LAW FIRM WAS LIABLE FOR ITS UNPAID EMPLOYMENT TAXES
The U.S. Court of Appeals upheld a Court of Federal Claims finding that an attorney and his wife could not re-litigate a Tax Court decision that held the attorney’s law firm liable for failing to withhold and pay employment taxes for the services he provided. The law firm had treated the attorney (sole shareholder) as an independent contractor. The Claims Court found that the attorney was the alter ego of the law firm and therefore was personally liable for the judgment. However, the appellate court found that the taxpayer, as the law firm's alter ego, may be entitled to at least a partial credit for his self-employment taxes.
Robert Kovacevich formed a C corporation called Western Management, Inc. (WMI) in which he was its sole shareholder, president, and secretary-treasurer. WMI’s only source of income was providing legal services through Kovacevich. He performed all services for WMI from generating all income to paying creditors, hiring employees (who did not perform legal services), signing checks, determining employee compensation, and signing its Federal tax returns.
Kovacevich received funds from WMI on a sporadic basis. WMI also issued checks to Kovacevich’s wife, Yvonne, as well as their creditors. Kovacevich informed WMI's tax return preparer that the payments were draws. WMI classified the payments as loans on its corporate books and did not file a Form 1099-MISC for these payments. WMI treated Kovacevich as an independent contractor who was employed by the firm. Accordingly, WMI did not withhold or pay any federal taxes in connection with the services he provided. Kovacevich did pay self-employment taxes consistent with his status as an independent contractor. The IRS challenged his employment classification.
The Tax Court found that Kovacevich was WMI's employee and that his wages were subject to income tax withholding and FICA and FUTA taxes as he was clearly a “statutory” employee under Code Sec. 3121. On appeal, the Ninth Circuit affirmed the Tax Court decision, but remanded for reconsideration of the extent to which Kovacevich had paid income tax on his wages. On remand, the Tax Court found that because he had paid his income taxes, the IRS could not penalize WMI for failing to withhold. However, the IRS refused to abate WMI's liability for the employer's share of employment taxes, which decision the Ninth Circuit Court affirmed.
The Kovaceviches paid the IRS for WMI's tax liability and then sought a refund for the amounts that they paid for WMI’s tax periods in question. They asserted that the checks were payments for Robert's trust-fund-recovery penalty, and that when that penalty was abated, the amounts should have been refunded and argued a theory that the IRS had wrongfully assessed WMI for taxes that had already been paid by the Kovaceviches individually. The government counterclaimed, seeking to hold both members of the couple individually liable for WMI's remaining employment tax liabilities. The government sought a judgment for recovery of these amounts from Kovacevich, as the alter ego of WMI, and from his wife as a member of the community with Robert under Washington state's community property law.
The Court of Federal Claims awarded summary judgment to the government finding that the IRS's decision to credit these checks to WMI was proper. With regard to the government's counterclaim, the court found that Robert was liable as WMI's alter ego, and Yvonne was liable as an owner of community property. The Court of Appeals upheld the lower court's conclusions with slightly different reasoning concerning the award of summary judgment to the government. It held that since the Kovaceviches were now liable for WMI's tax liability, they had received the full benefit of these payments and, as such, were not entitled to any further credit or refund for these payments except for the amount of a credit for self-employment taxes they paid under Code §6251.
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