When one person’s misstep in using a common industry practice gets reported in the press or a blog, a reader may worry if he or she has also strayed. Some have this response to the recent Tax Court case Fleischer v. Commissioner. The many differing opinions and commentaries on that case have advisors asking how this ruling affects their existing entity structures and tax reporting.
Many of the articles on Fleischer either oversimplify the court’s ruling, misinterpret the court’s decision to suggest an advisor with a business entity (either a corporation or a limited liability company) must abandon the entity, or miss the point entirely. The danger in those messages is their failure to understand the details of the Fleischer case, and not emphasizing that in the proper execution of an integrated plan – one that accommodates corporate law, tax law, and FINRA regulations – there would have been a different outcome.
From the Fleischer case, understand this: You won’t have a problem if you do things right. But setting up an entity in a highly regulated industry and operating it correctly is intricate. You cannot do it on LegalZoom or with an attorney or accountant unfamiliar with FINRA regulations. The Fleischer decision does not change the fact that entities are worthwhile for a wide variety of reasons.
The Fleischer Case
In the Fleischer case, the court focused on who controls the earning of the income, citing the two-part test recognized in the 1982 case of Johnson v. Commissioner. In that case, Charles Johnson played for the NBA’s San Francisco (now Golden State) Warriors in the 1970’s. He formed a Panamanian corporation to receive his income from the team. Citing additional precedent, the Johnson court held that the corporation did not meaningfully control Mr. Johnson’s services as a basketball player, nor did the Warriors have notice that its player was contractually affiliated with the entity. For those reasons, passing the player’s salary through the foreign corporation did not shelter Mr. Johnson from employment tax. The Johnson court stated two tests, both of which must be met: