TAX COURT OPINION

Case: Robert M. & Nancy I. Stewart
Docket Number: 365-01
Judge: Ruwe
Opinion Type: memo
Filed: 08/08/2002
Pages: 23

T.C. Memo. 2002-199 UNITED STATES TAX COURT ROBERT M. AND NANCY I. STEWART, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 365-01. Filed August 8, 2002. Martin Brant Fenster, for petitioners. Matthew A. Mendizabal, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION RUWE, Judge: Respondent determined deficiencies of $35,106 and $36,999 in petitioners' Federal income taxes, and accuracy- related penalties under section 6662(a)¹ of $6,753 and $7,400, ¹All section references are to the Internal Revenue Code in effect Tax Court Rules of Practice and Procedure. for the years at issue. All Rule references are to the BERVED AUG 8 2002 - 3 - The sign business and the computer company sold products to the general public. The corporation held real estate, and it provided management services to the sign business and the computer company. In December 1984, R.M. Stewart, Inc., and Mr. Stewart entered into a management agreement, which provided: The purpose of this agreement management agreement for Robert M Stewart's real estate business. to have full management control over the real estate office located at 2698 Berryessa Road San Jose. Inc is by this agreement is to establish a R M Stewart Inc is to be paid a [sic] annual retainer R M Stewart of $48,000 which is not before taxes. capital fall may carry forward upto two full calendar years. improvements or expansion, fees are not paid due to to exceed 70% of If the annual than [sic] the net profit the short This agreement sooner. is to be reviewed every three years or * * * For both R M Stewart [Signed Robert M. Stewart] Inc and Robert M Stewart * * * • Mr. Stewart executed four subsequent addendums to this agreement. In December 1987, the annual retainer was raised to $84,000; in December 1990, the annual retainer was raised to $120,000. In December 1993 and in December 1996, addendums were executed providing that "all terms and conditions to remain the same." There was no independent third party involved in the contract, and no party other than Mr. Stewart signed the contract or the addendums. . - 5 - allowance for salaries or other compensation for personal services actually rendered. Deductions are a matter of legislative grace, and the burden of clearly showing the right to any such deductions is on the taxpayer.4 INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Respondent determined that the amounts paid to R.M. Stewart·, Inc., as "management fees" were not ordinary and necessary business expenses or were not expended for the purpose designated.5 Petitioners argue that the management fees were ordinary and necessary expenses of Mr. Stewart's real estate business. They contend that the type of services provided to the real estate business involved "classic ordinary and necessary business expenses" and that they were provided pursuant to a binding and written contract. Petitioners suggest that R.M. Stewart, Inc., performed those services as a separate taxable entity. Ordinary expenses arise from transactions that are "of common or frequent occurrence in the type of business involved." Deputy v. DuPont, 308 U.S. 488, 495 (1940); ASAT, Inc. v. Commissioner, 108 T.C. 147, 174 (1997). Necessary expenses are 4Respondent submits that the examination of petitioners' 1995 and 1996 returns began on Mar. 21, 1997. Petitioners do not raise an issue as to the application of sec. 7491, and we find that Code section inapplicable to this case. SRespondent suggests that the fees were essentially capital contributions from Mr. Stewart to the corporation. the years at issue. Mr. Stewart has not shown that he performed those services as an employee or independent contractor of the corporation. Mr. Stewart was not paid by the corporation as an employee, independent contractor, or executive in 1995 and 1996, and it does not appear that the corporation ever compensated him for the general management services he performed in 1995 and 1996. There was no employment agreement between Mr. Stewart and the corporation, and there are otherwise no records which show Mr. Stewart provided the services in any capacity as an employee of the corporation. Also, there is no documentation showing the number of hours that Mr. Stewart spent providing the management services to the sole proprietorship. There is no reasonable basis to distinguish the services that Mr. Stewart provided generally to his sole proprietorship and those that he might have performed through the corporation. And, there is no reasonable basis for us to find that the corporation or any of its employees actually rendered services to the sole