TAX COURT OPINION

Case: Timothy James & Jennifer Monahan
Docket Number: 1246-09S
Judge: Colvin
Opinion Type: bench
Filed: 11/03/2009
Pages: 19

tkb,. jNw 5P UNITED STATES TAX COURT WASHINGTON , DC 2021 7 TIMOTHY JAMES & JENNIFER MONAHAN ;-(cid:127)) Petitioners, ) v . ) Docket No . 1246-09S COMMISSIONER OF INTERNAL REVENUE , Respondent . O R D E R Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it i s ORDERED that the Clerk of the Court shall transmit herewith to petitioner .and to respondent a copy of the pages of the transcript of the proceedings in the above case before Judge Laurence J . Whalen at Kansas City, Missouri, containing his oral findings of fact and opinion rendered on October 15, 2009 . In accordance with the oral findings of fact and opinion, decision will be entered for respondent . (Signed ) Laurence J. Whalen Judg e Dated : Washington, D .C . November 3, 2009 BED' OV 5 2009 1 Bench Opinion by Senior Judge Laurence J . Whale n 2 Timothy James & Jennifer Monahan October 15, 2009 3 3 Docket No . 1246-09 S 4 I . 5 THE COURT HAS DECIDED TO RENDER ORAL FINDINGS OF FACT 6 AND OPINION IN THIS CASE, AND THE FOLLOWING REPRESENTS THE 7 COURT'S ORAL FINDINGS OF FACT AND OPINION . 8 9 II . 10 This . proceeding was heard as a Small Tax Case pursuant 11 to the provisions of section 7463 of the Internal Revenue 12 Code of 1986, as amended, and Rules 170 through 179 of the 13 Tax Court Rules of Practice and Procedure . 14 15 III . 16 This bench opinion is made pursuant to the authority 17 granted by section 7459(b) of the Internal Revenue Code of 18 1986, as amended, and Rule 152 of the Tax Court Rules o f 19 Practice and Procedure . Hereinafter all section references 20 are to the Internal Revenue Code, as amended and in effect 21 for 2006, the taxable year in issue, and all Rule references 22 are to the Tax Court Rules of Practice and Procedure . 2 3 2 4 25 IV . and Mrs . Timothy James Monahan appeared in thi s Heritage Reporting Corporation (202) 628-4888 1 proceeding on their own behalf . Douglas S . Polsky, Esquire, 2 appeared on behalf of respondent . In this bench opinion , 3 references to "petitioner" are references to Dr . Monahan . 4 4 5 V . 6 Respondent determined a deficiency of $14,113 .24 i n 7 petitioner's Federal income tax for taxable year 2006 . The 8 deficiency is attributable to a single adjustment t o 9 petitioner's return . Respondent disallowed the deduction of 10 legal and professional fees in the amount of $40,325 .69 that 11 petitioners claimed on the Schedule C, Profit or Loss from 12 Business, for a business entitled, Timothy James Monahan , 13 orthopaedic surgeon . 1 4 15 VI . 16 Some of the facts have been stipulated and are so 17 found . 18 Petitioners resided in Liberty, Missouri, at the time 19 their petition was filed with the Court . 20 During the early part of 2003, Summit Orthopedics , 21 P .S .C . (herein referred to as Summit), a group of orthopedic 22 surgeons practicing in Georgetown, Kentucky, and Georgetown 23 Community Hospital, L .L .C . (herein referred to as Hospital), 24 a hospital located in the same city, recruited petitioner to 25 practice as an orthopedic surgeon in Georgetown, Kentucky , Heritage Reporting Corporation (202) 628-4888 5 1 and the surrounding area . Prior to relocating, petitioner 2 lived in Richmond, Virginia, where he pursued a fellowship 3 in orthopedic medicine . 4 Petitioner ' s legal and business relationship to Summit 5 and to the Hospital is described by two agreements . The 6 first is a document entitled " Summit Orthopaedics, P .S .C . , Employment Agreement " entered into between petitioner an d 8 Summit on or about April 18 , 2003 , ( hereinafter referred to 9 as employment agreement ) . The second is a document entitled 10 "CERTIFICATE , Physician Recruiting Agreement , LPH-462A " 11 entered into between and among Hospital , Summit and 12 petitioner on or about June 6, 2003 ( hereinafter referred to 13 as physician recruiting agreement) . 