier surgeons, Dr. Goyal, quit unexpectedly in June. As a result

Dr. Ahmad was required to take over Dr. Goyal’s prescheduled patients. Second,

petitioner’s only other retinal specialist, Dr. Irma Ahmed (Dr. I. Ahmed), began to

reduce her workload because she planned to leave to begin her own practice. Dr.

Ahmad began taking on Dr. I. Ahmed’s patients in anticipation of her departure.

During the relevant years the billings of each physician were:

                                                 Dr. I.           Total
        Year     Dr. Ahmad      Dr. Goyal        Ahmed           billings
        2007     $5,401,915      $743,354       $1,554,937   $15,512,343
        2008       4,931,361        -0-           921,973      14,040,135

Tax Returns

      Petitioner filed timely Forms 1120, U.S. Corporation Income Tax Return,

for the years at issue. Petitioner reported gross receipts of $7,309,385 and

$6,742,374 for 2007 and 2008, respectively. It reported a tax loss for 2007 and

taxable income of zero for 2008.

      Petitioner hired a professional return preparer to aid in the preparation of its

returns. On its 2007 return petitioner deducted $2,780,000 for Dr. Ahmad’s

compensation. On its 2008 return petitioner deducted a net operating loss

carryforward of $50,434.
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[*5] Notice of Deficiency

      Respondent disallowed $1 million of the claimed bonus compensation

deduction for 2007. Respondent determined that this amount was a disguised

dividend rather than bonus compensation. As a result of that adjustment,

respondent also disallowed deductions for $29,000 of the claimed taxes and

licenses expenses for 2007 and all of the claimed net operating loss carryforward

for 2008. Respondent also determined that petitioner was liable for an accuracy-

related penalty under section 6662 of $62,612 for 2007.

                                    OPINION

I.    Burden of Proof

      Generally, the Commissioner’s determinations in a notice of deficiency are

presumed correct, and the taxpayer bears the burden of proving that those

determinations are erroneous. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111,

115 (1933). The taxpayer likewise bears the burden of proving its entitlement to

deductions allowed by the Code and of substantiating the amounts of items

underlying claimed deductions. INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

84 (1992); sec. 1.6001-1(a), Income Tax Regs. Under section 7491(a), in certain

circumstances, the burden of proof may shift from the taxpayer to the

Commissioner. Petitioner has not claimed or shown that it meets the requirements
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[*6] of section 7491(a) to shift the burden of proof to respondent as to any

relevant factual issue. The burden of proof remains with petitioner.

II.   Section 162

      Deductions are a matter of legislative grace and are allowed only as

specifically provided by statute. INDOPCO, Inc. v. Commissioner, 503 U.S. at

84; New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Taxpayers are

required to substantiate each claimed deduction by maintaining records sufficient

to establish the amount of the deduction and to enable the Commissioner to

determine the correct tax liability. Sec. 6001; Higbee v. Commissioner, 116 T.C.

438, 440 (2001).

      Section 162(a)(1) allows taxpayers to deduct “ordinary and necessary

expenses”, including a “reasonable allowance for salaries or other compensation

for personal services actually rendered”. Thus, compensation is deductible only if

(1) reasonable in amount and (2) paid or incurred for services actually rendered.

See sec. 1.162-7(a), Income Tax Regs. Whether amounts paid as wages are

reasonable compensation for services rendered is a question of fact to be decided

on the basis of the facts and circumstances of each case. Estate of Wallace v.

Commissioner, 95 T.C. 525, 553 (1990), aff’d, 965 F.2d 1038 (11th Cir. 1992).

Bonuses paid to employees are deductible “when * * * made in good faith and as
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[*7] additional compensation for the services actually rendered by the employees,

provided such payments, when added to the stipulated salaries, do not exceed a

reasonable compensation for the services rendered.” Sec. 1.162-9, Income Tax

Regs.

        Petitioner contends that it is entitled to deduct the full amount of Dr.

Ahmad’s compensation as an ordinary and necessary business expense under

section 162. Respondent asserts that $1 million of Dr. Ahmad’s bonus

compensation is a disguised dividend.

        A.    The Independent Investor Test

        For compensation to be deductible, it “may not exceed what is reasonable

under all the circumstances.” Sec. 1.162-7(b)(3), Income Tax Regs. The Court of

Appeals for the Seventh Circuit, in Exacto Spring Corp. v. Commissioner, 196

F.3d 833, 839 (7th Cir. 1999), rev’g Heitz v. Commissioner, T.C. Memo. 1998-

220, has held that to determine whether payments of compensation are reasonable,

an “independent investor test” should be applied. See also Mulcahy, Pauritsch,

Salvador & Co. v. Commissioner, 680 F.3d 867 (7th Cir. 2012), aff’g T.C. Memo.

2011-74; Menard, Inc. v. Commissioner, 560 F.3d 620, 623 (7th Cir. 2009), rev’g

T.C. Memo. 2004-207. If the independent investor test applies then there is a
                                        -8-

[*8] rebuttable presumption that the compensation payment was reasonable. See

Exacto Spring Corp. v. Commissioner, 196 F.3d at 839.

      Both petitioner and respondent contend that petitioner is not entitled to the

presumption provided by the independent investor test.1 Therefore, the

presumption of reasonableness is not applied to petitioner.

