# PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b),THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.T.C. Sum m ary Opi ni on 20 13 -6 2

UNITED STAT ES TAX COURT
SEAN MCALARY LTD, INC., Peti ti on er v . COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 21 06 8- 11 S. Fil edAug us t 1 2, 2 01 3.

Sean P. McAl ary (anoff

ic er), fo r pe ti ti on er. Mark H. Pfe ffer , forres po nd en t.

SUMM ARY OPINION GUY, Spec ia l Tri al Ju dg e: Thi s ca se was h eardpu rs uantto th e p ro vi si on s of sec ti on 74 63 of t he Int ern al Rev enue Co de ineffe ctwhenth e p et it io n was- 2 -

fil ed
. Pur su an t t o s ect io n 7 46 3( b) , th e d eci si on to be en te redis no t re vi ewab le by 1
an y othe r co urt, an d thi s o pi ni on sh al l n otbe tre at edas p rece de ntforan y othe r cas e. The pe ti ti on inth is cas e was fil edinres po ns e to a no ti ce o f de te rm in at io n o f
worke r cl as si fic at io n (n ot ic e o f de te rm in at io n) is su edto SeanMcAl ary Ltd , Inc . (p et it io ne r), p ur su an t t o s ect io n 7 43 6. Th e n ot ic e o f de te rm in at io n c on cern s em pl oym en t t ax li ab il it ie s ar is in g u nd er the Fed eral Ins ur an ce Co ntrib ut io ns Act (FIC A) an d the Fed eral Unem pl oym en t Tax Act (F UTA) forqu art erl y pe rio ds
en di ng in20 06 . Att ach edto th e n ot ic e o f de te rm in at io n i s a s ch edul e se tt in g 2 fo rth pe ti ti on er’s l iabi li ti es forem pl oym en t t ax es forqu art erl y pe rio ds en di ng in 20 06 as f ol lo ws:

Unl es s o th erwi se in di cat ed , all sec ti on refe ren ces are t o the Int ern al 1 Rev enue Co de (Co de ), as am en de d andineffe ctfor 20 06 , andRu le refe ren ces are to th e Tax Co urt Ru le s o f Prac ti ce an d P ro cedur e. Sec. 7 43 6( e) d efi ne s the term “ em pl oym en t t ax ” as an y

tax im po se d b y 2 subt it . C, whi chen co m

pa ss es sec s. 3 10 1 t o 3 51 0 (i nc lu di ng FICA an d F UTA ta xe s)
.- 3 -

Old ag e, Income F ederal Tax period survivor, Hospital tax unemploy ment endingdisability insurance insurance withholding tax Mar. 31 $1,163.12 $272.02 $402 --- J une 30 3,124.80 730.80 1,080 --- Sept. 30 1,302.00 304.50 450 --- Dec . 31 2,569.28 751.10 1,110 $434 Total 8,159.20 2,058.42 3,042 434 Res po nd en t al so de te rm in edth atpe ti ti on er i s l iabl e fo r ad di ti on s t o t ax an d pe na lt ie s fo r qu art erl y

pe rio ds en di ng in20 06 as f ol lo ws: Tax pe rio d Add it io ns to tax Pena lty end in g Sec. 6 65 1( a)(1 ) Sec. 6 65 1( a)(2 ) Sec. 6 65 6 Mar. 3 1 $4 13 .36 $4 59 .29 $1 83 .71 Ju ne 30 1,1 10 .51 1,2 33 .90 49 3.5 6 Sep t. 3 0 46 2.7 1 51 4.1 3 20 5.6 5 Dec. 31 99 6.8 4 1,1 07 .60 48 6.4 4 Pet it io ne r fi le d ati m el y

pe ti ti on forrev ie w of re sp on de nt ’s det erm in at io n. At the ti m e th e p et it io n was fil ed , pet it io ne r’s pr in ci pa l p la ce o f bu si ne ss was i n Cal ifo rn ia
.- 4 -

Afte r co nc es si on s, th e is su es rem ai ni ng for de ci si on are: (1) th e am ou ntof 3 Sean P. McAl ary’ s co m

pe ns at io n tha t i s s ub

ject t o e m

pl oym en t t ax es ; (2 ) whe th er pe ti ti on er i s l iabl e fo r ad di ti on s t o t ax un de r se ct io n 6 65 1( a)(1 ) fo r fai li ng to fil e Fo rm 94 0, Em pl oyer’s Annua l Fe de ral Unem pl oym en t (F UTA) Tax Re tu rn , and Fo rm s 9 41 , Em

pl oyer’s Quarte rly Fede ral Tax R eturn; an d (3 ) whe th er p et it io ne r is li ab le forpe na lt ie s u nd er s ect io n 6 65 6 fo r fai li ng to m ak e ti m el y de po si ts of FICA an d F UTA tax es . Bac kg ro un d So m e o f th e fac ts ha ve be enst ip ul at edan d are s o fo un d. Th e st ip ul at io n o f fact s an d the acco m