14 Under the employment agreement , Summit agreed to employ 15 petitioner as an employee and to pay him an annual salary of 16 $300,000 plus the cost of certain business expenses , 17 including the cost of malpractice and excess liability 18 insurance . In return , petitioner agreed to work full-time 19 as an orthopaedic surgeon exclusively for Summit . The term 20 of the employment agreement was one year - commencing on or 21 before August 30 , 2003, . and was to " automatically renew for 22 additional one (1 ) year terms unless either party terminates 23 the Agreement" . 24 The employment agreement contemplated that ;.(cid:127)petitioner 25 would enter into the physician recruiting agreement, Heritage Reporting Corporatio n (202) 628-4888 1 mentioned above, and that the Hospital would make variou s 2 payments to petitioner under that agreement . As to payments 3 under the recruiting agreement, the employment agreement 4 provided as follows : 5 QUOTE Payments from Georgetown Community Hospital . 6 6 7 8 1 0 1 1 12 Except as provided in the following sentence, Physician will pay over or assign to the Corporation all advances or payment s from Georgetown Community Hospital (the "Hospital") under the practice assistance agreement between Physician and the Hospital (the "Recruitin g 13 Agreement") immediately upon receipt by 14 Physician of such advances or payments, 15 and the Corporation will use suc h 16 payments to pay Physician's salary an d 1 7 1 8 19 2 0 2 1 2 2 2 3 2 4 25 practice expenses . Physician will. not be required , however, to pay over or assign to the Corporation any amounts paid by the Hospital for reimbursement of moving expenses or any signing bonuses pursuant to the Recruiting Agreement . The Corporation will provide, or assist Physician in providing to the Hospital, suc h Heritage Reporting Corporation (202) 628-4888 7 1 financial information concerning 2 Physician ' s practice as is required 3 under the Recruiting Agreement . END 4 QUOT E 5 6 As suggested by the above provision of the employment 7 agreement , the financial incentives for petitioner' s 8 relocation to Kentucky were to be provided by the Hospital 9 under the physician recruiting agreement . Actually, that 10 agreement consisted of a package of nine agreements 01% 11 "addenda " under which petitioner would be guaranteed by the 12 Hospital an annual base payment of $300,000 , together with 13 reimbursement of his overhead expenses , and he would be pai d 14 certain other amounts by the Hospital . The other payments 15 to . petitioner included a "Sign on Bonus of $ 50,000 , A 16 reimbursement of his reasonable moving expenses up t o 17 $8,000, reimbursement,'of certain marketing expenses , such as 18 the cost of local newspaper advertising and mailing 19, announcement cards up to a maximum of $6,000, an d 20 reimbursement of the cost of an outside practice management 21 consultant up to $8,000 . All of these other payments under 22 the physician recruiting agreement were payable up front, 23 but they were subject to be returned, upon demand by th e 24 Hospital, under a fractional formula, to the exten t 25 petitioner failed to maintain a full time practice in the Heritage Reporting Corporatio n (202) 628-4888 1 community for five years . 2 The payments guaranteed by the Hospital, consisting of 3 petitioner's salary of $300,000, and~his overhead expenses 4 are described by one addendum, as follows : 8 5 7 8 QUOTE The total guarantee annual budget will consist of $300,000 base plus overhead expenses, which will be agreed upon with Summit Orthopedics, P .S .C . (the "practice") prior to Hospital CE O 10 signing any documents . END QUOTE . 11 Under The physician recruiting agreement, petitioner 12 was guaranteed to receive this so-called "Guarantee d 13 Payment" over a 24 month period, the "Guarantee Period" . 