## United States Court of Appeals FOR THE EIGHTH CIRCUIT

____________ No. 96-3610

____________ John F. Johnson, Sr.; * Joann Johnson; Ella Johnson, *
* Appellants. *

* Appeal from the United States v. * District Court for the
* Eastern District of Missouri Shirley S. Chater, Social * Security Administration, *
* Appellee. *

____________ Submitted: April 16, 1997 Filed: October 16, 1997

____________ Before McMILLIAN, Circuit Judge, HENLEY, Senior Circuit Judge, and BEAM, Circuit Judge.

____________ McMILLIAN, Circuit Judge.

Jo hnF. Johnson, Sr., his wife, Joann Johnson, an d their daughter, Ella Johnson (collectively claimants) ,The Honorable Lawrence O. Davis, United States Magistrate Judge for the 1 Eastern District of Missouri. The case was tried to a magistrate judge pursuant to the consent of the parties under 28 U.S.C. § 636(c).

2 appeal from a final order entered in the District Court 1 for the3

Eastern District of Missouri granting summary judgment in favor of the Commissioner of Social Security. Johnson v. Ch ater , No. 1:95CV00075 LOD (E.D. Mo. July 29, 1996 ) (ord er and memorandum). For reversal, claimants argu e (1) the Commissioner did not have the authority t o reallocate undistributed corporate profits as wages t o John Jo hnson, Sr., in 1991 for the purpose of computin g excess earnings under 42 U.S.C. § 403 and (2) th e Commissioner erred in “piercing the veil” of their family salary arrangements to reallocate some of the salary paid in 19 90 from Joann Johnson to John Johnson, Sr., and t o attribute self-employment profits to John Johnson, Sr

. For th e reasons discussed below, we affirm in part an d
rev erse in part the order of the district court an d
rem and the case to the district court for furthe r proceedings.

Th e following statement of facts is taken in larg e pa rt from the order and memorandum of the magistrat e judge

. John Johnson, Sr., filed an application fo r retirement insurance benefits and began receivin g benefits i n May 1989. His wife, Joann Johnson, filed an applicationfor spouse’s benefits, and their daughter , Ella Johnson, filed for child’s benefits on t he record of her father. In March 1993 the Social Securit y Administra tion (SSA) notified John Johnson, Sr., that he had receiv ed benefits greater than those to which he was entitled because of excess earnings. The exc ess earnings were wages and self-employment income attribu table to him in 1 990 and 1991 from two family farming corporations , Cowhill Fa rms, Inc., and J & J Hog Farms. John Johnson, Sr., was president of Cowhill Farms until January 1989 , when he reduced his activities. In May 1989 h e4

officially

retired from Cowhill Farms, and Joann Johnson beca me president upon her husband’s retirement. Joh n Johnson, Sr., also retired from J & J Hog Farms i n January 1989. Their son, John Johnson, Jr., took on more of t he management responsibility for the two famil y farming corporations.5

For 1990 John Johnso n, Sr., reported wages of $6,000 and Joann Johnson reported wages of $9,482 from Cowhil l Farm s. The SSA reallocated their wages and determine d that John Johnson, Sr., had received $9,482 in wages and Joann Johnson had received $6,000 in wages from Cowhil l Farms. The SSA also determined that John Johnson, Sr. , was self-employed with respect to J & J Hog F arms and had
re ceivedprofits of $6,217 in 1990. For 1991 Joh n Johnson, S r., reported wages of $7,000 and Joann Johnson repor ted wages of $8,400 from Cowhill Farms. The SS A ag reed that $8,400 was a reasonable salary for Joan n John son, but decided that John Johnson, Sr.’s work wa s worth twice that of his wife, and thus determined tha t his s alary was $16,800. The SSA noted that in 199 1 Cowhill Fa rms had “ample” profits available to pay these wages and to invest in corporate assets. Record at 22 8 (Special D etermination dated Feb. 27, 1993) (noting 1991 corp orate profits were $11,102 and expenses were dow n $13,484 over 1990)). These amounts exceeded the exemp t earnings a mount for 1990 and 1991. The redeterminations
were based on income and corporate tax returns, W- 2 forms, self-employment questionnaires, interviews, an d other information.

