Some of My Best Friends Are Accountants

I can't quite figure out whether on this FICA/SECA issue accountants are stubborn and hardheaded or simply dogged, but there is now another instance of an accountant failing in an attempt to avoid the characterization of compensation as, well, compensation.

In CCM 200305007, an accountant was the managing "partner" of an accounting firm doing business as a professional corporation. He had a written employment agreement with the professional corporation. That agreement contained an "exclusive effort" clause, but no covenant not to compete.

Together with other individuals (presumably the other principals in the professional corporation) the taxpayer formed a limited partnership with a virtual identical name as the professional corporation (i.e., ABC, LP and ABC, P.A., respectively). They purported to assign to ABC, LP, the rights to use their respective client lists in consideration for certain royalty payments. ABC, LP was given the exclusive right to perform accounting services for these clients. There was also a one-year covenant not to compete.

ABC, P.A. paid to the taxpayer and other shareholder/officers W-2 wages. ABC, P.A., paid to non-shareholder officers a slightly lower amount of W-2 wages and additional compensation in the form of purported "royalties" that it reported on Form 1099-MISC. Finally, ABC, P.A. paid what it categorized as royalty payments to ABC, LP. Of course, ABC, LP paid to each of its partners, including the taxpayer at issue, payments categorized as royalties. And, of course, the taxpayer contended that the royalty payments were not subject to FICA or SECA.

The Service did not have a difficult time rejecting the taxpayer's argument and said as follows:

"The parties characterization of payments does not control the taxability of the payments. In Phillies v. United States, 153 F. Supp. 2d 612 (E.D. Pa. 2001) the court stated, 'both FICA and FUTA define 'wages' as 'all remuneration for employment' unless excluded. 26 U.S.C. Sections 3121(a), 3306(b). 'Employment' as used in this definition means 'any service of whatever nature performed by an employee for the person employing him...' 26 U.S.C. Sections 3121(b), 3306(c).'

"Based on the expansive definition of wages, the definition of royalty payments, and the lack of economic substance of the parties' royalty arrangement, we conclude that amounts received by Taxpayer and other accountants performing services for ABC PC which were treated as royalty payments were, in fact, wages subject to FICA, FUTA, and income tax withholding."