proprietorship in 1995 and 1996. Petitioners point to the management fee agreement between Mr. Stewart and the corporation. The agreement does not specify or otherwise describe the management services to be performed by the corporation, and the "annual retainer" does not relate to any services actually to be rendered by the corporation. The agreement was not the product of arm's-length negotiations. The _ 9 _ greater of 10 percent of the tax required to be shown on the return for the taxable year or $5,000. Sec. 6662(d)(1) (A). An understatement is the excess of the tax required to be shown on a return for the taxable year over the amount of the tax imposed which is shown on the *return. Sec. 6662(d)(2) (A). The understatement is reduced where the taxpayer has substantial authority for his tax treatment of any items or where the relevant facts affecting the item's tax treatment are adequately disclosed in the return or in a statement attached to the return and there is a reasonable basis for such tax treatment. Sec. 6662(d) (2) (B). Petitioners rely on section 162 and section 1.162-1, Income Tax Regs., as substantial authority for taking their deductions; however, given the particular circumstances of this case, we cannot agree that those authorities represent substantial authority for petitioners' deductions. Further, • simply claiming the deductions on the Schedules C attached to their 1995 and 1996 returns does not constitute adequate disclosure. Petitioners did not disclose any relevant facts or attach any statement to their returns. We find a substantial understatement of income tax in this case. The accuracy-related penalty is not imposed if the taxpayer shows there was a reasonable cause for the underpayment and that he acted in good faith with respect to the underpayment. Sec. 6664(c)(1). Mr. Stewart was previously audited by respondent for UNITED STATES TAX COURT NANCY I. STEWART, Docket No. 365-01 In the Matter of: ROBERT M. STEWART AND ) ) ) ) ) ) ) ) COMMISSIONER OF INTERNAL REVENUE, ) v. Petitioners, Respondent. ) BRIEF FOR PETITIONERS FEB 6 2002 RECORDED CE STA T. Martin B. Fenster Attorney for Petitioner 14625 Big Basin Way Saratoga, CA 95070 (408) 867-8600 Tax Court No. FM0313 SERVED 4 TABLE OF CONTENTS Cover Page PAGE Citations ................................................................................................................... Petitioner's Preliminary Statement (Nature ofControversy and Issues to be Decided).................................................... Issues to be Decided as Presented by Petitioner......................................................... Petitioner's Request for Findings ofFact................................................................... Petitioner's Request for Ultimate Findings of Fact..................................................... Points Relied Upon................................................................................................... Argument.................................................................................................................. I. The Management Fees Paid in 1995 and 1996 Were Ordinary and Necessary Business Expenses of Petitioner's Sole Proprietorship Deductible under Section 162(a) of the Internal Revenue Code. ........................................................... II. R. M. Stewart, Inc., Was Organized with Independent Business Purpose, Was the Earner ofthe Management Fee Income and Properly Reported the Income. ............................................................................................................... III. The Substantial Understatement Penalty Is Improper Because the Commissioner Improperly Denied the Deduction for Management Fees for Which There Was Substantial Authority, It Was Disclosed on the Return and There Was a Reasonable Basis for Such Tax Treatment.............................................................. Conclusion................................................................................................................ Signature of Counsel................................................................................................. Certificate of Service................................................................................................. 