14 The agreement established a mechanism under which petitioner 15 would give the Hospital monthly statements of the cas h 16 collected form his practice, his "Gross Cash Receipts", and, 17 for any month that his receipts were less than the guarantee 18 amount, computed on a monthly basis, the Hospital promised 19 to make up the difference, the "Guaranteed Payment" . 20 Significantly, the guaranteed payments of the Hospital 21 were designated as advances of a "loan" to petitioner . The 22 total of the guaranteed payments would become due an d 23 payable at the end of the guarantee period but would be 24 forgiven and cancelled to the extent of one twenty-fourt h 25 (1/24th) of the debt "for each full calendar month Physician Heritage Reporting Corporatio n (202) 628-4888 9 1 remained in the full-time practice of medicine in th e 2 Community after the end of the Guarantee Period", and he 3 satisfied certain other conditions . 4 Summit was an integral party to the physicia n 5 recruitment agreement . One addendum to the agreemen t 6 entitled, Recruitment into Existing Medical Practice, was 7 executed by Summit, the Hospital, and petitioner an d 8 provides as follows : 9 QUOTE This Addendum is attached to, made a part 10 of and executed simultaneously with tha t 11 certain Recruiting Agreement between th e 1 2 1 3 1.4 1 5 1 6 17 1 8 1 9 2 0 2 1 2 2 2 3 2 4 25 undersigned Hospital and Physician dated the 26th .day of March, 2003 . 1 . Summit Orthopedics, P .S .C . (hereinafter "Medical Practice") is entering int o this Addendum in order to assist in the recruitment of Physician into the Medical Practice under the terms and conditions set forth .herein . 2 . Hospital Payment(s) of the monthly Guarantee payments. made pursuant to an d in accordance with Section 3 of the Net Collectable Revenue Guarantee Addendum shall be payable jointly to the Medical Practice and Physician . Heritage Reporting Corporation (202) 628-4888 1 3 4 5 6 7 1 3 1 4 1 5 16 1 7 1 8 19 2 0 2 1 2 2 2 3 2 4 25 The Medical Practice hereby agree s 1 0 to be . jointly and severally liable for the repayment of Physician's debt to Hospital incurred pursuant to the terms and conditions of the Recruiting Agreement and all addenda attached thereto, including but not limited to the Net Collectable Revenue Guarantee Addendum . The Medical Practice hereby grants and conveys to Hospital a security interest in all of its accounts receivable generated by Physician, and Hospital may perfect such security interest at any time during the term of the Recruiting Agreement . Further, in the event Physician terminates his/her relationship with the Medical Practice during the term of the Agreement, the Medical Practice shall not restrict Physician from engaging in the practice of medicine in the Community . 4 . The Medical Practice shall provide .Hospital with the monthly statement described in Section 3 of the Net Collectable Revenue Guarantee Addendu m Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 1 0 1 1 1 2 13 1 1 and otherwise cooperate with Hospital, and the Medical Practice hereby,agrees to the terms and conditions applicable to Physician that are set out in the Net Collectable Revenue Guarantee Addendum . Hospital shall have the right to review and audit the Medical Practice's books and records to assure compliance with this Addendum . 5 . In the event an employment agreement is entered between the recruite d physician and medical practice, a copy of the employment agreement is included 14 as an attachment hereto . Additionally, 15 a copy of how operating expenses will be 16 allocated between medical practice and 17 recruited physician is included as a n 18 attachment . END QUOT E 19 Thus, under the above addendum, Summit affirmatively . 