Mulcahy, Pauritsch, Salvador & Co., Ltd. v. Comm'r of Internal Revenue, No. 11-2105 (7th Cir. 2012)Annotate this Case
The taxpayer, a C-corporation with about 40 employees, claimed that its revenues ($5 million to $7 million a year) were offset by deductions for business expenses, primarily compensation paid to owner-employees, three of the firm's accountants. These founding shareholders owned more than 80 percent of the firm's stock in 2001 and received salaries from the firm that year that totaled $323,076. The firm reported taxable income of only $11,279 that year and, in the following year reported a loss of $53,271. The IRS did not question the salary deductions, but disallowed more than $850,000 in consulting fees paid in each of the three years to three entities owned by the founding shareholders, which passed the money on to the founding shareholders. The IRS reclassified the fees as dividends, resulting in a deficiency in corporate income tax of more than $300,000 for 2001 and similar deficiencies for the following two years. The Tax Court added the 20 percent statutory penalty for substantial understatement of income tax, 26 U.S.C. 6662(a),(b)(2). The Seventh Circuit affirmed, stating: "That an accounting firm should so screw up its taxes is the most remarkable feature of the case."