In Ju ne 1994 a hearing was held before a n adminis trative law judge (ALJ). The ALJ found that th e SSA had pr operly reallocated wages between John Johnson, Sr., and Joann Johnson for 1990 and 1991 and that Joh n John son, Sr., had been overpaid retirement benefits i n 1990 an d 1991 in the amount of $5,488. (The ALJ als o found that Ella Johnson had been overpaid ben efits.) The ALJ found that John Johnson, Sr., had provided more than “minimal” services to the two corporations, i ncluding 25%6

of the labor, such as spraying and combining, for Cowhill Farms. The ALJ also found there had been considerabl e commi ngling of activities among family members, Joan n Johnson’s duties had not substantially increased in 1990 and 1 991 to justify the significant increase in he r salary after 1989, and John Johnson, Sr., had continue d to exercise significant decision-making responsibilit y and had provided invaluable services to Cowhill Farms.7

The ALJ’s decision was affirmed by the Appeal s Coun cil. Claimants sought judicial review in federa l distr ict court. 42 U.S.C. § 405(g). The parties file d motions fo r summary judgment. The district court denied cl aimants’ motion for summary judgment and grante d
su mmaryjudgment in favor of the Commissioner. Thi s appea l followed. 28 U.S.C. § 1291; Fed. R. App. P

. 4(a)(1).

We will uphold the final decision of the Commissione r if it is s upported by substantial evidence in the record
as a whole. 42 U.S.C. § 405(g). “Substantial evidenc e is that wh ich a reasonable mind might accept as adequate to s upport the [Commissioner]’s conclusion.” House v

. Shalala , 34 F.3d 691, 694 (8th Cir. 1994). Qualified applicants are entitled to retiremen t benefits. 42 U.S.C. § 402(a). However, an a pplicant who is eligibl e for social security benefits may not work or enga ge in self-employment which results in income i n exces s of a certain amount per year. Id. § 402(f)

. “Wag es are defined to mean all employment remuneration , irrespe ctive of the name by which the compensation i s desig nated or the way in which it is paid.” Martin v

. Sull ivan , 894 F.2d 1520, 1531 (11th Cir. 1990) (citin g applicable Social Security regulations).

An ap plicant for benefits must submit th e evidence necessary to establish that al l entitlement requirements are m et, and failure to submit such evidence shall be the basis for the SSA to determine that the cond itions for receipt of So cial Security benefits have not been met

. The claimant, therefore, has the burden o f rebutting the presumption of excess earning s under the Act.8

Id. at 1531-32 (citations omitted). “[T]he [Commissioner] has the right to examine th e subs tance over the form of business transactions an d rela tionships for purposes of the Social Security Act. ” Heer v . Secretary of Health & Human Services , 670 F.2 d 653, 655 (6th Cir. 1982) (per curiam). “Dete rmination of
an in dividual’s earnings for Social Security purpose s must9

be related to the reality of his [or her] con nection with the labor market and cannot be based on paper allocation of income.” Martin v. Sullivan , 894 F.2d at 1524, citing Reconsideration Redetermination at 2. In par ticular, the Comm issioner can “pierce the veil” of fictitious famil y salaryarrangements “where a claimant’s allege d retirement and consequent shifting of salary to a family memb er is for the purpose of receiving Social Securit y [retiremen t] benefits.” Id. at 1532. The Commissioner should consider the following factors before “piercin g the v eil” of “fictitious family salary arrangements” : “(1) whether the claimant continues to contribut e substantial and valuable services to the corp oration; (2) whether th e family member receiving the income increases his o r her duties commensurate with the increase i n salary; and (3) whether the family member’s income i s used to support the claimant.” Heer v. Secretary o f Health & H uman Services , 670 F.2d at 655; cf. Diamond v. Harr is , 512 F. Supp. 216, 219 (W.D.N.Y. 1981) (holdin g Secr etarycannot allocate half of wife’s salary t o clai mant husband absent evidence that her salary wa s exces sive or that she had not earned it or her salar y incr easedin direct relation to decrease in his salar y and cannot reclassify distributed Subchapter S dividends
as sala ry absent evidence that dividends were paid as a result of his services).

UNDISTRIBUTED CORPORATE PROFITS
Claimants first argu e the Commissioner does not have the authority to reallocate undistributed corporat e profits as wages to John Johnson, Sr., for th e purpose of computing excess earnings under 42 U.S.C. § 403, citin g10

Ludeki ng v. Finch , 421 F.2d 499 (8th Cir. 1970)

. Claimants also argue that, even assuming the Commissioner doe s have the authority to reallocate undistribute d corporate profits, it was an abuse of discret ion to do so beca use the undistributed corporate profits had bee n reta ined by the corporation for future capita l improvements.