20 undertook petitioner's obligations under the physician 21 recruiting agreement by agreei:4 to be jointly and 22 severally liable for repayment of the Guaranteed Payment, by 23 granting the Hospital a security interest in its account s 24 receivable generated by petitioner, by agreeing to provide 25 monthly statements to the Hospital, and by giving the Heritage Reporting Corporatio n (202) 628-4888 12 1 Hospital the right to audit its books . In return th e 2 Hospital agreed to make monthly guarantee payments jointly 3 to Summit and petitioner . Under the, employment agreement, 4 quoted above, . petitioner agreed to pay over to Summit al l 5 advances or payments from the Hospital immediately upon 6 receipt and Summit agreed to use such payments to pa y 7 petitioner ' s salary and practice expenses . 8 Petitioner began his practice as an employee of Summit 9 at the end of 2003 . Circa June 2004, petitioner becam e 10 concerned that payments by the Hospital under the physician 11 recruitment agreement might have been used to benefit Summit 12 in violation of either the Stark Law (see 42 U .S .C . sec . 13 . 1395nn) or the Anti-Kickback statute (see 42 U .S .C . sec . 14 1320a-7b) . See generally, McDonnell v . Cardiothoracic & 15 Vascular Surgical Assoc . , 2004 WL 3733402 (S .D .Ohio 2004) . 16 Petitioner was not satisfied with the responses to hi s 17 inquiries about the matter from Summit and the Hospital's 18 administrators . Accordingly he submitted his notice o f 19 intent to resign from Summit effective August 30, 2004 and 20 he left Summit's employ at that time . 21 After his resignation from Summit, the Hospita l 22 demanded that petitioner repay the total Guarantee payments, 23 and possibly other payments made under the physicia n 24 recruiting agreement, in the aggregate amount o f 25 $255,689 .52 . See Position Paper and FRCP 26(a) Type Heritage Reporting Corporatio n (202) 628-4888 A 13 1 Disclosures of'Georgetown Hospital, LLC, filed in Monahan v . 2 Georgetown Community Hospital , an arbitration before th e 3 American Health Lawyers Association Alternative Disput e 4 Resolution Service, No . A-081106-441, (herein referred to as 5 "arbitration proceeding"), at page 1 . The basis for the 6. Hospital's claim against petitioner was "a simple breach of 7 contract claim for the non-repayment of the amounts du e 8 under the terms of the Contracts [i .e . the addenda of the 9 physician recruitment agreement] ." Id . at 2 . 10 Petitioner refused the Hospital' s demand that he make 11 such repayment, and he initiated an arbitration proceeding 12 before the American Health Lawyers Association . Based upon 13 further investigation, petitioner came to believe that his 14 physician recruiting agreement "was being used to 15 inappropriately benefit Summit Orthopedics in a mag tier that, AA 16 at minimum, violated Stark II Law and anti-kickbac k 17 statute ." See Dr . Monahan's Preliminary Position Statement, 18 filed in the arbitration proceeding, at page 17 . In fact, 19 petitioner claimed in the arbitration proceeding that the 20 physician recruitment agreement "is in violation of the 21 Stark II and anti-kickback statutes and, therefore, [is] 22 unenforceable under Kentucky law ." Id . at 19 . 23 On February 3, 2007 petitioner and Hospital entere d 24 into Confidential Settlement Agreement and Mutual Releas e 25 .(herein "settlement agreement") in which they agreed not to Heritage Reporting Corporatio n (202) 628-4888 1 4 1 pursue the arbitration but to submit to the arbitrator a n 2 Agreed Order and Award Dismissing Claims . Under the 3 settlement agreement, the Hospital agreed to pa y 4 petitioner's filing fee in the arbitration . The Hospital 5 also agreed to pay petitioner's share of the arbitrator' s 6 fees and expenses, and his attorney's fees, up to a maximum 7 payment of $50,000 for those fees and expenses . The 8 Hospital also agreed to release petitioner from all claims 9 for payments under the physical recruiting agreement . 10 11 VII . 12 The sole issue for decision by this Court is whether 13 petitioners are entitled to deduct the legal and 14 professional fees that were incurred by petitioner in th e 15 arbitration proceeding as an ordinary and necessary business 16 expense under section 162, or whether, as responden t f 17 determined, petitioners are limited to deducting those fees 18 on Schedule A of petitioners' income tax return as a 19 miscellaneous itemized deduction that is subject to the two 20 percent floor under section 67 . 