Eye Center Fails to Justify $2M Bonus Paid to Sole Shareholder Surgeon

by Bruce Givner on April 2, 2015

On March 23, Judge Kathleen Kerrigan of the US Tax Court ruled that, because Midwest Eye Center, S.C. failed to produce any comparable salary data or the method for computing a 2007 bonus paid to the company’s sole shareholder and officer, the Tax Court would uphold corporate tax deficiencies and an accuracy-related penalty assessed by the Internal Revenue Service (Midwest Eye Center, S.C. v. Commissioner, T.C., No. 14053-13, T.C. Memo. 2015-53, 3/23/15). Kerrigan upheld more than $320,000 in tax delinquencies along with a $62,000 penalty assessed.

The IRS had previously disallowed as a business expense deduction half of the $2 million in bonuses paid to Afzal Ahmad, who served as the company’s president, medical director, chief executive officer, chief operation officer, chief financial officer, and worked as an active surgeon in the practice.

In 2007, Ahmad took on additional surgical responsibilities after another of the company’s surgeons quit without warning and another began working fewer hours in preparation to open an independent practice.

On its Form 1120, US Corporation Income Tax Return, for that year, Midwest reported gross receipts exceeding $7 million and claimed a compensation deduction for salary and bonuses paid to Ahmad of more than $2.7 million. However, using a net operating loss carryforward, Midwest reported zero taxable income for 2008 despite gross receipts in excess of $6 million for that tax year.

In its assessment, the IRS held that half of the $2 million bonus paid in 2007 was in fact a disguised dividend, a finding to which the court agreed. “Petitioner produced no evidence of comparable salaries. Instead, petitioner argues that there are no ‘like enterprises’ under ‘like circumstances’ from which to draw comparisons,” the court wrote, rejecting Midwest’s contention that the large bonus was reasonable.

Midwest also failed to provide the identity of its return preparer or evidence as to whether or not it had relied on the preparer’s judgement, so the company wasn’t entitled to penalty relief on that basis, according to the court.

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