2 3 5 5 9 10 10 10 13 15 16 16 17 1 CITATIONS Cases Foglesong V. Comm., 621 F.2d 865, 868-869 (7* Cir. 1980) Johnson v. Comm., 78 T.C. 882 (1982) Klein v. Board ofSupervisors, 282 U.S. 19, 24 ( 1930) Latham Park Manor, Inc. v. Comm., 69 TC 199, 199-200 (1977) Moline Properties, Inc. v. Comm., 319 U.S. 436, 438-439 (1943) pg 14 15 14 12 14 Code Sections Internal Revenue Code Section 162(a) 4, 5, 10, 12, 13, 16 Internal Revenue Code Section 6662(a) 3,5 Miscellaneous Regulation Section 1.162-1 10, 13, 16 2 UNITED STATES TAX COURT In the Matter of: ROBERT M. STEWART AND NANCY I. STEWART, ) ) ) Docket No. 365-01 v. Petitioners, ) ) ) COMMISSIONER OF INTERNAL REVENUE, ) ) ) Respondent. BRIEF FOR PETITIONERS PETITIONER'S PRELIMINARY STATEMENT (NATURE OF CONTROVERSY AND TAX INVOLVED) NATURE OF CONTROVERSY This is a proceeding for the redetermination ofa deficiency in income tax determined against the Petitioners for the 1995 and 1996 calendar tax years. The amount of the deficiency for 1995 is $35,106.00 together with a substantial understatement penalty of $6,753.00 under Section 6662(a) ofthe Internal Revenue Code. The amount ofthe deficiency for 1996 is $36,999.00 together with a substantial understatement penalty of $7,400.00 under Section 6662(a) of the Internal Revenue Code. These proposed deficiencies are based on the Respondent's determination that the Petitioners improperly assigned income to Petitioner's wholly owned Corporation which reported the income, 3 and therefore the Petitioner improperly took a deduction for same. More particularly, the nature ofthe controversy is one involving the validity ofthe deductions taken by Petitioner for management fees paid from his sole proprietorship real estate sales business to Petitioner's wholly owned corporation for general management services provided by the corporation through its agent, the Petitioner, to the sole proprietorship for the years 1995 and 1996. Petitioner claims the deductions are ordinary and necessary and properly deductible under Internal Revenue Code Section 162. Respondent claims it is not properly deductible because it constitutes an assignment of income. The evidence consists of a First and Second Stipulation of Facts and Exhibits offered and accepted at trial and oral testimony at trial. The following concessions were agreed to as set forth in the filed Stipulations of Settled Issues. 1. The Petitioner concedes the adjustment to income for the car and truck expenses in the amount of $4,313.00 for the 1995 taxable year. 2. 3. The Petitioner concedes the adjustment to income for unreported interest expense in the amount of $3,430.00 for the 1995 taxable year. The Respondent concedes the adjustment for rent expense in the amount of$1,735.00 for the 1995 taxable year. 4. The Respondent concedes $20,000.00 of the $120,000.00 proposed as an adjustment for commission expense described in Line 7b of the Form 5278 for the 1996 taxable year. The Trial was held before The Honorable Judge Robert R. Ruwe, Special Trial Judge, on December 7, 2001 in Room 2-1408, Federal Building & Courthouse, 450 Golden Gate Avenue, 4 San Francisco, CA. The court ordered simultaneous briefs to be filed by February 5, 2002. Judge Ruwe said that there would be no reply briefs unless he decided to issue a written order asking for same. ISSUES TO BE DECIDED AS PRESENTED BY PETITIONER 1. Whether the payment of $120,000.00 for management expenses in 1995 by the Petitioner's sole proprietorship business, Robert M. Stewart dba Century 21 Stewart and Associates to R. M. Stewart, Inc., was properly deductible as an ordinary and necessary business expense under Section 162(a) oftheInternalRevenue Code as contended by Petitioner or an improper assignment of income as contended by Respondent. 2. Whether the payment of $100,000.00 for management expenses in 1996 by the Petitioner's sole proprietorship business, Robert M. Stewart dba Century 21 Stewart and Associates and later Prudential California Realty to R. M. Stewart, Inc., was properly deductible under Section 162(a) ofthe Internal Revenue Code as an ordinary and necessary business expense as contended by Petitioner or an improper assignment ofincome as contended by Respondent. 3. Whether the Commissioner properly determined the substantial understatement penalties of $6,753.00 for 1995 and $7,400.00 for 1996 under Section 6662(a) ofthe Internal Revenue Code. PETITIONER'S REQUEST FOR FINDINGS OF FACT 1. Petitioners timely filed their 1995 U.S. Individual Income Tax Return (Form 1040). (First Stipulation ofFacts, Paragraph 1) 2. Petitioners timely filed their 1996 U.S. Individual Income Tax Return (Form 1040). (First Stipulation of Facts, Paragraph 2) 5 3. The Statutory Notice ofDeficiency upon which jurisdiction in this case is based was mailed to the Petitioners on October 12, 2000. (First Stipulation ofFacts, Paragraph 3) At the time offiling the Petition, Petitioners resided in San Jose, California. (First Stipulation of Facts, Paragraph 4) Petitioner, Robert M. Stewart, was the owner of a sole proprietorship real estate agency business. (Trial Transcript 10:21-23; Exhibits 4-J and 5-J) In 1995, the real estate agency business was called Century 21 Stewart and Associates. (Trial 4. 