2 1 22 VIII . 23 As a general rule, the Commissioner's determinations 24 are presumed correct and the taxpayer bears the burden of 25 proving that those determinations are erroneous . Rule Heritage Reporting Corporation (202) 628-4888 1 5 1 142(a) . Parenthetically, we note that section 7491(a)(1) 2 shits the burden of proof to the Commissioner in certain 3 cases "if, in any court proceeding, . aka to payQl"Ot 4 introduces credible evidence with respect to any factual 5 issue" . In this case, we did not rely on the burden o f 6 proof in finding any factual issue relevant to ascertaining 7 petitioner's tax liability . 8 10 As mentioned above, respondent determined tha t IX . 11 petitioner's legal fees of $40,325 .69 were deductible from 12 adjusted gross income asAmiscellaneous itemized deduction, 13 subject to the limitations of section 67 . The issue i s 14 whether petitioners are allowed to deduct the legal fee s 15 incurred in the . arbitration only as a miscellaneous itemized 16 deduction, as respondent determined, or whether they ca n 17 deduct the legal fees from gross income under sectio n 1 8 1 9 2 0 2 1 22 62(a)(1), as an ordinary and necessary busines s they contend . Responden t asserts that (cid:127)this'issue is governed by th e 1~ 'origin of the claim' doctrine that was first art icculate d by the Supreme Court in United States v . Gilmore ti Unde r l 23 that doctrine, petitioners would be entitled to deduct the 24 legal fees under section '162 if the origin of the claim in 25 the arbitration proceeding related to petitioner's trade or Heritage Reporting Corporatio n (202) 628-4888 1 6 1 business of providing medical services as an independent 2 contractor for the Hospital, rather than as an employee of . 3 Summit . See , e .g . , United States v . 'Gilmore, supra . 4 The origin of the claim is found by analyzing the facts 5 of the case and the basis of the transaction out of whic h 6 the litigation arose . C' f73 ) ETg . , Boagni v . Commissioner , bra 7 at 713 . This is not a mechanical search for the first in A btu 8 the chain of events which led to the litigation )p, rather, 9 requires an examination of all the facts . Id ., The inquiry 10 is directed to ascertaining the "kind of transaction" out of 11 which the litigation arose . Id . Consideration must b e 12 given to the issues involved, the nature and objectives of 13 the litigation, the defenses asserted, the purposes fo r 14 which the claimed deductions were expended, the backgroun d (L' nr 15 of the litigation, and all facts pertaining to th e 16 controversy . Id . ; Morgan's estate v . Commissione r 17 Petitioners appear to concede that the origin of the 18 claim doctrine governs the resolution of this case . 19 effect , they argue that the subject legal fees resulted from 20 petitioner ' s trade or business performing medical services 21 for the Hospital as an independent contractor under the 22 physician recruiting agreement . Petitioners point to . 23 paragraph six of the addendum to the physician recruiting 11 24 agreement , entitled Recruiting Agreement , which states,- t 25 all times during the term of this Agreement , Physician i s Heritage Reporting Corporation . (202) 628-4888 1 7 1 and shall be an independent contractor and not a servant, 2 agent or employee of the Hospital . " 3 Petitioners argue that the physician recruitin g 4 agreement and the employment agreement were separate and 5 unrelated agreements and created separate relationships with 6 petitioner , independent contractor and employee , 7 respectively . According to petitioners , the subject legal fees were incurred in "attempting to enforce the terms of the Recruitment Agreement ", under which petitioner was a n 10 independent contractor . They also argue that Summit , 11 petitioner ' s employer , had nothing to do . with the physician 12 recruiting agreement . For example , they make the erroneous 13 claim that "Summit was never a party to the underlying 14 Recruiting Agreement" . 