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Aspro v. Commissioner: IRS Denies Deductions For Management Fees of C Corporation

The Eighth Circuit Court of Appeals sustained a tax court’s ruling that management fees for C corporation shareholders could be taxed as dividends. This case highlights the importance of careful documentation and accuracy in preparing tax returns.

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Aspro v. Commissioner

An asphalt paving company in Iowa, Aspro, Inc., is incorporated in the state of Iowa and treated as a subchapter C corporation for federal tax purposes. The company’s tax returns were recently examined by the IRS. It was discovered that the company was not paying dividends to its stockholders, and had not since the 1970s with the exception of one year. Instead, it had been paying out what it called “management fees” for at least 20 years. Unfortunately for Aspro, there were no written agreements between Aspro and its three shareholders regarding these fees, and there was no employment contract for its president.

After examination, the IRS denied the deductions that had been made for the management fees, stating that Aspro had not established that these fees were paid or incurred for ordinary and necessary business purposes, as required by the tax code. Instead, the IRS believed the management fees were actually disguised distributions that were paid out to the three shareholders.

Aspro filed a petition to challenge the IRS’s conclusions, but the tax court denied their appeal. The company then appealed to the Eighth Circuit Court, who examined the case and ultimately denied the deductions.

Failure to Establish Deductible Business Expenses

The panel found multiple problems within Aspro’s arguments. They agreed with the Tax Court and the IRS that Aspro had not sufficiently established
or demonstrated that the management fees were deductible business expenses. In their case, Aspro did not present evidence showing what similar companies would pay for comparable services, nor did they quantify the value of those services. The lack of written agreement regarding the fees was also determined to be a significant issue.

The court also noted that the actual amount of management fees was very similar to the percentage of ownership interest held by each shareholder, and were incidentally paid out at the end of the year, which brought the corporation’s taxable income to a much smaller amount. Finally, Aspro failed to prove that the management fees represented reasonable compensation for services that were actually rendered to the company.

As a result, both the tax court and the Eight Circuit Court established that the nature of these payments seemed to be more consistent with shareholder payments or distribution of profits, which are typically called a divided payment and taxed as such. Thus, they could not be claimed as deductions on corporate tax returns.

What Can Be Learned From This Case?

Perhaps the most important lesson from this case is that neither court ever considered allowing this deduction to be claimed simply because it had been unnoticed and unchallenged for so many years – 20 years, in this situation – or because other companies had done the same and never been caught. Since the IRS had never challenged this deduction previously, the company had the impression that the IRS accepted their payments as stated on their tax returns. Ahwatukee tax attorneys may see more prosecution of these types of situations as the IRS runs into more of these types of arrangements.

The importance of careful documentation is also highlighted by this case, especially when payments are involved and the IRS could see that payment from a different perspective. Even the most basic documentation regarding the agreement terms and what services were to be rendered had not been established.

Arizona’s Leading Tax Attorney Firm Is Ready To Protect Your Rights

If you’ve been contacted by the IRS and are wondering what to do next, schedule a free consultation with the attorneys at Silver Law, PLC. As former IRS employees, our attorneys have a comprehensive understanding of tax law. We draw on our extensive knowledge and experience to provide quality and effective representation across many areas of tax law, including innocent spouse relief, tax audit representation, and more. Call our office to schedule your no-obligation case review and learn how we can help you.

 

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