Adviser loses IRS fight, putting tax status for solo practitioners in question
In October, I wrote a column about a financial adviser who was squaring off…
In October, I wrote a column about a financial adviser who was squaring off with the IRS in a dispute over using a flow-through tax structure known as an “S corporation” to pay himself.
Financial advisers who are solo practitioners have been operating like this for years, and some in the industry regarded the fight between the adviser, Ryan Fleischer, and the IRS as a cautionary tale for small-business owners. If the IRS could come after Mr. Fleischer and claim he owed about $40,000 in back taxes, would the federal government, ever hungry for more revenue, soon be gunning for them?
Mr. Fleisher got bad news at the end of last year when a U.S. tax court judge ruled against him.
“There’s a lot of confusion around this case and a lot of misunderstanding,” said Mr. Fleischer, whose practice, Fleischer Wealth Plan, or FWP, is based in Omaha, Neb.
The central point in the dispute was assigning income to Mr. Fleischer’s S Corp, he said. The ruling went against him because Mr. Fleischer has a contract and receives payment from his broker-dealer, LPL Financial, but his S Corp, FWP, does not, according to the adviser.
“This puts thousands of reps in the crosshairs of the IRS, and could be detrimental to them,” said Mr. Fleischer, who doubts he will appeal because he has already sunk roughly $50,000 in legal costs into the fight.
Let’s back up for a moment.
As we reported last fall, the IRS audited Mr. Fleischer in 2012. The government later determined he owed about $40,000 in back taxes from 2009 to 2011. The IRS claimed Mr. Fleischer, the sole shareholder of FWP, had not properly set up his business by using the S Corp format, which allowed him to pay less in taxes.
The IRS maintained that Mr. Fleischer is a sole proprietor and should have used a Form 1040 and Schedule C to report his business income.
In May 2015, Mr. Fleischer, who also sold Massachusetts Mutual Life Insurance Products, sued the IRS in U.S. Tax Court in Nebraska, hoping to overturn the order to pay back taxes.
According to court documents, in 2010 FWP paid Mr. Fleischer a salary of about $35,000, and reported business income from the S Corp of $147,600. No amount was reported for self-employment tax.
Both his LPL and MassMutual contracts were with himself as an individual and did not mention the S Corp. Broker-dealers cannot pay a business entity unless it is another licensed broker-dealer.
“The only issue for decision is whether [Mr. Fleischer] or his S corporation must report the income earned for the years in issue,” according to the U.S. tax court decision. Mr. Fleischer “individually, not FWP, should have reported the income earned under the representative agreement with LPL and the broker contract with MassMutual for the years in issue.”
There was no way to know whether Mr. Fleischer’s S Corp battle was an outlier or a potential nightmare for the financial advice industry, said one tax attorney familiar with the case.
“It’s a one-off in that we haven’t seen another case like this, but it’s also something very relevant to the industry,” noted the attorney, who asked not to be identified due to potential future work on the issue. “This case can hurt a business model that is being used and unique to the registered rep community because of the prohibition of giving brokerage commission dollars to someone other than a rep.”
When my first column about Mr. Fleischer’s predicament appeared, a few readers contacted me and wondered whether he had paid himself too little income, thus drawing the ire and attention of the IRS.
“I’m pretty sure that if Mr. Fleischer paid himself a reasonable salary the IRS would not care that he assigned his income to his S Corporation,” noted one reader. “Paying yourself a salary of $35,000 on $150,000 of income is not a reasonable salary. If the sole purpose of your S Corporation is to avoid employment taxes, the IRS will take notice.”
Mr. Fleischer sharply disagrees with such an assessment and stresses the potential problems for advisers with one-person shops who assign income to an S Corp.
“This was never about not paying enough salary or avoiding the self-employment tax,” he said. “In my opinion, it’s government overreach.”
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