These arguments have not been preserved for appellat e revie w. In the statement of facts in the memorandum i n support of their motion for summary judgment in the11

distr ict court, claimants referred to the SSA’ s dete rminationthat Cowhill Farms had “ample profits” t o pay John J ohnson, Sr., a salary of $16,800 in 1991, mem. at 6, fund s which John Johnson, Sr., had never received, id. , and which Cowhill Farms had retained fo r “grading/leveling” corporate lands. Id. at 7 . Claimants challenged, among other things, the determination tha t John Jo hnson, Sr.’s services were worth twice as muc h those of Joann Johnson and the failure to specify wha t those invaluable services were. Id. at 9 (¶ 5)

. Claim ants did not challenge the reallocation o f undis tributedcorporate profits in the district cour t revi ewproceeding. However, we cannot affirm th e deci sionof the Commissioner unless it is supported by su bstantial evidence. We have found nothing in thi s reco rd which supports the Commissioner’s decision t o “rea llocate” funds that have never in fact bee n distrib uted in any form by Cowhill Farms or received by claimants. For that reason, we reverse that part of the Commissioner’s decision attributing to John J ohnson, Sr., $16,800 inwages from Cowhill Farms in 1991, an increase of $9,800 over the $7,000 that he reported.

“The [Commissioner] has, without question, th e auth orityand the duty to pierce any fictitiou s
arra ngements among family members, and others, to shif t sala rypayments from one to the other when th e arrange ment is not in accord with reality.” Gardner v

. Hall , 366 F.2d 132, 135 (10th Cir. 1966) (citing case s shif ting salary payments from one family member t o another). This is what the Commissioner did with respect to th e wages reported by the claimants for 1990. Th e Commissioner examined the wages reported by t he claimants12

in li ght of their respective corporate offices , experience, responsibilities, and hours worked, an d reallocated their wages, reducing those repor ted by Joann Johnson by $3,482 and increasing those reported by Joh n Johnson , Sr., by $3,482 (as well as $6,217 i n self-employment income). For 1991, however, th e Commissioner did not reallocate salary payments betwee n John Johnson, Sr., and Joann Johnson, but instea d reallocated undistributed profits from Cowhill Farms t o John Johnson, Sr.13

Reallocationoften arises in cases involvin g Subchapter S corporations because, for income ta x purp oses, the net profits of Subchapter S corporation s are taxable to the shareholder as dividends. Th e co rporationis treated as a partnership. For socia l securitypurposes, dividends are excluded fro m “self-empl oyment income,” 42 U.S.C. § 411(a)(2), but are not specif ically excluded from “wages.” Id. § 409. For this reason, benefits claimants would often argue tha t all earnings of a Subchapter S corporation, whether o r not denominated as dividends for income tax p urposes, are not wag es for social security purposes and that the SS A has no authority to classify or recharacteriz e Subchapter S divi dends as wages. The courts rejected thes e arguments and distinguished between distributed an d und istributed corporate dividends. For example, i n Ludeking v. Finch , the claimant received no salary fro m the Subchapter S corporation but did receive $8,400 i n the for m of corporate dividends. The Secretary foun d that the c laimant was much more than a mere shareholder, that he ha d not retired and was the principal officer of the c orporation, and that his services were worth a minim umof $400 per month, or $4,800 per year. Th e Secr etarydetermined that $4,800 of the $8,400 receive d as Subchapter S dividends was in reality remu neration for services r endered and should be denominated as wages for soci al security purposes. This court upheld th e Secr etary’s authority to reclassify or denominate a s wages suchportion of distributed Subchapter S corporate divi dends as found to reasonably constitute wages o r salary for the purpose of determining whether a claimant had excess earnings. 421 F.2d at 502-04, citing Gant v. Ce lebrezze , No. C-124-G-62 (N.D.N.C. Mar. 6, 1964 )14

(claimant was president of newly incorporated Subchapter S corporation actively engaged in its operation and wh o receiveddistributed corporate dividends but no salar y and was considered to be employee of corporatio n recei ving wages for social security purposes); accor d Owens v. Sullivan , 790 F. Supp. 195, 197-98 (E.D. Ark

. 19 91) (holding claimants who received Subchapter S dist ributed dividend income, part of which was i n exchange f or services rendered, were recipients of wages for social security purposes).15