5. 6. Transcript 11:1-3) 7. In 1996, the real estate agency business was called Century 21 Stewart and Associates for part of the year and Prudential California Realty. (Trial Transcript 11:4-8) 8. Robert M. Stewart was the sole shareholder and director of R.M. Stewart, Inc. (Trial Transcript 11:9-17) 9. R. M. Stewart, Inc., was formed in 1984. (Trial Transcript 11:18-19) 10. R. M. Stewart, Inc., (the corporation) was formed to protect assets and designed to protect the real estate sales office. (Trial Transcript 11:20-24) 11. 12. The corporation engaged in real estate development. (Trial Transcript 12:4-10) The corporation through a subsidiary also engaged in a screen printing sign business (Trial Transcript 12:11-14) which products were offered to the public (Trial Transcript 12:13-16). 13. Robert M. Stewart's sole proprietorship real estate agency business (the sole proprietorship) purchased less than five percent ofthe signs ofthe subsidiary. (Trial Transcript 12:18-24) 14. The corporation also formed a computer company which sold products to the public. (Trial Transcript 13:3-12) 6 15. 16. The corporation also held real estate. (Trial Transcript 13:14-16) The corporation provided management services to the sign company, computer store and the sole proprietorship. (Trial Transcript 13:17-25; 14:1-3) 17. The corporation entered into a written Management Agreement with the sole proprietorship. ( Trial Transcript 14:19-23, Exhibit 9-J) 18. The purpose of the Management Agreement was to entrust full management control ofthe real estate sales office to the corporation and to establish fees to be paid to the corporation from the sole proprietorship for this service. (Trial Transcript 15:6-10; Exhibit 9-J) 19. The management fees were set by looking at the models oftwo other real estate companies and what they were paying their managers. (Trial Transcript 15:11-19) 20 The Management Agreement originally entered into in 1984 was renewed every three years through addenda to the Management Agreement. (Trial Transcript 15:20-23; Exhibit 9-J) 21. The Addendum to the Management Agreement dated December, 1990 established the management fees at $120,000.00. (Trial Transcript 16:7-11) 22. The $120,000.00 figure which was in effect in 1995 and 1996 was established by looking to what Cornish and Carey, a twenty-two office real estate office, was paying to manage an office the same size as the sole proprietorship. (Trial Transcript 16:12-15; Exhibit 9-J) 23. General management services consisting ofrunning the company, overseeing the training of managers, the sales manager, overseeing accounts receivable, accounts payable, motivating agents, reviewing contracts, both for residential and business contracts, determining phone systems were provided by the corporationto the sole proprietorship throughthe corporation's agent, Robert Stewart. (Trial Transcript 16:19-25; 17:1-4) 7 24. The sole proprietorship paid the corporation $120,00.00 for management services provided in 1995. (Trial Transcript 17:15-17; Exhibit 16-J) 25. The sole proprietorship deducted the $120,00.00 payment on Schedule "C" attached to Petitioner's Form 1040 for 1995. (Exhibit 4-J) 26. The sole proprietorship paid the corporation $100,00.00 for management services provided in 1996. (Trial Transcript 17:18-20; Exhibit 11-J) 27. The sole proprietorship deducted the $100,00.00 payment on Schedule "C" attached to Petitioner's 1040 for 1996. (Exhibit 5-J) 28. The corporation reported the income received from the sole proprietorship in 1995 and 1996 on its Forms 1120. (Exhibits 6-J, 7-J and 8-J) 29. Having the Management Agreement in place better positioned the sole proprietorship for an acquisition or merger. (Trial Transcript 17:25; 18:1-11) 30. The corporation provided real property management services to the clients of the sole proprietorship. (Trial Transcript 18:12-14) 31. By agreement, the clients of the sole proprietorship who used the property management services were required to list the property with the sole proprietorship if the property came up for sale. (Trial Transcript 19:11-20) 32. 33. These listings benefitted the sole proprietorship. (Trial Transcript 19:21-25) The sole proprietorship was prohibited from providing this valuable service that was provided by the corporation because ofits franchise agreements. (Trial Transcript 18:16-25; 19:1-10, 20:1-4) 34. The corporationpaid a propertymanager forthese services.