While S corporations can be an effective means to reduce FICA taxes, the form of the arrangement must be consistent with the taxpayer’s intended reporting position(s). The S corporation, not the S corporation’s employee-shareholder, must be in control of the receipt of income in order shift income from the shareholder’s personal income tax return to an S corporation. After the fact tax planning to shift income to an S corporation by utilizing Schedule C with “reported on” or nominally including income reported to the shareholder on Form 1099 but zeroing out the income out with a deduction or expense could easily fail if challenged by IRS.


The taxpayer in Fleischer v. Commissioner[1] is a financial consultant, who develops investment portfolios for clients. The taxpayer had a number of licenses (series 6, 7, 24, 63, and 65), so that he could purchase and sell securities under the ’34 Act, FINRA, and NASAA rules.

The taxpayer started his career with an investment firm. Eventually, the taxpayer opened his own business so that he could have his own clients and accounts.

The Taxpayer’s Setup

On February 2, 2006, the taxpayer signed an agreement, in his personal capacity, to act as an independent contractor with a financial services firm (“LPL”).  Five days later, on the advice of his business attorney and CPA, the taxpayer set up a corporation (“Newco”) and caused the newly formed corporation to elect S corporation status. On February 28, the taxpayer entered into an employment agreement with Newco. For his service, the taxpayer received an annual salary.  This is a classic tax plan designed to reduce the taxpayer’s FICA taxes. For a recent summary of the strategy see this recent post link.

On March 13, 2006, the taxpayer and Mass Mutual Financial Group (“Mass Mutual”) entered into a broker contract, which made no reference to Newco. The contacts with LPL and Mass Mutual did not require payments to Newco and they did not recognize Newco in any capacity.

Both LPL and Mass Mutual issued Forms 1099 to the taxpayer, in his personal name, for 2009, 2010, and 2011.

Tax Return Reporting

For 2009, 2010, and 2011, the income and expenses associated with taxpayer’s financial consulting business were reported on Newco’s Form 1120S and flowed through to the taxpayer on Form K-1.  The taxpayer reported wages received from Newco on his personal income tax return.  In addition, the taxpayer took steps to deal with the Form 1099s that he received in his name.

As most tax return professionals are aware, if items reported on Forms 1099 are not reported on the taxpayer’s return, then the IRS’s On-Line TIN Matching Program computers will automatically kick out “matching notices” (i.e., CP2000).[2]

On his 2009 personal return, the taxpayer did not take any steps to address the Form 1099s he received.

On his 2010 personal tax return, the taxpayer attached Schedule C page 2 in and reported a majority of his gross sales as “other expenses” and typed “Reported by” across the top of his return. These are the same sales that were reported on Newco’s Form 1120S. No amount was reported for self-employment tax.

On his 2011 personal return, he attached a Schedule C with the taxpayer’s name as the name of the business and as his principal business or profession. On Schedule C, the taxpayer reported gross income of $266,292 and “other expenses” of $266,292 for a net profit or loss of zero. No amount was reported for self-employment tax.

The taxpayer did not attach any Form 1099 to any of his personal income tax returns for 2009, 2010, or 2011.[3] Although the taxpayer paid no self-employment tax, he claimed a deduction for self-employment health insurance deduction for 2009, 2010, and 2011.


Income must be taxed to him who earns it. This case turns on the question of who earned the income: the taxpayer or his corporation.  In the context of a corporation and service-provider employee, the Tax Court has refined the analysis to who controls the income from the services rendered.

“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, 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’”.[4]

The Tax Court’s analysis cited to a several cases applying the two element test. One dealt with a NBA Player’s Panamanian tax planning and the other dealt with a doctor that owned a professional corporation.

NBA Player’s Panamanian Tax Planning

In Johnson v Commissioner, the taxpayer was a NBA player that received advice from an attorney to save on taxes. Under the attorney’s advice, the taxpayer setup a Panamanian corporation to contract directly with the San Francisco Warriors. The taxpayer also signed an employment agreement with the Panamanian corporation. Presumably, the idea was to shift the taxpayer’s income to a lower tax jurisdiction.