pa nyin g e xh ib it s ar e in co rp or at edhe rei n b y th is refe ren ce. I. SeanP. McAl ary Mr. Mc Alary

earn eda ba ch el or ’s deg ree wi th a m ajorinbu si ne ss adm in is tra ti on fro m

th e Uni ve rs ity

of S ou th ernCal ifo rn ia , andhe sp en t m an y y ears work in g i n the co m pu te r te ch no lo gy indus try. In 20 02 , at the ag e o f 54 , Mr. Mc Alary

ob ta in eda Cal ifo rn iareal est at e sa le s l ic en se an d b eg anto earn
The parti es ag ree tha t Se anP. McAl ary was pe ti ti on er’s em pl oyee 3 th ro ug ho ut20 06 an d tha t n o re li ef i s av ai labl e to pe ti ti on er u nd er the Rev enue Act of 19 78 , Pub . L. No. 95 -6 00 , sec . 53 0, 9 2 S ta t. at28 85 , as a m en de d. Fu rth er, pu rs ua ntto a te le ph on e co nf eren ce ca ll th atth e Co urt h el d wi th th e p art ie s o n J ul y 1, 2 01 3, re sp on de ntco nc ed es th atpe ti ti on er i s n otli ab le for ad di ti on s t o t ax un de r se c. 66 51 (a)( 2) forth e ta xabl e p eri od s i n i ss ue .- 5 -

co m m is si on s s el li ng res id en ti al real est at e in so ut he rnCal ifo rn ia . He con cl ud ed th atearn in g re al est at e sa le s co m m is si on s wo ul d b e a g oo d way to g en erat e in co m e to setasi de for

ret ire m en t, an d i n 2 00 4 h e o bt ai ne d aCal ifo rn iareal est at e br ok er’s l ic en se . II. Sean McAl ary Ltd , Inc . Mr. Mc Alary

m etMarkBo tt a, a ta x re tu rnpre pa rer wi th off ic es inNewpo rt Bea ch , Cal ifo rn ia , andLas Veg as , Neva da , at a b us in es s m eet in g. Mr . McAl ary was im pr es se d wi th Mr. Bo tt a an d h ire d h im to pro vi de bu si ne ss advi ce an d
se rv ic es inco nn ect io n wi th hi s emergi ng real est at e act iv ity . In 2 00 3 Mr. Mc Alary , with M r. Bo tt a’s as si st an ce, o rg an iz edpe ti ti on er as a co rp or at io n un de r th e la ws o f th e St at e o f Nev ad a, an d p et it io ne r el ect edto be tax edun de r subc hapt er S o f ch ap te r 1 o f th e Co de
. Mi nu te s fo r pe ti ti on er’s b oa rdof d ire ct or s m eet in g h el d o n Ap ril 1, 2 00 4, st at e in rel ev an t p artas f

ol lo ws: Ann ua l Co m

pe ns at io n fo r Sean M cAla ry , Pres id en t o f th e Co rp or at io n, s ha ll be ba se d o n the nu m be r of Rev enue Gene rat in g Rea l Es ta te Agen ts an d As so ci at e Bro ke rs (Affi li at es ) as so ci at edwith th e Co rp or at io n. Th e Annua l Ba se Co m pe ns at io n s ha ll be $2 4,0 00 whe n the nu m

be r of Affil ia te s i s n otm or e th anten (10 ). Annua l Add it io na l Co m

pe ns at io n i n the am ou ntof $ 10 ,00 0 s ha ll be earn ed fo r eac h i nc rem en t o f te n (1 0) Add it io na l Affi li at es . No Add it io na l Co m pe ns at io n s ha ll be earn edforan y parti al in crem en t o f te n (1 0) Affi li at es .- 6 -

III. Pet it io ne r’s Ope rat io ns Mr. Mc Alary

was p et it io ne r’s pr es id en t, s ecre tary , tre as ur er, s ol e d ire ct or , an d s ol e sh areh ol de r. He als o was th e o nl y pe rs onwork in g fo r th e fi rm th athe lda real est at e b ro ke r’s li cen se . He m an ag edall asp ect s o f pe ti ti on er’s o pe rat io ns , in cl ud in g re cru it in g andsupe rv is in g s al es ag en ts , con du ct in g re al est at e sa le s, pr oc ur in g a dv ert is in g, p ur ch as in g s up pl ie s, an d m ai nt ai ni ng ba si c b oo ks an d
reco rd s. Mr . McAl ary of te n wo rk ed12 -h our da y s wi th few d ay s o ff. Mr. Mc Alary

ho pe d t o g ro w pet it io ne r’s op erat io ns by inc reas in g the
nu m be r of sal es ag en ts an d a ss oc ia te bro ke rs on pe ti ti on er’s s ta ff. He di sc ov ered , ho wev er, tha t m an y

sal es ag en ts want edto workforlar ge r, es tabl is he d re al est at e br ok erag e fi rm s. Pet it io ne r’s sa le s ag en ts op erat edas i nd ep en de ntco ntract or s, an d the y earn edbe twee n 6 0% and85 % of t he sal es co m m is si on s g en erat edon real
es ta te sal es th ey