(Trial Transcript 20:9-25; 21:1-5) 8 35. During 1995 and 1996, Robert J. Stewart did not receive a salary from the corporation (Trial Transcript 26:12-14) 36. During 1995 and 1996, Robert M. Stewart took no draw from the sole proprietorship. (Trial Transcript 26:16-17) 37. Robert M. Stewart did not get a salary from the corporation or a draw from the sole proprietorship in 1995 and 1996 because of unusual business expenses in those years associated with expanding the office, being in the process of purchasing the building where they were located, and unusual legal expenses to defend lawsuits. (Trial Transcript 26:12-18; 26:20-23; 25:20-24; 26:7-9) 38. Robert M. Stewart received compensation in other years from R. M. Stewart, Inc., for general management services provided to the sole proprietorship. (Trial Transcript 26:24-25; 27:1-2) 39. Robert M. Stewart's sole proprietorship was the subject of an IRS audit for the 1985 tax year. (Trial Transcript 23:8-10) • 40. Robert M. Stewart received a no change audit letter from the IRS dated June 9, 1987. (Trial Transcript 23:11-12, Exhibit 17-P) 41. Petitioner reasonably believed that as a result ofreceiving the no change audit letter (Exhibit 17-P) that there was no problem with the management fees paid by the corporation to the sole proprietorship in 1995, 1996 and other years. (Trial Transcript 25:8-18) PETITIONERS' REQUEST FOR ULTIMATE FINDINGS OF FACT 42. The Respondent's determination of the Petitioners' tax liability for calendar year 1995 resulting in a deficiency of $35,106.00 in taxes and $6,753.00 in penalties is in error. 9 43. The Respondent's determination of the Petitioners' tax liability for calendar year 1996 resulting in a deficiency of $36,999.00 in taxes and $7,400.00 in penalties is in error. 44. Petitioners are entitled to a deduction of $120,000.00 for management fees paid in 1995 to R. M. Stewart, Inc., as an ordinary and necessary business expense. 45. Petitioners are entitled to a deduction of $100,000.00 for management fees paid in 1996 to R. M. Stewart, Inc., as an ordinary and necessary business expense. POINTS RELIED UPON Petitioner's sole proprietorship business, a real estate sales agency, paid management fees to Petitioner'swhollyowned corporation, R. M. Stewart, Inc., of$120,000.00 in 1995 and $100,000.00 in 1996 pursuant to a written Management Agreement between the sole proprietorship and the corporation. The management fees were set at the prevailing market rates paid by other real estate sales offices for similar work in the area for the years at issue. General management services were provided by the corporation to the sole proprietorship as contracted for first in 1984 and continuing through 1995 and 1996. It is the Petitioner's position that the management fees paid in 1995 and 1996 are ordinary and necessary business expenses allowed by Section 162(a) oftheInternalRevenue Code andRegulation Section 1.162-1. The sole proprietorship took the deductions. The corporation reported the income. ARGUMENT I. THE MANAGEMENT FEES PAID IN 1995 AND 1996 WERE ORDINARY AND NECESSARY BUSINESS EXPENSES OF PETITIONER'S SOLE PROPRIETORSHIP DEDUCTIBLE UNDER SECTION 162(a) OF THE INTERNAL REVENUE CODE. During 1995, Robert M. Stewart, a sole proprietorship real estate sales business was doing 10 business as Century 21 Stewart and Associates. In the latter part of 1996, the sole proprietorship business was known as Prudential Realty Stewart and Associates. In 1995, the sole proprietorship paid $120,000.00 to R. M. Stewart, Inc., the Petitioner's solely owned corporation (the corporation), for general management services pursuant to a written Management Agreement between the sole proprietorship and the corporation. In 1996, the sole proprietorship paid the corporation $100,000.00 for general management services rendered to the sole proprietorship. The income was reported by the corporation. The payments were pursuant to a written Management Agreement which was entered into first in December, 1984 and provided as follows: MANAGEMENT AGREEMENT DECEMBER 1984 This agreement is between R. M. Stewart, Inc., and Robert M. Stewart. The purpose of this agreement is to establish a Management Agreement for Robert M. Stewart's real estate business. R. M. Stewart, Inc., is by this agreement to have full management control over the real estate office located at 1698 Berryessa Road, San Jose. R. M. Stewart, Inc., is to be paid an annual retainer of $48,000.00 which is not to exceed 70% ofthe net profit before taxes. If the annual fees are not paid due to capital improvements or expansion, than the short fall may carry forward up to two full calendar years. This agreement is to be reviewed every three years or sooner. Robert M. Stewart For Both R. M. Stewart, Inc. and Robert M. Stewart In 1987, the annual retainer was raised to $84,000.00 by written Addendum to the Management Agreement. In 1990, the annual retainer was set at $120,000.00 by written Addendum to the Management Agreement. 