Every so often I have to educate my clients that if it sounds too good to be true, it probably is. Today, the Tax Court educated a businessman that S Corporations are flow-through entities: in general, the owners of an S Corporation get the income from the S Corporation and are liable for any tax.
William Tinnerman is the sole stockholder of an S Corporation in Florida. From 1986 through 1998 he used a CPA to prepare his personal and S Corporation tax returns, and all was well. In 1999, he told his accountant to stop preparing his individual tax returns. The accountant still prepared the S Corporation returns.
But Mr. Tinnerman “enhanced” his S Corporation return by adding some verbiage to it:
“The corporation has determined the net income shown on the Schedule K-1 (Form 1120S) does NOT constitute ‘gross income’ as determined by rules set forth in the Treasury Regulations at 26 CFR (4-1-99) Parts 1.61-1(a) and (b) and 1.931-1(b)(1)-(4). Therefore, since there is NO gross income, the net income shown on the K-1 is NOT reportable on your 1040 as taxable income.”
Strike one.
Mr. Tinnerman didn’t make estimated tax payments for 1999 through 2002 nor did he file tax returns for those years. He also amended his 1996 through 1998 returns and changed his income to zero and his tax to zero.
Strike two.
Mr. Tinnerman then bought a sham trust package from Bay Point Enterprises, run by John Ellis and Jeff Pollard. Mr. Ellis was sentenced in 2002 to 10.5 years at ClubFed for marketing sham trusts.
The IRS tried to get Mr. Tinnerman to see the error of his ways. They provided him with a pamphlet, “The Truth About Frivolous Tax Arguments.” Apparently Mr. Tinnerman believed the trust proponents who were serving time rather than the IRS.
Strike three.
The Tax Court was faced with deciding if Mr. Tinnerman owed taxes and penalties for 1999 – 2002. With three strikes against him, it’s not a surprise that the Court found that Mr. Tinnerman owed the tax, a penalty for fraud, failure to file a return, failure to pay the tax shown on the return (here, the substitute for returns prepared by the IRS), and failure to pay estimated taxes.
The Court was sufficently annoyed with Mr. Tinnerman’s frivolty that it imposed a $10,000 penalty for persisting in raising frivolous arguments.
That was strike four.