in it ia te d andclo se d, wi th pe ti ti on er re ta in in g the ba lanc e. Duri ng 20 06 Mr. Mc Alary

supe rv is edeig htsal es ag en ts , fou r of who m ge ne rat edsal es co m m is si on s fo r pe ti ti on er tha t year. Mo stof p et it io ne r’s gr os s re cei pt s wer e at tri bu tabl e to sal es co m m is si on s ge ne rat edby Mr. McAl ary, as o pp os edto pe ti ti on er’s o th er s al es ag en ts . Pet it io ne r rep orte d g ro ss rece ip ts an d n etin co m e fo r th e cal en dar y ears 20 04 an d 20 05 as f ol lo ws:- 7 - Year Gros s re cei pt s Net in co m e 20 04 $3 76 ,45 3 $1 22 ,60 5 20 05 405 ,24 4 16 1,6 60 IV. Peti ti on er’s In co m e Tax Return Mr. Mc Alary

pe rs on al ly del iv eredpe ti ti on er’s t ax reco rd s fo r 20 06 to Mr. Bo tt a athi s o ffi ce i n Las Vega s o n M arch 8, 2 00 7. Al th ou gh he in qu ire d o ve r th e en su in g m on th s ab ou t the pro gr es s b ei ng m ad e in pre parin g the tax return, h e rece iv edno res po ns e fro m Mr. Bo tt a. Mr. Bo tt a d el iv eredpe ti ti on er’s Fo rm 11 20 S, U.S. Inc om e Tax Return fo r anS Co rp or at io n, t o M r. McAl ary inearl y Decem be r 20 07 . Mr. Mc Alary

fil edpe ti ti on er’s Fo rm

11 20 S o n Dec em

be r 11 , 20 07 . Pet it io ne r rep orte d g ro ss rece ip ts of $ 51 8,1 89 , var io us de du ct io ns to ta li ng $2 86 ,73 5, an d n etin co m e o f $2 31 ,45 4. Pe ti ti on er d idno t i ss ue a Fo rm W -2 , W ag e an d Tax Sta te m en t, t o M r. McAl ary, no r di d i t cl ai m a de du ct io n fo r an y am ountpa idto Mr. Mc Alary as wa ge s o r co m

pe ns at io n fo r se rv ic es . Duri ng 20 06 Mr. Mc Alary

tra ns ferr eda to ta l o f $2 40 ,00 0 fr om pe ti ti on er’s acc ou ntto hi s pe rs on al acco un t. Pet it io ne r di d n otfil e Fo rm 94 0 fo r 20 06 or F orm

94 1 fo r an y

qu art erl y pe rio d e nd in g i n 2 00 6.- 8 -

V. Mr. McAl ary’ s In co m e Tax Return Mr. Mc Alary

an d h is sp ou se fil eda joi ntFo rm 10 40 , U.S. Ind iv idua l In co m e Tax Return, o n Dec em be r 11 , 20 07 . Mr. McAl ary di d n otrep ort an y am ountforwage s o r sa larie s o n l in e 7 of t he return, n ordi d h e rep ort o r pa y an y se lf- em pl oym en t t ax durin g 2 00 6. OnSch edul e E, Sup pl em en ta l In co m e an d Los s, M r. McAl ary rep orte d alo ss of $ 15 ,03 5 o n P artI, Inc om e o r Los s Fr om Ren ta l Re al Est at e an d R oyalt ie s, i nc om e o f $2 00 ,87 7 o n P artII, In co m e o r Los s Fro m Partne rs hi ps an d S Co rp or at io ns , andto ta l i nc om e o f $1 85 ,84 2 o n P artV, Su m m ary. VI. Res po nd en t’s Ex pe rt Witne ss At tria l the Co urt re cei ve d i n e vi de nc e anex pe rt wi tn es s re po rt p rep aredby Ig orOstro vs ky, an em

pl oyee inth e In te rn al Rev enue Serv ic e’s en gi ne eri ng an d
va lu at io n p ro gr am . Mr. Ost ro vs ky op in edth at , of the $2 40 ,00 0 tha t M r. McAl ary 4
rece iv edfro m

pe ti ti on er dur in g 2 00 6, $ 10 0,7 55 rep res en te d re as on ab le
co m pe ns at io n, i .e., th e fai r m ark etva lu e o f th e se rv ic es th atMr. Mc Alary pe rfo rm edforpe ti ti on er tha t year.
Mr. Os tro vs ky earn edun de rg radua te de gr ees inm athe m at ic s an d e le ctric al 4 en gi ne eri ng an d am as te r of bu si ne ss adm in is tra ti on de gr ee fr om th e Uni ve rs ity

of Mi nn es ot a. He is reco gn iz edas a n a ccre di te d v al ua ti on an al y stby the Nati on al Ass oc ia ti on of C ert ifi edValu at io n An al y st s.- 9 -