11 In 1993 and again in 1996, by written Addenda to the Management Agreement between R. M. Stewart, Inc., and Robert M. Stewart sole proprietorship, the terms and conditions were reaffirmed. Full management control ofthe sole proprietorship's real estate sales office was entrusted to the corporation. The management fees were set at the prevailing market rates by first looking to what two other real estate sales companies were paying their managers. For 1995 and 1996, the management fees were established by looking at what Cornish and Carey, a twenty-two office real estate sales company, was paying its manager for a similar size office. A deduction for management fees paid by a taxpayer, subsidiary, to its parent was allowed in the amounts determined by the Commissioner to be the prevailing rate charged by professional management offices in the area. Latham Park Manor, Inc. v. Commissioner, 66 T.C. 199, 218-219 (1977) R. M. Stewart, Inc., provided general management services to the sole proprietorship consisting ofrunning the real estate sales office, overseeing the training ofmanagers, the sales manager, overseeing accounts receivable, accounts payable, motivating agents and reviewing contracts. In 1995 and 1996, this was done through the corporation's agent, Robert M. Stewart. In other years it was also done through other agents. The type of services that were provided by R. M. Stewart, Inc., to the sole proprietorship were classic ordinary and necessary business expenses deductible under Internal Revenue Code Section 162(a). We have payments made to R. M. Stewart, Inc., under a binding written contract. The expenditures were directly connected with and pertaining to taxpayer's trade or business. These were not expenses of a personal, living or family nature, capital, sale or exchange of capital, etc. "Business expenses deductible from gross income include the ordinary and necessary expenditures 12 directly connected with or pertaining to the taxpayer's trade or business, except items which are used as the basis for a deduction or a credit under the provisions of law other than Section 162...Among the items included in business expenses are management expenses, commissions (See Section 263 and the Regulations thereunder),..." Regulation Section 1.162-1. The management fees and expenses were paid and incurred in the trade or business carried on by the taxpayer. The expenses are ordinary and necessary. The expenses are not capital in nature. These expenses are paid and incurred in connection with an ongoing trade or business. These types ofexpenses are common and acceptable in the taxpayer's type of business. The management fees of $120,000.00 paid in 1995 and $100,000.00 paid in 1996 by the sole proprietorship to the corporation were ordinary and necessary expenses properly deductible under Section 162(a) ofthe Internal Revenue Code. II. R. M. STEWART, INC., WAS ORGANIZED WITH INDEPENDENT BUSINESS PURPOSE, WAS THE EARNER OF THE MANAGEMENT FEE INCOME AND PROPERLY REPORTED THE INCOME. BUSINESS PURPOSE The corporation since its inception in 1984 has carried on its business activities. The corporation was formed to protect assets and designed to protect the real estate sales office from claims of the creditors of the corporation. It was also formed to engage in a variety of businesses including a sign company and computer store selling products to the public, real estate development, real property management and to provide general management services. The policy favoring the recognition of corporations as entities independent oftheir shareholders requires that the corporate form not be ignored as Respondent is trying to do so long as the corporation actually conducts 13 business. "Whether the purpose (ofincorporating) be to gain an advantage under the law ofthe state of incorporation or to avoid or to comply with the demands of creditors or to serve the creator's personal or undisclosed convenience, so long as that purpose is the equivalent ofbusiness activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity." Moline Properties, Inc. v. Commissioner, 319 U.S. 436, 438-439 (1943). EARNER OF INCOME Respondent argues that Petitioner, not the corporation was the true "earner" ofthe income from the management fees paid by the sole proprietorship to the corporation. This argument ignores the Management Agreement, the separate existence ofthe corporation which was property formed with business purpose followed by the carrying on ofthe business ofthe corporation. Respondent's denial ofthe deduction for the management fees would have the effect of rendering the corporation (which reported the income) a nullity for federal income tax purposes. Foglesong v. Commissioner, 