When the taxpayer approached the Warriors about the contract, the Warriors would not agree to contract with the Panamanian corporation because they wanted the taxpayer to be contracted under a uniform NBA player’s contract. However, the Warriors did agree to pay over the taxpayer’s salary directly to the taxpayer’s Panamanian corporation if the taxpayer assigned his rights.

The Tax Court held that since the taxpayer in Johnson had the legal right to control the income, he was the taxpayer that earned the income. The Tax Court could not find a relationship between the Warriors and the taxpayer’s Panamanian corporation sufficient to satisfy the second element of the test. Therefore, the taxpayer’s attempt to assign his income to his Panamanian corporation was ineffective.

Doctor versus Professional Corporation

In Pacella v. Commissioner[5],  the taxpayer, a doctor, established a personal services corporation to run his medical practice.  Despite the lack of a contract between the doctor and his patients, the Tax Court held that the medical fees earned were taxable to the PC and not personally to the doctor.

The Tax Court held that the PC controlled the right to the patient fees because the PC had contracted with the doctor for his services and the PC was the separate legal entity whose separate status was, for the most part, respected.

The Tax Court rejected the IRS’s argument that the lack of a contract between the doctor and the PC was determinative. The IRS also argued that the patients did not have contracts with the PC.

The Tax Court found that the since the patients were billed by the PC on PC’s letterhead and the PC otherwise dealt with the patients, the patients believed that they were dealing with the PC. Most importantly, the PC, through its contract with the taxpayer, controlled the receipt of funds from services rendered by its employee (i.e., the taxpayer). Therefore, the second element of the control test was fulfilled, and, the PC, and not the doctor, earned the patient fees for federal income tax purposes..

Application in Fleischer

In Fleischer, Newco did not have a contract with either LPL or MassMutual. The court found that LPL and MassMutual had no indication that Newco had any control over the taxpayer (i.e., through Newco’s employment contract with the taxpayer). As a result, LP and MassMutual had no indication that they were dealing with an employee of Newco. Therefore, the Tax Court held that taxpayer did not meet the second element of the control test.

The taxpayer argued that the it was a legal impossibility for Newco to contract with LPL and MassMutual because Newco was not registered under applicable securities laws and regulations. The Tax Court indicated that Newco could have been registered but the taxpayer chose not to cause Newco to register. The fact that it would have been expensive is no defense. The Tax Court held that failure to register Newco does not allow the taxpayer to side-step the second element and assign his income to Newco.

The Tax Court also noted that it was not disputing Newco’s validity as a corporation. However, it takes more than merely forming a corporation to have income attributed to the corporation.


The key takeaway for taxpayers with closely-held service based businesses, is that in order to effectively utilize S corporation FICA planning, the arrangement must be legally structured so that the corporation is in “control.” Control is found where both (i) there is an employee agreement; and (ii) there is either a contract between the corporation and the person or a similar indicium recognizing the corporation’s controlling position.

Without the necessary control, the IRS will be able to reallocate the income to the taxpayer’s Schedule C, which effectively negates the planning. Attempting to deflect income reported on Form 1099  by attaching a Schedule C (i.e., by showing income and equal deduction and “reported on”) to the recipient’s personal tax return is not sufficient to shift the actual control over the income.

Finally, the “control” test is important to keep in mind when considering any tax planning in which income from a key employee’s services must be “earned” by the employer-corporation (e.g., performance based compensation planning).


[1] T.C. Memo. 2016-238 Link to Tax Court opinion.

[2] The Matching Program includes Real Estate Brokers and Barter Exchange Transactions (1099-B); Dividends and Distributions (1099-DIV); Interest Income (1099-INT); Merchant Card Third Party Network Payments (1099-K); Miscellaneous Income (1099-MISC); Original Issue Discount (1099-OID); Taxable Distributions Received from Cooperatives (1099-PATR).

[3] It is not clear whether the taxpayer paper filed or efiled. If he efiled, it is plausible that it difficult or impossible to attach a Form 1099 in 2009, 2010, or 2011 to the efile submission.

[4] Citing Johnson v. Commissioner, 78 T.C. 882 (1982) (link).  In Fleischer, the Tax Court noted that the control elements can be found in the employment tax regulations. Treas. Reg. § 31.3121(d)-1(c)(2) (link).

[5] 78 T.C. 604 (1982) (link).