Inco m pu ti ng Mr. Mc Alary ’s reas on ab le co m pe ns at io n fo r 20 06 , Mr. Ostro vs ky firs t co nc lu de d tha t M r. McAl ary’ s p rimary job fun ct io n was th atof a real est at e b ro ke r supe rv is in g re al est at e ag en ts . He th enco ns ul te d the Cal ifo rn ia Occupa ti on al Em

pl oym en t St at is ti cs Surv ey for20 06 , de te rm in edth atth e m ed ian

5 wag e fo r a rea l es tate bro ke r in so ut he rnCal ifo rn iawas $ 48 .44 pe r ho ur , an d 6
m ul ti pl ie d tha t am ou ntby 2,08 0 h ou rs (40 ho ur s p er weekx 5 2 wee ks pe r y ear) to 7 arri ve at t ot al an nu al co m pe ns at io n o f $1 00 ,75 5. Insupp ort o f hi s co nc lu si on th at$1 00 ,75 5 re pr es en te d re as on ab le
co m pe ns at io n fo r Mr. M cAla ry ’s servi ces du rin g 2 00 6, M r. Ostro vs ky com pa red pe ti ti on er’s fi na nc ia l p erfo rm an ce wi th th atof i ts pe ers inth e rea l es ta te in du st ry . 8 The Cal ifo rn iaOccupa ti on al Em pl oym en t St at is ti cs Surv ey is anan nu al 5 rep ort p ro du cedjoi nt ly by th e U.S. Depa rtment o f Lab or Bureauof Lab or St at is ti cs an d the Cal ifo rn iaDepa rtment o f Lab or , anditin cl ud es a co m pr eh en si ve rep ort o f wag e rat es forwork ers invario us in du st rie s. The Cal ifo rn iaOccupa ti on al Em pl oym en t St at is ti cs Surv ey rep orte d tha t 6 ho ur ly w ag es forreal est at e b ro ke rs inso ut he rnCal ifo rn iaran ge d fr om $3 2.9 9 (2 5t h p erce nt il e) t o $ 64 .28 (75 th pe rcen ti le ), with am ed ian h ou rly wage o f $4 8.4 4. Mr. Os tro vs ky ackn owl ed ge d tha t M r. McAl ary rep orte d tha t h e o fte n 7 worke d s ev enday s a we ek , bu t h e n ev erthe le ss us eda st an da rd40 -h ou r work weekinco m

pu ti ng Mr. Mc Alary ’s reas on ab le co m pe ns at io n. Mr. Os tro vs ky defi ne d p et it io ne r’s pe er g ro up to in cl ud e b us in es se s 8 de sc rib edinth e North Am eri canIndus try Clas si fic at io n S y st em (NAICS), Co de No. 5 31 21 0, Offi ces of R eal Est at e Age nt s an d B ro ke rs , and , sp eci fic al ly, real (co nt in ue d...)- 10 -

He co ns ul te d the Ris k M an ag em en t As so ci at io n An nu al Sta te m en t Stud ie s an d 9
no te d tha t p et it io ne r’s 44 .7% p ro fitm arg infor20 06 far s ur pa ss edth e 2 1.9 % av erag e p ro fitm arg inforth e in du st ry . As was no te d at tria l, h owe ve r, th e 4 4.7 % pr of itm arg inth atMr. Ostro vs ky cit eddi d n otacco un t fo r pe ti ti on er’s o bl ig at io n to pay Mr. Mc Alary ’s reas on ab le co m pe ns at io n. As su m in g M r. McAl ary’ s reas on ab le co m

pe ns at io n i s $ 10 0,7 55 , as M r. Ostro vs ky sug ge st s, p et it io ne r’s pr of itm arg inon ly sli gh tl y

ex ceed edth e in du st ry

av erag e. Mr. Os tro vs ky furthe r no te d tha t co m pe ns at io n o f $1 00 ,75 5 e qu al ed19 .4% of pe ti ti on er’s g ro ss rece ip ts of $ 51 8,1 89 , andhe op in edth atth is lev el of
co m pe ns at io n c om

pa redfav or ab ly w ith R MA s tati st ic s s ho win g tha t of fic ers /d ire ct or s/ own ers at c om pa rab le real est at e b us in es se s wer e co m pe ns at ed

(...co nt inue d) 8 es ta te bu si ne ss es inth is cat eg ory with annua l n etsal es an d a ss et s u nd er $ 1 m il li on . Ri skMan ag em en t As so ci at io n (R MA) i s a m em be r as so ci at io n c om

pr is in g 9 fin an ci al in st itut io ns an d p ro fes si on al s tha t re gu larly eng ag e in ris k ana lysis (e.g ., cred it , m ark et , ent erp ris e, an d o pe rat io n ri sk ). RMA co m pi le s fi na nc ia l pe rfo rm an ce d at a drawnfro m th e fi nanc ia l s ta te m en ts of i ts m em be r’s cu st om ers -- pr im ari ly sm al l t o m ed iu m -s iz e b us in es se s, i nc lu di ng 45 7 b us in es se s fa ll in g u nd er NAICS Co de 53 12 10 .- 11 -

