Is Your S Corporation Really Earning Your Income? Lessons From Fleischer v. Commissioner

Is Your S Corporation Really Earning Your Income? Lessons From Fleischer v. Commissioner

Here is a question worth asking before your next tax season: if the IRS called each of your clients tomorrow and asked who they hired, what would they say? If the answer is your name rather than your company's name, your S corporation may not be doing the job you think it is.

Service professionals often elect S corporation status so they can draw a reasonable salary and take the rest of the profit as pass-through income, which can lower self-employment and payroll taxes. That benefit depends on a premise that is easy to overlook. The corporation, and not you as an individual, has to be the party that earns the revenue. When the paperwork says otherwise, the IRS can look past the entity and tax everything on Schedule C of your Individual return, self-employment tax included.

Why the Entity Alone Is Not Enough

Tax law has long held that income belongs to whoever actually earns it, an idea rooted in Lucas v. Earl, a 1930 Supreme Court case. You cannot redirect what you earn simply by telling the money to land somewhere else. This is the assignment of income doctrine.

For a one-owner service business, the "earner" question is tricky, because the owner and the company are doing the same work through the same person. So the courts reframe it: who controls the earning of the income? Tax Court precedent (Johnson v. Commissioner, 78 T.C. 882 (1982)) gives the corporation credit only when two things are true at once. We find it helpful to think of them as an inside test and an outside test.

1. The inside test: your company is your boss. You are an employee of the corporation, and the corporation has genuine authority to direct and control how you perform the work. A job title and a payroll account are a start, but the authority has to be real.
2. The outside test: your customer knows it hired your company. There must be a contract, or a similar indicium, between the corporation and the party receiving the services that acknowledges the corporation is the one in control.

Failing either test is enough to lose. A useful comparison is a staffing agency. When a business wants a temporary worker, it signs with the agency, and the agency sends someone over. Nobody doubts the agency earned the revenue. If the business instead signed directly with the worker and the agency merely collected the checks, the agency would look like a mailbox rather than a business. Your S corporation needs to look like the agency.

The Case That Illustrates the Point

The Tax Court applied this framework in Fleischer v. Commissioner, T.C. Memo. 2016-238. The taxpayer, Ryan Fleischer, was a Nebraska financial advisor and Certified Financial Planner who held securities licenses and insurance licenses. He had worked for an investment and planning firm and later a bank before setting up his own practice.

Notice the order in which his arrangements came together:

• February 2, 2006: he signed an independent contractor agreement with the brokerage firm LPL, in his own name.
• February 7, 2006: on the advice of his attorney and CPA, he formed Fleischer Wealth Plan (FWP) and made an S election. He owned all of it and held every officer role.
• February 28, 2006: he and FWP executed an employment agreement. FWP would pay him an annual salary to work as a financial advisor and could reasonably change his duties. He signed it on both sides, as company president and as the employee. What the agreement did not do was require him to hand over the commissions he collected from LPL or anyone else.
• March 13, 2008: he signed a broker contract with MassMutual, again in his own name, with no reference to FWP.

Neither outside contract was later amended to bring FWP in. For 2009 through 2011, FWP filed Form 1120-S reporting the commission revenue and its expenses, and Mr. Fleischer reported his FWP salary plus his share of FWP's profit. No self-employment tax was paid. The IRS concluded that FWP's gross receipts were really his self-employment income, reportable on Schedule C, and the Tax Court sided with the IRS.

The decision turned entirely on the outside test, so the court never had to rule on the inside test. LPL contracted with him before FWP existed, so it could not have viewed FWP as the party in control. MassMutual signed years after FWP was formed, yet the contract identified only him. No contract or other evidence showed either company treating FWP as the service provider.

Three Defenses the Court Turned Down

The defenses raised in Fleischer are ones we hear from owners in other fields, which makes them worth understanding.

