Tony L Robucci, et al. v. Commissioner, TC Memo 2011-19
It's funny how a tax court decision can cause me to reflect on my misspent youth. David Rothman's book, which was relatively new when I read it in 1974 inspired me to take on as my masters project at the famous University of Chicago a multiple career line biography of the Association of Medical Superintendents of Institutions for the Insane. The organization is now known as the American Psychiatric Association. My time spent in a basement pouring through their journals and in the computer center creating 80 column cards that summarized biographical data and then were fed into a massive computer to be analyzed by SPSS helped me develop a fondness for the psychiatric profession. That generation, which did not yet call themselves psychiatrists, seemed to think that if they could just get the building design right they could cure people, perhaps another instance of the phenomenon known as edifice complex. The other outcome of my foray into historical research was my realization that I was ill suited to it. So I took up public accounting, which, at least at the start of your career, is much less competitive than the academic life.
My sympathy for the psychiatric profession makes me feel bad for Dr. Robucci, who appears to have been ill served by my profession. His advisor was both an attorney and a CPA which softens my pain a bit, although I'm sure it is of little comfort to Dr. Robucci. Dr. Robucci met with the firm of Mark H. Carson to come up with ways and means of minimizing his tax liabilities. I must say their plan was something of a doozy.
Mr. Carson recommended, and persuaded Dr. Robucci to adopt, the organizational structure, involving an LLC and two corporations, that is at issue herein. That initial discussion also covered the possibility of structuring Dr. Robucci's practice in such a way as to reduce the amount of self-employment tax that he was paying while also minimizing any other tax liabilities that he might incur. ............On November 2, 2001, Mr. Carson incorporated Westsphere, and on December 20, 2001, he organized Robucci LLC and incorporated Robucci P.C.
The basic idea is that Dr. Robucci's return from his psychiatric practice consisted of two elements. One was from the value of the goodwill of his practice and the other was from the work that he did. The structure segregated the two elements There were some problems with execution:
Mr. Carson determined the ownership percentages, and he also determined the 85-percent-10- percent split in Dr. Robucci's ownership interest between that of limited and general partner. Mr. Carson, who has testified as an expert in valuation matters since 1976, based his determination of an 85-percent limited partner ownership interest for Dr. Robucci on what he determined to be the value of Dr. Robucci's goodwill and what would be a reasonable rate of return on that goodwill at the time he formed Robucci LLC. Mr. Carson never discussed with Dr. Robucci the basis for the 85-percent-10 percent allocation between his limited and general partner interests in Robucci LLC (although Dr. Robucci did understand that his 10-percent general partnership interest represented his interest as a provider of medical services and his 85-percent limited partnership interest represented his interest attributable to his capital contribution of intangibles), nor did Mr. Carson prepare a written valuation in support of his (which describes Robucci LLC) is treated, for Federal tax purposes, as a partnership. Thus, Robucci LLC's members would constitute partners for Federal tax purposes if it were respected as a two-member entity. attribution of an 85-percent limited partner interest to transferred intangibles. Dr. Robucci did not make any written assignment of the tangible or intangible assets of his practice to Robucci LLC.
During the years in issue Robucci LLC and Westsphere had bank accounts; Robucci P.C. did not. Dr. Robucci did not have an employment agreement with any of those three entities, nor did any of them have employees during the years in issue. Neither Robucci P.C. nor Westsphere paid a salary to Dr. Robucci or to anyone else during those years. Dr. Robucci did not keep records of any time he might have spent working for Westsphere. Although Robucci LLC deducted “management fees” for each of the years in issue ($31,475, $25,500, and $38,385 for 2002, 2003, and 2004, respectively), its returns do not specify to whom they were paid or for what services.
Beginning with their dates of organization and throughout the years in issue, Robucci LLC and the corporations used the same business address, although there was no written lease agreement between Robucci LLC and either of the corporations.
The corporations did not (1) have separate Web sites or telephone listings, (2) pay rent to Dr. Robucci or Robucci LLC, (3) have customers other than Robucci LLC or contracts with any other third parties, or (4) advertise. Westsphere did not have separate dedicated space in Dr. Robucci's office
Although Mr. Carson, who, inter alia, was a valuation expert did not prepare a valuation of the intangibles nor any sort of document assigning the intangibles to any of the entities he did whip up a few other documents including a loan agreement, an employee reimbursement agreement (with a formal grievance procedure), a medical reimbursement plan and an operating agreement for the LLC. It was probably a pretty impressive binder. So at least the attorney side of Mr. Carson produced a bulky, if incomplete, package. The CPA side seems to have fallen down on the job, although we really can't tell this for sure. It may be that he gave advice on execution that the doctor did not follow.
Regardless of the execution issues, I think the plan was fundamentally flawed. It is based on the premise that 85% of the net income of a single doctor psychiatric practice is attributable to the goodwill. We had an acronym we used to use for notions such as this. It was RFD which stood for "Reeee - diculous". (Many of our acronyms contained a silent F). As my own admittedly fairly limited exposure doing tax consulting for mental health professionals and this story in the New York Times indicates psychiatry is fairly labor intensive and given the educational qualifications not all that lucrative. There is very little opportunity for leveraging the work of others, which is critical for a return on the goodwill of a professional practice. It might be that Mr. Carson could have plausibly made the argument about his own firm, which had 3,500 clients, but I doubt that there is a single physician medical practice of any type, where it would be reasonable. Unlike CPA's psychiatrists cannot subdivide their deliverables into pieces some of which can be provided by other psychiatrists or para-professionals who are paid somewhere between 30 to 40 per cent of what they are billed out for. Outsourcing portions of the work to India would probably be impossible as opposed to just a bad idea.
I can't find any fault with the Tax Court's decision on Dr. Robucci's tax liability:
The result is that Dr. Robucci is treated as a sole proprietor for Federal tax purposes, which was his status before the formation of Robucci LLC and the corporations. It follows, and we hold, that the net income arising from his psychiatric practice during the years in issue, including any amounts paid to Robucci P.C. and Westsphere, was self-employment income of Dr. Robucci subject to self-employment tax under section 1401.
I do take exception to the Tax Court subjecting Dr. Robucci to penalties. Here is part of their rationale:
It is not that Mr. Carson's goal of directing some of Dr. Robucci's income to a third-party corporate management service provider and bifurcating Dr. Robucci's interest in Robucci LLC so that he would be separately compensated for the use of his intangibles was obviously unreasonable. On the contrary, had it been more carefully implemented, it well might have been realized, at least in part. The problem for Dr. Robucci is that Mr. Carson's strategy for implementing his tax minimization goal was patently inadequate to the task, a fact that should have been obvious to Dr. Robucci and have prompted him to either question Mr. Carson or seek a second opinion.
Unless there is another Colorado CPA with the same name Mark H. Carson is still operating. Given the extent to which public accounting and the legal profession are regulated Dr. Robucci's reliance on him was reasonable. I'm wondering if it is possible that the penalties have been misdirected.