ina ran ge of 7 % of n etsal es (25 th pe rcen ti le ) to 18 .9% o f ne t s al es (75 th pe rcen ti le ), with am ed ian o f 11 % of n etsal es . 1 0 Dis cu ss io n I. Em pl oym en t Tax es Sect io n 7 43 6( a) v es ts th e Co urt wi th juri sd ic ti on to rev ie w cert ai n de te rm in at io ns m ad e b y

th e Co m m is si on er re ga rd in g e m

pl oym en t s ta tu s (wo rk er cl as si fic at io n) an d t o d et erm in e th e p ro pe r am ou ntof e m pl oym en t t ax ari si ng fro m su chde te rm in at io n. Se e Ch arl ot te ’s Offic e Bo ut ique , Inc . v. Co m m is si on er, 1 21 T.C. 89 , 10 2- 10 3 (2 00 3) , aff’d, 4 25 F.3d12 03 (9t h C ir. 2 00 5)
. Sect io ns 31 11 an d 3 30 1 i m po se FICA an d F UTA em pl oym en t t ax es on em pl oyers i n c on ne ct io n wi th wage s p ai d t o the ir e m pl oyees. Se e se cs . 31 .31 21 (a)- 1( b) , 31 .33 06 (b )-1 (b ), Em pl oym en t Tax Reg s. Fo r Fed eral
em pl oym en t t ax pu rp os es anem pl oyee is de fin edinrel ev an t p artas a ny offi cer o f
a co rp or at io n. Se e se c. 31 21 (d )(1 ); s ee al so sec . 33 06 (i) . An o ffi cer wh o p erfo rm s m or e th anm in orservi ces fora co rp or at io n andwho rece iv es rem un erat io n i n any fo rm forth os e se rv ic es is co ns id eredanem pl oyee who se wage s ar e subjec t t o
Mr. Os tro vs ky didno t ex pl ai n h ow a c om paris on of c om

pe ns at io n 1 0 m eas ur edas ape rcen ta ge of g ro ss rece ip ts with c om pe ns at io n m eas ur edas a pe rcen ta ge of n etsal es wou ldaidth e Co urt i n thi s ca se . In the en d, we d o n otfin d th is po rti on of M r. Ostro vs ky’ s re po rt t o b e p ers ua si ve or h el pf ul
.- 12 -

Fed eral em

pl oym en t t ax es . Sec. 3 1.3 12 1( d) -1 (b ), Em pl oym en t Tax Reg s.; see Vete rin ary Surg ic al Co ns ul tant s, P.C. v . Comm is si on er, 1 17 T.C. 14 1, 1 44 -1 45 (2 00 1) , aff’d s ub no m . Yeag le Drywall Co ., Inc . v. Un it edSta te s, 5 4 F ed . App x. 10 0 (3 d C ir. 2 00 2)
. Inge ne ral , an S co rp or at io n s ha reh ol de r is tax edon th e sh areh ol de r’s pr o rat a sh are o f th e co rp or at io n’s i nc om e, reg ard le ss of wh ethe r th e sh areh ol de r actua ll y rece iv es a di st rib ut io n. Se c. 13 66 (a)( 1) . Whe re the sh areh ol de r is als o an em pl oyee of th e co rp or at io n, the re i s an in cen ti ve bo th for th e co rp or at io n andfor th e em pl oyee/s ha reh ol de r to ch arac te riz e a p aym en t t o the em pl oyee/s ha reh ol de r as a di st rib ut io n ra th er tha n a s co m pe ns at io n b ecau se on ly paym en ts for
co m pe ns at io n are s ub

ject t o F ed eral em

pl oym en t t ax es . See s ecs . 31 11 (a) and(b) , 33 01 ; s ee al so Dura nd o v . Uni te d S tate s, 7 0 F .3d54 8, 5 50 n.5 , 55 2 (9 th Cir . 19 95 ) (a s ha reh ol de r’s sh are o f anS co rp or at io n’s i nc om e is no t s ub ject t o s el fem pl oym en t t ax ). In s uc h i ns tanc es , th e Co m m is si on er m ay

rech arac te riz e a di st rib ut io n a s co m

pe ns at io n i n o rd er t o re fle ctth e true na tu re o f th e p aym en t. See Rev . Rul . 74 -4 4, 1 97 4- 1 C .B. 28 7 (“ di vi de nd s” pa idto S co rp or at io n s ha reh ol de rs tre at edas r eas on ab le co m pe ns at io n fo r se rv ic es ren de redan d s ub jecte d t o F ed eral- 13 -

em pl oym en t t ax es ); s ee al so Vete rin ary Surg ic al Co ns ul tant s, P.C. v . Co m m is si on er, 1 17 T.C. at 1 45 -1 46 . II. Rea so nabl e Co m

