I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox 👇 Also on YouTube at PlugAccountingandTax!
Can You Put that Income in a S-Corp?
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Two hockey players for the Minnesota North Stars ran their NHL contracts through their own corporations and beat the IRS in the 1980s. A financial advisor did the same thing in the 2010s with his commissions and got assessed $41,563 in self-employment tax. Same structure, same idea, opposite outcomes. The difference had nothing to do with the entity type, the election, or the bookkeeping. It came down to whose name was on the contract with the people writing the checks. This is a terrifying reality for taxpayers being sold into S-Corps. They set up the LLC, run payroll, set up QBO for it - but never change the underlying contracts or economic substance. Let's dive in to what you need to know 👇 Your S-corp only owns the income it controlsThe rule is 96 years old. In Lucas v. Earl, decided in 1930, a lawyer and his wife signed a contract agreeing that everything either of them earned would be owned by both of them jointly. The Supreme Court said no. You are taxed on what you earn, and you cannot hand that off by signing a piece of paper. The Tax Court's current working version comes from Johnson v. Commissioner, a 1982 case involving a pro basketball player, and it has two parts. Both have to be true. First, ☝️ you have to be an employee of your corporation, and the corporation has to be able to direct and control what you do. Second, ✌️ there has to be a contract, or something that functions like one, between your corporation and the person paying it, that recognizes your corporation is the one in charge. Johnson lost. His club sent money to a corporation, but nothing in the arrangement put that corporation in control of his services. The IRS assessed deficiencies of $100k+ across three years. Put plainly: if the person paying you never agreed to pay your company, it isn't your company's money. The advisor who did everything right except the one thing that mattered 🧾Fleischer v. Commissioner, 2016... This is the case every commission earner needs to know. Ryan Fleischer signed his representative agreements with LPL Financial and MassMutual personally. Then he formed an S-corp, Fleischer Wealth Plan, made himself the only shareholder, and started running his commissions through it. He never went back and changed the agreements to name the company. The numbers: $147,617 in commissions in 2009, $284,963 in 2010, $266,292 in 2011. He paid himself about $35,000 in salary each year and took the rest as distributions, roughly $275,000 over three years that skipped self-employment tax. The court moved all of it to his personal return. $41,563 in self-employment tax, plus interest and penalties. Notice what was not wrong. The S-election was valid. The payroll ran. The corporate returns were filed. He lost because the broker-dealer's contract had his name on it and not the company's, and a corporation cannot earn income under an agreement it isn't a party to. What the hockey players had that Fleischer didn't 🏒 > 🏦In Sargent v. Commissioner (the hockey jocks), Gary Sargent and Steven Christoff each set up a personal service corporation, and the North Stars contracted with those corporations. The corporations then paid the players a salary and funded their pension plans. The Tax Court sided with the IRS (against the taxpayer). But the Eighth Circuit reversed in 1991, holding the players were employees of their own corporations rather than of the team. In Foglesong v. Commissioner, a salesman formed a corporation in 1966, kept 98% of it, and worked exclusively for it. The corporation held the customer contracts, not him. The Tax Court pushed the income onto his personal return, but the Seventh Circuit reversed. 🔀 The corporation was real, it contracted with the customers directly, and he worked only for it. The pattern across every case the taxpayer won: the corporation was in the contract before the money moved. There's a second hurdle if you hold a license, and it isn't a tax rule at all. State licensing law often decides whether the brokerage can legally pay your entity in the first place. In California, a corporation generally has to hold its own real estate license, with a designated licensed officer, before commissions can be paid to it. Insurance producers and securities reps run into the same wall. Fleischer's realistic fix was to license or register the entity itself, which is exactly the step people skip. You can get too cute here. The CaveatSection 269A is aimed squarely at "loan-outs." 👀 It lets the IRS reallocate income between a personal service corporation and its owner when substantially all of the corporation's services go to one other business and the main reason the corporation exists is tax avoidance. Historically speaking, the courts have found the "principal purpose of tax avoidance" is a high bar. Things like limiting liability and centralizing administration and management of the business can be powerful counter-arguments. But still beware. The TakeawayAn S-corp doesn't earn income by existing. It earns income by being the party in the contracts. Fix the contract before you form the entity. Get the agreement changed to name the company, get the company licensed if your state requires it, and get the payor to sign with the company. But beware the 269A risks. I'm a CPA, but I'm not your CPA. All of this turns on your specific facts, so run it past your own advisor before you move a dollar. 🫡 Group Chat Worthy Posts 🔥📲
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I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox 👇 Also on YouTube at PlugAccountingandTax!
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