The distinction between distributed and undistribute d corporate profits is important. Although the distinction of tenarises in cases involving Subchapter S corporatio ns, we think the distinction is not limited to Su bchapter S corporations and instead reflects th e broader distinction between actual and merely theoretical
or c onstructive payments of corporate profits in an y form, w hether as salary, dividends or otherwise. Fo r example, i n Somers v. Gardner , 254 F. Supp. 35 (E.D. Va. 1966), the claimant was the president of a Subchapter S corp oration, owned all of the outstanding stock, an d
exer cisedcomplete control over the corporation. H e perf ormedservices for the Subchapter S corporation bu t did not in fact receive any income from the corporatio n in any for m. The Secretary argued that the claimant had received constructive dividends for income tax purpose s and that, for social security purposes, such constructive divi dends could be reclassified as salary for service s rend ered. The district court rejected the Secretary’ s argument and held that the Secretary could no t reclassify the undistributed net income of a Subchapter S corpo rationas wages but could reclassify distribute d dividends as wages. Id. at 36-38. The district cour t carefully noted that

where dividends are in fact re ceived by the sole stoc kholder who had performed services for hi s corporation, there may be authority fo r per mitting the Secretary to reclassify the d e facto dividends as salary to r eflect appropriate compensationfor such services. Additionally , ther e is substantial authority for the genera l principle that the Secretary can allocate funds in fact paid out by a corporation in order t o properlyreflect the value of services rendered16

byemployees and to prevent fraudulen t arrangements which are tantamount to “shiftin g wages. ” However, no case has been cited no r foun dby this Court which authorizes th e Secretaryto “reallocate” moneys which hav e nev er in fact been distributed in any form by the corporation involved.
Id. at 36-37 (citations omitted).17

Si milarly, in Gardner v. Hall , the Secretar y contended that undistributed income and earni ngs had been “channeled ” to the claimant. The claimant, his wife and their sons operated a ranch first as a partnership an d then as a Subchapter S corporation. The claimant was in activ e charge of the ranch, and his wife was activel y involved in the bookkeeping and related activ ities. Each fami lymember was a shareholder and corporate officer

. Each corporate officer, except the claimant, received a sal ary. The claimant received no salary or othe r re munerationdirectly from the corporation for hi s servi ces. His wife deposited her salary into a join t checking a ccount and some of the household expenses were paid fr om that account. The Secretary argued that par t of th e salary paid to the wife should be reallocated t o the claimant. The court of appeals disagreed, holdin g that th is was not a reallocation case because there wa s no evidence or finding that the wife’s salary wa s excessive or not earned by her or that there was an y shifting in the corporation of salary payments from th e claimant to the wife. 366 F.2d at 135. In a ddition, and more important to our analysis, the court of appeals held that the Secretary had no authority to alloca te a portion of t he corporation’s undistributed profit and income t o th e claimant as remuneration for his services. Id. ;
accor d Herbst v. Finch , 473 F.2d 771, 774-76 (2d Cir

. 1972 ) (holding it was improper to make excess earning s deduc tionwhere corporation did not actually o r symb olicallyset aside funds to pay salary to claiman t and n either he nor corporation contemplated payment) ; Taube nfeld v. Bowen , 685 F. Supp. 237, 240 (S.D. Fla

. 1988) (holding Secretary cannot allocate retaine d corporate earnings as additional wages to cla imant); Letz18

v. W einberger , 401 F. Supp. 598, 602 (D. Colo. 1975 ) (holding Secretary could not allocate to claiman t corp orate profits of Subchapter S corporation that ha d not been d istributed and were not available for personal
use of claimant, emphasizing that remuneration must b e paid by the employer and received by the empl oyee, either actuallyor constructively, before Secretary ca n reallocate or shift salary payments).

The pre sent case is analogous to Notini v. Heckler , 624 F. Supp. 552 (D. Mass. 1986), in which th e Secretary’ s theory was essentially that the claimant had been underpaid. In that case the claimant had been th e chief executive officer and plurality19

sh areholder of a successful corporation. In 1979 h e worked part-time, about 12 hours per week, mo stly, in his words, “puttering around,” and later retired; he attended directors meetings several times a year but did not make significant managerial decisions or control dail y management . The corporation paid him wages of $4,410 in 197 9, $4,960 in 1980 and $5,500 in 1981, and a bonus o f $1 00,000 in 1982. The Secretary determined that th e clai mant’s services to the corporation were worth mor e than th e wages paid and that his benefits for 1979-198 1 would instead be based on estimated earnings of $37,92 5 (which represented 25% of his 1978 income of $151,700)