pe ns at io n The parti es ag ree tha t M r. McAl ary was pe ti ti on er’s em pl oyee withi n the
m ean in g o f se ct io n 3 12 1( d) du rin g 2 00 6. In de ed , he p erfo rm edsubs tant ia l pr of es si on al servi ces forpe ti ti on er tha t year. The que st io n p res en te d i s the va lu e of th os e se rv ic es an d, m or e p reci se ly, th e am ou ntto be tre at edas M r. McAl ary’ s co m pe ns at io n fo r pu rp os es of c om pu ti ng pe ti ti on er’s Fed eral em pl oym en t t ax li ab il it ie s. As p rev io us ly m en ti on ed , res po nd en t as se rts th at$1 00 ,75 5 o f th e $ 24 0,0 00 Mr. Mc Alary

rece iv edfro m

pe ti ti on er dur in g 2 00 6 s ho ul d b e tr eat edas h is wage s. Res po nd en t av ers th atMr. Mc Alary , act in g i n h is cap aci ti es as p et it io ne r’s so le of fic er an d re al est at e b ro ke r, pe rfo rm eda va rie ty of se rv ic es th atwere es se nt ia l t o pe ti ti on er’s o pe rat io ns an d o ve ral l s uc ces s. Pet it io ne r co nt en ds th atth e Co urt s ho ul d re sp ectth e rem un erat io n ag reem en t b etweenMr. Mc Alary an d p et it io ne r whi chsethi s an nu al ba se pay at $2 4,0 00 an d p ro vi de d fo r in crea se d c om pe ns at io n i f Mr. M cAla ry was abl e to recrui t ad di ti on al sal es ag en ts an d a ss oc ia te bro ke rs . Peti ti on er fu rth er co nt en ds , with l it tl e el ab or at io n, tha t i n the li gh t o f pe ti ti on er’s m od es t o pe rat io ns , Mr.- 14 -

McAl ary’ s co m

pe ns at io n s ho ul d b e m eas ur edby rank in g p et it io ne r in th e 1 0t h pe rcen ti le of c om

pa rab le real est at e b us in es se s i n s ou th ernCal ifo rn ia
. W e are no t p ers ua de d tha t the rem un erat io n a gr eem en t re pr es en ts a so un d
m eas ur e o f th e v al ue of t he servi ces th atMr. Mc Alary pro vi de d t o p et it io ne r du rin g 2 00 6. We casta sk ep ti cal ey e o n the ag reem en t i na sm uc h a s M r. McAl ary sa t o n b oth s id es of t he tab le when th e ag reem en t was ex ecu te d, o ccupyin g the po si ti on s o f bo th em

pl oyer an d e m

pl oyee. The ag reem en t cl earl y was n otth e pr oduc t o f anarm ’s-le ng th ne go ti at io n. Se e Ch arl es Sch ne id er & C o. v . Co m m is si on er, 5 00 F.2d14 8, 1 52 (8t h C ir. 1 97 4) , aff’g T.C. Mem o. 1 97 3- 13 0. Add it io na ll y , alt ho ug h the nu m be r of real est at e sa le s ag en ts an d a ss oc ia te bro ke rs th atMr. Mc Alary

supe rv is edis a fact orto co ns id er i n d et erm in in g h is reas on ab le
co m pe ns at io n, i t i s o nl y

on e fac to r am on g m any . Fin al ly, th ere i s n o e vi de nc e in th e rec or d tha t p et it io ne r actua ll y pa idMr. Mc Alary

any am ou ntpu rs ua ntto th e ag reem en t, s ug ge st in g tha t i t was for go tt en , ig no red , or a do pt edas m ere wi nd ow dr es si ng . Co urts ha ve weig he d v ari ou s fa ct or s i n a ss es si ng th e rea so nabl en es s o f
co m pe ns at io n, i nc lu di ng th e em pl oyee’s qu al ifi cat io ns , th e n atur e, ex te nt , and
sc op e o f th e em

pl oyee’s work , th e si ze an d c om pl ex ity of t he bu si ne ss , pre va il in g ge ne ral eco no m ic co nd it io ns , th e em pl oyee’s co m

pe ns at io n a s a p erce nt ag e o f- 15 -

gr os s an d n etin co m e, th e em pl oyee/s ha reh ol de r’s co m pe ns at io n c om

paredwith di st rib ut io ns to sh areh ol de rs , th e em pl oyee/s ha reh ol de r’s co m pe ns at io n c om

pa red with tha t p ai d t o n on sh areh ol de r/e m pl oyees, p rev ai li ng rat es of c om pe ns at io n fo r co m pa rab le po si ti on s i n c om

pa rab le co nc ern s, an d c om pa rab le co m

pe ns at io n p ai d to a pa rti cu lar sh areh ol de r/e m pl oyee inpre vi ou s years wh ere the co rp or at io n h as a li mit ednu m