• Regulation made it impossible. Mr. Fleischer said the firms could only sign with him because FWP was not registered to deal in securities. The court agreed that an unregistered company could not sell securities, but nothing barred FWP from registering. His claim that registration would have been very costly did not change the result. A licensing gap you choose not to close does not let you shift income to the entity. The court also pointed out that the MassMutual contract involved only fixed insurance products, which FWP could have handled.
• An appellate precedent favored him. He relied on Sargent v. Commissioner, 929 F.2d 1252 (8th Cir. 1991), in which professional hockey players' corporations were respected. The difference was decisive: those corporations had signed contracts with the teams. FWP had no contract with LPL or MassMutual.
• The corporation was legitimate. He pointed to Rev. Rul. 70-101, which addresses when professional service organizations are treated as corporations. The court noted that no one questioned whether FWP was a valid corporation. A perfectly valid entity can still have income reassigned to its owner when the owner, not the entity, controls the earnings.

A Common Shortcut That Does Not Solve It

Practitioners have described a pattern that grows out of the same facts (see this piece in The Tax Adviser). An owner takes on a client as an individual, forms the S corporation afterward, and never gets the agreement reissued. The client keeps sending a Form 1099 in the owner's name, but deposits go into the corporate account. At filing time, the owner reports the 1099 amount on Schedule C and then deducts an equal amount as contract labor, so the net lands in the S corporation.

That approach balances the books, but it does not answer the outside test. Under the reasoning in Fleischer, the client never treated the corporation as its counterparty, so moving the cash afterward does not change who controlled the earnings. The cleaner solution is upstream: rewrite the independent contractor or services agreement so that the corporation is both the provider and the payee.

Warning Signs in Your Own Business

Use this list as a quick self-audit. Each item is a place where the outside world may see you rather than your company:

• Agreements you signed before forming the entity that were never assigned or reissued.
• New statements of work or contracts still signed with only your name.
• Client or platform onboarding that uses your Social Security number, so Forms 1099 come to you instead of the company.
• Licenses, registrations or carrier appointments held only by you when the entity is eligible to hold them too.
• Invoices, proposals and websites that never mention the corporation.
• No written employment agreement with your corporation, or one that gives the company no real say over your work.
• An employment agreement that says nothing about outside compensation, leaving no obligation to turn client payments over to the company.

How to Make the Structure Hold Up

The fixes are mostly administrative, and most can be handled with your attorney in a short project:

1. Have the company sign. Every client, carrier, broker and platform agreement should list the corporation as the party, with you signing in your officer role, for example "Northside Consulting, Inc., by Maria Lopez, President."
2. Clean up older agreements. Assign, amend or reissue anything signed before the corporation existed, and ask the other party to confirm the change in writing.
3. Strengthen the employment agreement. Give the corporation real authority over your work and state that what you earn for client services belongs to the company and must be remitted to it. Then operate that way.
4. Lead with the company's EIN. Send clients a Form W-9 in the corporation's name so payments and information returns go to the entity.
5. Address licensing directly. In securities, insurance, real estate and other regulated fields, find out whether the entity can be licensed, registered or appointed. If it cannot, talk with counsel about whether an S corporation fits your situation at all.
6. Show the company to the world. Use the corporate name on invoices, engagement letters, bank accounts, email signatures and your website.
7. Keep the basics clean. Reasonable salary, separate accounts and timely filings will not satisfy the control test alone, but sloppy administration invites a closer look at everything else.
8. Revisit with every new relationship. Each new client, carrier or platform brings a new contract. Make the corporate signature a habit.

Key Takeaways

• An S corporation reduces tax on service income only when the corporation, not you, controls the earning of that income.
• Think of it as two tests: inside, the company truly directs your work; outside, your customers recognize the company as the party they hired. Both must be met.
• Forming the entity, filing Form 2553, running payroll and filing Form 1120-S are necessary but do not satisfy either test on their own.
• A licensing or registration gap that could have been closed is not a defense.
• Routing deposits through the corporation, or offsetting a 1099 on Schedule C as contract labor, does not fix a contract that names only you.
• The remedy usually sits in the paperwork: corporate signatures, updated agreements, a meaningful employment agreement and consistent use of the corporate name and EIN.

If you are not sure your contracts and licensing support your S corporation, schedule a consultation with SMB CPA Group. We can review how your revenue is earned and documented, and work alongside your attorney on any agreements that need updating. You can also read more about the benefits of an S corporation or explore our business entity structuring resources.

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