Glass Blocks Unlimited v. Comm., T.C. Memo. 2013-180 (2013)

In Glass Blocks Unlimited v. Commissioner, the United States Tax Court addressed whether payments made by an S corporation to its sole officer and shareholder, Mr. Blodgett, should be classified as wages subject to employment taxes, or as loan repayments or dividends.

Key facts and findings:

• Mr. Blodgett was the president, sole shareholder, and only full-time employee of the S corporation. He performed all significant operational and financial duties for the business.
• The corporation did not pay Mr. Blodgett a formal salary or wages, nor did it file employment tax returns (Forms 941) or issue him a Form W-2 or 1099-MISC for 2007 and 2008.
• Instead, the corporation made distributions to Mr. Blodgett as cash was available, totaling at least $30,844 in 2007 and $31,644 in 2008.
• The corporation argued these distributions were either repayments of loans made by Mr. Blodgett (and his fiancée) to the corporation or were dividends, not wages.

The Tax Court’s analysis and conclusions:

1. Employee Status and Wages:

1. Under IRC sections 3101 and 3111, FICA taxes are imposed on wages paid for employment. Wages are defined broadly as all remuneration for employment (IRC § 3121(a)).
2. An officer who performs more than minor services and receives remuneration is considered an employee, and payments for those services are wages subject to employment taxes.
3. The court found Mr. Blodgett was an employee, and the distributions he received were remuneration for his services, regardless of how the corporation characterized them.
4. Loan Repayment Argument:

2. The court applied a multi-factor test to determine whether the funds advanced by Mr. Blodgett were bona fide loans or capital contributions. Factors included the presence of promissory notes, fixed repayment schedules, security, and the parties’ intent.
3. The court found no promissory notes, no fixed repayment schedule, no security, and no evidence of an unconditional obligation to repay. Repayment depended solely on the corporation’s financial success.
4. The court concluded the advances were capital contributions, not loans, so the distributions were not loan repayments.
5. Dividend Characterization:
6. The court held that characterizing payments as dividends does not avoid employment taxes if the payments are actually remuneration for services rendered.
7. Reasonableness of Compensation:
8. The corporation argued that the amounts recharacterized as wages were unreasonably high. The court found that Mr. Blodgett’s role was substantial and that the amounts were not unreasonable for a full-time employee performing all key functions.
9. Penalties and Additions to Tax:
10. The court upheld penalties for failure to file employment tax returns (IRC § 6651(a)(1)) and for failure to deposit employment taxes (IRC § 6656), as the corporation did not show reasonable cause for its failures.

Conclusion:
The Tax Court sustained the IRS’s determination that the S corporation was liable for employment tax deficiencies, penalties, and additions to tax. The payments to Mr. Blodgett were wages subject to employment taxes, not loan repayments or dividends, and the corporation was liable for failing to file and deposit employment taxes as required by law.