be r of off ic ers . Cha rle s Sc hn ei de r & Co . v. Co m m is si on er, 5 00 F.2d at15 1- 15 2; K & K Veter in ary Supp ly, In c. v. Co m m is si on er, T.C. Mem o. 2 01 3- 84 , at * 9- *1 0. Whethe r co m pe ns at io n i s re as on ab le is a qu es ti on to be res ol ve d o n th e b as is of a n e xa m in at io n o f al l the fact s an d c irc um st an ces of t he cas e, an d n o si ng le fact oris de ci si ve . Jo ly v. Comm is si on er, T.C. Mem o. 1 99 8- 36 1, af f’d witho utpubl is he d o pi ni on , 21 1 F .3d12 69 (6th C ir. 2 00 0)
. Dur in g 2 00 6 M r. McAl ary si ng le -h an de dl y co nduc te d p et it io ne r’s da il y bu si ne ss op erat io ns , m ak in g a ll m an ag em en t d eci si on s wh il e al so en ga gi ng inreal
es ta te sal es tra ns act io ns on pe ti ti on er’s b eh al f as bo th a br ok er an d asal es ag en t. Eve n tho ug h M r. McAl ary was rel at iv el y ne w to th e rea l es ta te sal es in du st ry , th e co m m is si on s tha t h e earne d a s a s al es ag en t an d abro ke r rep res en te d m os t o f pe ti ti on er’s g ro ss rece ip ts . W e rec og ni ze tha t p et it io ne r’s fin an ci al su cces s was at tri bu tabl e in no sm al l p artto fav or ab le real est at e m ark etco nd it io ns . Nev erthe le ss , alt ho ug h p et it io ne r’s op erat io n was m od es t an d the nu m be r of- 16 -

ag en ts th atMr. Mc Alary

supe rv is edwas s m al l, h e was co m m it te d t o the su cces s o f th e o pe rat io n a s ev id en cedby his wil li ng ne ss to worklo ng ho ur s wi th few d ay s of f. Pet it io ne r’s pr of

itm arg indu rin g the y ear i n i ss ue sl ig ht ly excee de d the
av erag e o f it s p eers inth e in du st ry . Res po nd en t’s ex pe rt, M r. Ostro vs ky, opi ne d tha t p et it io ne r co ul d h av e ex pe ct edto pay

$4 8.4 4 p er h ou r, or$1 00 ,75 5 ann ua ll y , to anin di vi du al in
ex ch an ge forth e v ari ou s s erv ic es th atMr. Mc Alary pe rfo rm edforth e fi rm

du rin g 20 06 . Alth ou gh th e $ 48 .44 ho ur ly rate re pr es en ts th e m ed ian h ou rly wage fo r rea l
es ta te bro ke rs inso ut he rnCal ifo rn iadu rin g the pe rio ds inis su e, th e p orti onof Mr. Os tro vs ky’ s re po rt p ur po rti ng to reco nc il e h is co nc lu si on with the
co m pe ns at io n p ract ic es of p et it io ne r’s in du stry pe ers was n otpe rs ua si ve . Dete rm in in g an e m

pl oyee’s reas on ab le co m

pe ns at io n i s d ep en de ntup on a nu m be r of fact or s an d i s fa r fro m

anex actsci en ce. Co ns id eri ng th e to ta li ty of th e fact s an d c irc um st an ces , in cl ud in g the pe rti ne ntwage an d l ab orst at is ti cs cit edin Mr. Os tro vs ky’ s re po rt, g en eral m ark etco nd it io ns , Mr. Mc Alary ’s so m ewh at li mit edexpe rie nc e, an d p et it io ne r’s m od es t o pe rat io ns , we ho ldth atanho ur ly rate of $4 0 (i .e., ann ua l co m

pe ns at io n o f $8 3,2 00 ) rep res en ts reas on ab le co m pe ns at io n fo r th e v ari ou s s erv ic es th atMr. Mc Alary pe rfo rm edfor

pe ti ti on er dur in g 2 00 6.- 17 -

III. Ad di ti on s t o Tax an d P en al ti es : Se ct io ns 66 51 (a)( 1) an d 6 65 6 Res po nd en t d et erm in edth atpe ti ti on er i s l iabl e fo r ad di ti on s t o t ax un de r se ct io n 6 65 1( a)(1 ) fo r fai li ng to fil e Fo rm s 9 40 an d 9 41 an d fo r pe na lt ie s und er se ct io n 6 65 6 fo r fai li ng to m ak e ti m el y de po si ts of F ICA an d F UTA tax es . Sect io n 6 65 1( a)(1 ) im

po se s an ad di ti on to tax forfai lure t o t im el y fil e a t ax return unl es s i t i s s ho wn tha t s uc h fa il ur e is du e to reas on ab le cau se an d n otdu e to wil lfu l n eg le ct . The ad di ti on to tax is equa l t o 5 % of t he am ou ntof t he tax requi redto be sh own on th e return i f th e fai lu re t o fi le is no t fo r m or e th anon e m on th . Sec. 6 65 1( a)(1 ). An ad di ti on al 5% i s i m po se d fo r eac h m on th or f ract io n th ereo f in whi chth e fai lu re t o fi le co nt in ue s, t o am ax im um of 2 5% o f th e ta x. Id
. If a t ax pay er ex erci se d o rd in ary bu si ne ss care an d p ru de nc e an d was no ne th el es s un ab le to fil e th e return wi th inth e d at e p res cri be d b y law, the n re as on ab le cau se ex is ts . Sec. 3 01 .66 51 -1 (c)( 1) , Pro ced . & Adm in . Reg s. “ W il lfu l n eg le ct ” m ean s a