15 16 X . 17 Based upon our review of the record of this case, we 18 find no evidence to support petitioner ' s position that the 19 subject legal fees were incurred by petitioner in hi s 20 capacity as an independent contractor for the Hospital . We 21 find no evidence that petitioner conducted any activity as 22 an independent contractor between August, 2003 ...E he whi n 23 began his employment with Summit, and August, 2004, when he 24 resigned . To the contrary, the purpose of the arrangement 25 created under the physician recruiting agreement and th e Heritage Reporting Corporation (202) 628-4888 1 8 1 employment agreement was to recruit petitioner to perfor m 2 medical services in Georgetown, Kentucky, as an employee of 3 Summit . With the exception of the moving expenses and sign 4 on bonus, the financial incentives provided by the Hospital, 5 including the guarantee payments,at issue in the 6 arbitration, were paid by the Hospital to immit, and Summit 7 used those funds to compensate petitioner for his service s as an employee . Iftthis regard, we note that the Agree d 9 Order and Award Dismissing Claims that was submitted to the 10 arbitrator as part of the settlement of the arbitration 11 states as follows : 12 QUOTE *** the Hospital agrees and stipulates that, 13 to the best of its knowledge and belief , 14 the facts developed in these proceedings 15 have established that guaranteed paymen t t 16 checks which i issue' pursuant to the 17 Recruiting Agreement, whether payable to 18 Dr . Monahan and to Summit or solely to 19 Dr . Monahan, were received by Summit and 20 deposited to Summit's account . EN D 21 QUOTE 22 The financial incentives provided by the Hospital were 23 designed to induce petitioner to stay in the community for 24 24 months, in the case of . the guarantee payments, and for 60 25 months, in the case of certain other payments . I f Heritage Reporting Corporation (202) 628-4888 ;,, 19 1 petitioner left the community before those periods, then the 2 Hospital could demand repayment of all or a portion of th e 3 payments petitioner received from the Hospital, throug h 4 Summit . In fact, after petitioner resigned from Summit, the 5 Hospital demanded repayment of $255,689 .52 of the payment s 6 that had been made .by the Hospital, . through Summit . 7 Petitioner initiated the arbitration and incurred the 8 subject legal fees in . depending against the Hospital' s 9 demand for the repayment of those monies that had been paid 10 to him as an employee of Summit . Petitioner did not incur 11 the legal fees "attempting to-enforce the terms of the 12 Recruiting Agreement", as he claims in this proceeding . To 13 the contrary, petitioner argued in the arbitratio n 14 proceeding that his Recruiting Agreement was being used in a 15 manner that violated the Stark law and the anti-kickbac k 16 statute, such that the agreement was "unenforceable under 17 Kentucky law" . 18 For the foregoing reasons, we agree with the respondent 19 that the subject legal fees incurred by petitioner fo r 20 representation in the arbitration proceeding related to 21 petitioner's business of being an employee of Summit . 22 Accordingly, the legal fees are only deductible as a 23 miscellaneous itemized deduction, subject to the two percent 24 floor limitation imposed by section 67 . 25 Heritage Reporting Corporation (202) 628-4888 1 XIII . 2 To give effect to our disposition of the disputed issue 3 decision will be entered for respondent . 2 0 4 5 XIV . 6 THIS CONCLUDES THE COURT'S ORAL FINDINGS OF FACT AND 7 OPINION IN THIS CASE . 8 (Whereupon, at 10 :45 a .m ., the bench opinion in the 9 above-entitled matter was concluded . ) // . 10 11 12 13 1 4 15 16 17 18 19 20 2 1 22 23 24 // 25 Heritage Reporting Corporation (202) 628-4888