Academic journal article Journal of Accountancy

From the Tax Adviser: Royalties or Wages? Earnings by Any Other Name ... Are Still Earnings

Academic journal article Journal of Accountancy

From the Tax Adviser: Royalties or Wages? Earnings by Any Other Name ... Are Still Earnings

Article excerpt

The Tax Court ruled that "royalties" paid to a C corporation's officer were wages for which the corporation was liable for payroll (for example, Social Security, Medicare and unemployment) taxes (Charlotte's Office Boutique, Inc., 121 TC no. 6 (2003)). The case teaches CPAs how not to structure a self-employed client's transfer of intangibles to a corporation.

BACKGROUND

In 1995 Charlotte Odell incorporated Charlotte's Office Boutique Inc. as a C corporation. Before incorporation Odell (an officer of the corporation and one of two shareholders) operated the business as a sole proprietorship that sold office supplies and equipment to the federal government.

On incorporation Odell purportedly did not transfer ownership interests in her customer lists and contracts. Instead, she entered into a "licensing and sale agreement" that set forth a royalty fee, based on gross receipts, stemming from the transfer of her "know-how," "existing contracts" and "woman-owned-business status," and also executed employment and rental agreements with the C corporation. She was to be paid $400 a month under the employment agreement.

The corporation paid Odell rent, wages and royalties, and sporadically filed employment tax returns. In 2001, after an employment tax audit, the IRS issued a notice reclassifying Odell as the corporation's employee.

In Tax Court the IRS established that Odell, as a corporate officer, was performing significant services for the corporation and receiving remuneration. This is the definition of employee (Veterinary Surgical Consultants, P.C., 117 TC 141 (2001)).

TAX COURT'S RULING

The court held for the IRS; the amounts paid to Odell were wages subject to employment taxes and not royalties. …

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