      B.     Reasonableness

      Without the presumption of reasonableness petitioner must show that the

bonuses paid to Dr. Ahmad were otherwise reasonable. Generally, “reasonable

and true compensation is only such amount as would ordinarily be paid for like

services by like enterprises under like circumstances”. Sec. 1.162-7(b)(3), Income

Tax Regs. Similarly, the Court of Appeals for the Seventh Circuit has

acknowledged that when the presumption does not apply “other factors besides the

percentage of return on equity have to be considered, in particular comparable

salaries.” Mulcahy, Pauritsch, Salvador & Co. v. Commissioner, 680 F.3d at 871.

Evidence of comparable salaries is helpful only if it “takes into account the details




      1
        Although the presumption would be applied to petitioner’s benefit,
petitioner contends on brief that it is impossible to generate a meaningful
comparison of petitioner’s business because there are no businesses sufficiently
similarly situated. Because of this lack of comparability, petitioner contends that
the independent investor test cannot be applied.
                                         -9-

[*9] of the compensation package of each of the compared executives, and not just

the bottom-line salary.” Menard, Inc. v. Commissioner, 560 F.3d at 623.

      Petitioner produced no evidence of comparable salaries. Instead, petitioner

argues that there are no “like enterprises” under “like circumstances” from which

to draw comparisons. Petitioner argues that Dr. Ahmad’s large bonus was

reasonable for several other reasons. Petitioner points to Dr. Ahmad’s increased

workload during 2007 and the various roles that Dr. Ahmad performed, such as

CEO, CFO, and COO, and the corresponding managerial duties of those positions.

However, petitioner did not provide any methodology to show how Dr. Ahmad’s

bonus was determined in relation to these responsibilities.

      Petitioner did not explain how the amount of the bonus was determined and

why it was divided into four payments. Dr. Goyal left in June, and Dr. Ahmad

increased his surgeries and therefore billings as a result. Petitioner did not explain

how the increased billings translated to bonus payments. Petitioner did not

provide evidence to show that the full $2 million bonus was reasonable.

Accordingly, petitioner did not meet its burden.

      Because petitioner failed to show that the bonus constituted reasonable

compensation, we do not reach the issue of whether it was paid or incurred for

services actually rendered.
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[*10] III.    Section 6662(a) Penalty

        Respondent determined that petitioner is liable for an accuracy-related

penalty pursuant to section 6662(a) for tax year 2007. Section 6662(a) imposes a

20% penalty on any underpayment attributable to, among other things, negligence

or disregard of rules or regulations within the meaning of subsection (b)(1), or any

substantial understatement of income tax within the meaning of subsection (b)(2).

Only one accuracy-related penalty may be applied with respect to any given

portion of an underpayment, even if that portion is subject to the penalty on more

than one of the grounds set out in subsection (b). Sec. 1.6662-2(c), Income Tax

Regs. The amount of the understatement is reduced to the extent it is attributable

to a tax treatment for which the taxpayer had substantial authority. Sec.

6662(d)(2)(B). Substantial authority for a tax treatment exists only if the weight

of the authorities supporting the treatment is substantial in relation to the weight of

the authorities supporting contrary treatment. Sec. 1.6662-4(d)(3)(i), Income Tax

Regs.

        Petitioner, as a corporation, bears the burden of proving that it is not liable

for the accuracy-related penalty pursuant to section 6662(a). See NT, Inc. v.

Commissioner, 126 T.C. 191, 195 (2006).
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[*11] The penalty is applicable if the underpayment is attributable to a substantial

understatement of income tax as defined in section 6662(d)(1)(A). See Janis v.

Commissioner, T.C. Memo. 2004-117, slip op. at 28, aff’d, 469 F.3d 256 (2d Cir.

2006). In the case of a corporation (other than an S corporation or a personal

holding company), the phrase “substantial understatement of income tax” means

an understatement that exceeds the lesser of (1) 10% of the tax required to be

shown on the return for the taxable year (or, if greater, $10,000) or (2) $10

million. Sec. 6662(d)(1)(B). As discussed above, petitioner understated its tax by

$313,062 for 2007. Petitioner’s return shows a tax loss for 2007. Because this

understatement exceeds $10,000 and exceeds 10% of the total tax required to be

shown on the return, the understatement was substantial.

      Petitioner therefore is liable for the accuracy-related penalty unless it can

show it had reasonable cause for and acted in good faith regarding the

underpayment. See sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. For

purposes of section 6664(c) a taxpayer may establish reasonable cause and good

faith by showing reliance on professional advice. Sec. 1.6664-4(b)(1), Income

Tax Regs. A taxpayer relies reasonably on professional advice if he or she proves

the following by a preponderance of the evidence: (1) the adviser was a

competent professional who had sufficient expertise to justify reliance, (2) the
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[*12] taxpayer provided necessary and accurate information to the adviser, and (3)

the taxpayer actually relied in good faith on the adviser’s judgment. See

Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299

F.3d 221 (3d Cir. 2002); see also Rule 142(a); Welch v. Helvering, 290 U.S. at

115.

       Petitioner failed to provide any evidence about the identity of its tax return

preparer, the information it provided to its tax return preparer, or whether it relied

on the preparer’s judgment. Moreover, the tax return preparer did not testify at

trial. Petitioner has not shown that it had reasonable cause or acted in good faith.

       Additionally, petitioner failed to show that it is entitled to a partial reduction

of the penalty pursuant to section 6662(d)(2)(B) because it did not show that it

relied on substantial authority for its tax treatment of the bonus payments.

       Accordingly, petitioner is liable for the accuracy-related penalty under

section 6662(a) to the extent of the understatement as calculated herein.

       Any contentions we have not addressed are irrelevant, moot, or meritless.

       To reflect the foregoing,


                                                  Decision will be entered for

                                         respondent.