“ co ns ci ou s, i nt en ti on al fai lu re o r rec kl es s i nd iff eren ce.” Un it edSta te s v . Boyle, 46 9 U.S. 2 41 , 24 5 (1 98 5)
. Sect io n 6 65 6( a) i m

po se s a p en al ty for fai lu re t o d ep os itan y am ou ntof t ax with aGov ern m en t d ep os it ory . As rel ev an t h erei n, the pe na lty is equa l t o 1 0% o f th e und erp aym en t i f th e fai lure i s fo r m or e th an15 day s. Sec . 66 56 (b )(1 )(A)(i ii ). As i s tru e wit h re sp ectto th e ad di ti on to tax un de r se ct io n 6 65 1( a)(1 ), a ta xp ay er- 18 -

m ay av oi d ape na lty

un de r se ct io n 6 65 6( a) i f th e ta xp ay er’s fai lu re t o m ak e a requi redde po si t was du e to reas on ab le cau se an d n otwil lfu l n eg le ct . Mr. Mc Alary

tes ti fie d tha t h e p ro vi de d p et it io ne r’s ta x i nf orm at io n t o pe ti ti on er’s acc ou nt an t, Mr . Bot ta , andth athe co un te d o n h im to pro pe rly
co m pu te pe ti ti on er’s t ax li ab il it ie s. Re li an ce o n the advi ce o f a t ax pro fes si on al
m ay est ab li sh reas on ab le cau se an d g oo d fa ith. Se e Uni te d S ta te s v . Boyle, 4 69 U.S. at 2 50 . Reli an ce o n atax pro fes si on al , ho wev er, i s n otanab so lu te de fen se bu t m erel y

a fact orto be co ns id ered . Freyta g v . Comm is si on er, 8 9 T.C. 8 49 , 88 8 (1 98 7) , aff’d, 9 04 F.2d10 11 (5t h C ir. 1 99 0) , aff’d, 5 01 U.S. 86 8 (1 99 1) . Whe th er reas on ab le cau se ex is ts when a ta xp ay er h as rel ie d upo n atax pro fes si on al to pr ep are atax return m

us t b e d et erm in edup on a rev ie w of a ll th e fac ts an d ci rcu m st an ces . Neon at ol og y Ass oc s., P.A. v. C omm is si on er, 1 15 T.C. 43 , 98 (2 00 0) , aff’d, 2 99 F.3d22 1 (3 d C ir. 2 00 2) . W e h av e h el d tha t fo r a t ax pa y er t o rel y reas on ab ly upo n the advi ce o f a t ax pro fes si on al , th e ta xp ay er m us t p ro ve by a pr ep on de ran ce o f th e ev id en ce tha t the tax pa y er m eet s ea chrequi rem en t o f th e fo ll owi ng th ree- pr on g t es t: (1) th e advi se r was a co m pe te ntpro fes si on al who ha d
su ffi ci en t ex pe rti se to jus ti fy rel ianc e, (2 ) th e ta xp ay er p ro vi de d n eces sa ry an d
accu rat e in fo rm at io n t o the advi se r, an d (3 ) th e ta xp ay er ac tu al ly reli edingo od fai th onth e advi se r’s jud gm en t. Id . at 9 9.- 19 -

Oth er tha n M r. McAl ary’ s t es ti m on y th athe ge ne ral ly w as im pr es se d wi th Mr. Bo tt a, th ere i s n o e vi de nc e th atpe ti ti on er i nv es ti ga te d M r. Bo tt a’s ba ck gr ou nd
orqu al ifi cat io ns or t ha t p et it io ne r ot he rwis e co nf irmed th atMr. Bo tt a was a co m pe te ntpro fes si on al who ha d s uf fic ie ntex pe rti se to jus ti fy rel ianc e o n h is advi ce. Co ns id eri ng all th e fac ts an d c irc um st an ces , we are n otpe rs ua de d tha t pe ti ti on er ex erci se d o rd in ary bu si ne ss care an d p ru de nc e an d was no ne th el es s un ab le to fil e Fo rm s 9 40 an d 9 41 by the date pre sc rib edby law orun ab le to rem it th e p ro pe r am ou ntof e m

pl oym en t t ax es to th e Gov ern m en t. Co ns eque nt ly,
we su st ai n re sp on de nt ’s det erm in at io n tha t p et it io ne r is li ab le forad di ti on s t o t ax un de r se ct io n 6 65 1( a)(1 ) an d p en al ti es un de r se ct io n 6 65 6( a) fo r th e ta xabl e pe rio ds inis su e. Co ns is te ntwith the pre ced in g d is cu ss io n, Deci si on wil l b e en te red
un de r Ru le 15 5.