. There was no evidence of any additional or “hidden ” payme nts from the corporation to the claimant. Th e district court upheld the Secretary’s charact erization of the $100,0 00 bonus as compensation for 1981, id. at 554, but held that the Secretary could not allocat e undi stributed corporate profits to the claimant on th e grounds th at he had been “underpaid.” Id. The district
cour t noted that no corporate distributions had bee n made, in any form, during the period in question and , thus, there was no plan to “hide” salary in dividends

. Id. Nor was there any evidence that the capitalize d
earn ings of the corporation had been unusually hig h dur ing the relevant period or that the value of th e clai mant’s stock had been inordinately affected by hi s failure to draw a full salary. Id. Here, the Commissioner did not seek to shift 199 1 salary payments from Joann Johnson to John Johnson, Sr

. Under the Commissioner’s calculations, Joann Johnson’ s 1991 salary of $8,400 remains unchanged. Th e Comm issioner did not argue that Joann Johnson’s salar y was unr easonable or excessive or had not been earned by20

her. Rather, the Commissioner determined that Joh n Johnson, Sr., was underpaid, that is, that his service s were worth $16,800, or $9,800 more than he was paid i n 1991. Even though Cowhill Farms apparently had th e corporate funds available to make such a payment, ther e is no evid ence in this record that such funds (in excess of the reported $7,000) were actually paid or distributed to Joh n Johnson, Sr. We hold the Commissioner cannot , for social security purposes, allocate a portion o f undistribu ted corporate profits to John Johnson, Sr., as remuneration for his services for social securit y purposes.21

Whethe r or not the corporation is a Subchapter S corp orationis irrelevant, and in fact the recor d indicates that Cowhill Farms is not a Subchapter S corp oration(it filed Tax Form 1120 and not Tax For m 1120 -S). The Commissioner does not argue that Cowhil l Farms is not a bona fide corporation.

For this reason, we reverse that part of the distric t court orde r affirming the Commissioner’s reallocation of $9,800 as wages to John Johnson, Sr., for 199 1 and remand the case to the district court for further proceedings

.

REALLOCATION OF FAMILY SALARIES

Clai mants next argue the Commissioner erred i n “pie rcing the veil” of their family salary arrangement s to realloc ate some of the salary paid in 1990 from Joann John sonto John Johnson, Sr., and to attribut e self -employment profits from J & J Hog Farms to Joh n Johnson, S r. Claimants argue that the circumstances did not justify “piercing the veil” of their family salar y arran gements because John Johnson, Sr., did no t contribute substantial and valuable services to Cowhil l Farms or J & J Hog Farms in 1990 and that Joann Johnso n had increa sed her corporate duties commensurate with her incr eased salary in 1990. Claimants specifically argu e that the ALJ failed to identify the “invaluab le services” provided by John Johnson, Sr., and improperly discounted Joa nnJohnson’s farming skills and contributions t o Cowhill Farms. We disagree.22

We hold that the Commissioner did not err in piercin g the veil o f the family salary arrangements. Substantial evidenc e in the record as a whole supports the finding s that John Johnson, Sr., provided substantial and valuable services to Cowhill Farms and J & J Hog Farms in 1990 and that Joann Johnson had not increased her corp orate duties
co mmensurate with her increased salary in 1990. Th e burden of proof was on the claimants. The record showed that the operations of the two corporations w ere the same
as they were in 1989 when it was determined in anothe r social security23

proceedingthat John Johnson, Sr., had provided valuable
serv ices to Cowhill Farms; there were no writte n agre ements or corporate minutes showing the manner i n whic hthe two corporations were operated; there wa s considerab le evidence of commingling of activities among the Joh nsons and their son; and there was evidence tha t John Johnson, Sr., had provided at least 25% of the field work and other “invaluable” services to the c orporations, including significant decision-making responsibilitie s and invaluable experience. With respect to Joan n Joh nson, no specific evidence showed what corporat e decisions she had made since taking over as president of Cowhill Farms in 1989 or how her corporate ac tivities had subs tantiallyincreased in 1989 to correspond to th e significant increase in her salary since 1988.

We h old that substantial evidence supports th e dete rminationof the Commissioner that there was a fict itious family salary arrangement in this case an d that the Commissioner did not err in making adjustment s to John Jo hnson, Sr.’s wages and income for 1990 for the purp ose of computing excess earnings under 42 U.S.C. § 403.
Accordingly, the order of the district court i s affir medin part and reversed in part and the case i s remanded to the district court for further proceedings.

A true copy.

Attest:24 CLERK, U.S. COURT OF APPEALS, EIGHT H CIRCUIT.