621 F.2d 865, 868-869 (78' Cir. 1980), revg. and remanding T.C. Memo. 1976-294, quotes with approval the following statement by Mr. Justice Holmes, speaking for the Supreme Court in Klein v. Board ofSupervisors, 282 U.S. 19, 24 (1930), about the nature of corporations: "But it leads nowhere to call a corporation a fiction. Ifit is a fiction it is a fiction created by law with intent that it should be acted on as iftrue. The corporation is a person and its ownership is a nonconductor that makes it impossible to attribute an interest in its property to its members." The corporation discharged its contractual obligation by providing general management services to the sole proprietorship. It was the true earner ofthe income which it reported. Certainly in 1995 and 1996, Petitioner performed the management services for which the corporation was paid. A corporation can only perform services through its agents, whether it be a one-man corporation or 14 an international conglomerate. The corporation paid its property manager which services benefitted the sole proprietorship. The corporation did not pay Robert M. Stewart in 1995 and 1996 because it had unusual expenses associated with expanding the office, defending lawsuits, etc. The corporation did pay Robert M. Stewart in other years for the general management services he provided on behalfofthe corporation. The corporation also paid other individuals in other years for providing general management services to the sole proprietorship in order to fulfill its obligations under the Management Agreement. The Respondent has argued that the case of Johnson v. Commissioner 78 TC 882 (1982) requires that Robert M. Stewart be an employee ofthe corporation whom the corporation has the right to direct or control in some meaningful sense and that there must exist between the corporation and the person or entity using the services, a contract or similar evidence recognizing the corporation's controlling position. Certainly the corporation had, through its many business activities, business dealings, sales ofproducts and services to unrelated third parties. Ninety-five percent of the sign business was done with businesses other than the Petitioner's sole proprietorship. Johnson, infra, dealt with an entity that was at all times a personal services corporation, not a general business corporation such as R. M. Stewart, Inc. The Tax Court in Johnson, infra, held that a basketball player was required to include his earnings in gross income even though they were paid to his wholly owned corporation because the contract for personal services was between the team and the player. The contract in this case was between the corporation and the sole proprietorship. R. M. Stewart, Inc., was the true earner of the management fees paid by the sole proprietorship pursuant to a binding written contract. R. M. Stewart, Inc., properly reported the income. III. THE SUBSTANTIAL UNDERSTATEMENT PENALTY IS IMPROPERBECAUSE THE 15 COMMISSIONER IMPROPERLY DENIED THE DEDUCTION FOR MANAGEMENT FEES FOR WHICH THERE WAS SUBSTANTIAL AUTHORITY, IT WAS DISCLOSED ON THE RETURN AND THERE WAS A REASONABLE BASIS FOR SUCH TAX TREATMENT. Management fees are recognized as ordinary and necessary business expenses under Section 162(a) of the Internal Revenue Code and Regulation Section 1.162-1. The Petitioner on his Schedules "C" attached to his Forms 1040 for both 1995 and 1996 disclosed the deductions at Line 11 which is for Commissions and Fees. The Petitioner reasonably relied on a no change letter from the IRS for the 1985 tax year where the issue of management fees was reviewed by the IRS and understood that to mean that there would be no problem with continuing this practice in subsequent years including 1995 and 1996. CONCLUSION It follows that the determination ofthe Commissioner ofInternal Revenue should be overruled 'and that no deficiency be found to be owing by the Petitioners. Dated: February 5, 2002 Respectfully submitted Martin Brant Fenster Attorney for Petitioner 14625 Big Basin Way Saratoga, CA 95070 Telephone: (408) 867-8600 Fax: (408) 867-8260 Tax Court Bar No.: FM0313 16 CERTIFICATE OF SERVICE This is to certify that the original plus three (3) copies ofthe foregoing Petitioners' Briefwas served on the Tax Court by sending the same by Federal Express and by U.S. Mail on February 5, 2002 in a Federal Express prepaid wrapper and in a U.S. Mail postage paid wrapper addressed as follows: Judge Robert R. Ruwe United States Tax Court 400 Second Street, N.W. Room 420 Washington, D.C. 20217 Date: February 5, 2002 MARTIN BRANT FENSTER Attorney for the Petitioners 14625 Big Basin Way Saratoga, CA 95070 Tel: (408) 867-8600 Fax: (408) 867-8260 Tax Court Bar No. FM0313 17