In a recent Tax Court case (Caselli, T.C. Memo. 2018-81), Ronald Caselli, a shareholder of a restaurant organized as an S corporation, attempted to take the Federal Insurance Contributions Act (FICA) tip credit on his Form 1040X, Amended U.S. Individual Income Tax Return, although the S corporation had claimed a deduction in place of the credit. Caselli argued that it was in his rights as a shareholder to unilaterally make the FICA tip credit election for the S corporation.
Apple Gilroy Inc. (AGI) was an S corporation with three shareholders that operated multiple restaurants. As at most restaurants, AGI's workers' earnings came partly from tips, and it was required to pay FICA taxes on these tips. Under Sec. 45B, employers may claim a general business credit for FICA taxes paid for certain employee tips, a provision known as the FICA tip credit.
In 2006 and 2007, AGI did not claim a FICA tip credit on its Form 1120S, U.S. Income Tax Return for an S Corporation, nor did it claim it by filing a Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips. Instead, the corporation deducted all FICA taxes paid.
Caselli filed his personal tax returns for 2006 and 2007, claiming flowthrough deductions from the Schedules K-1, Shareholder's Share of Income, Deductions, Credits, etc., that he received from AGI. In 2010, Caselli received a notice of deficiency for 2006 from the IRS, which prompted him to petition the Tax Court in January 2011. Later that year, Caselli filed a Form 1040X for tax year 2007. With the Form 1040X, Caselli filed a Form 8846 claiming the FICA tax credit for his personal return, which resulted in a 2007 refund claim of $65,526. AGI did not amend its Form 1120S, and no amended Schedule K-1 from AGI was included with the Form 1040X.
The IRS sent another notice of deficiency in October 2011 disallowing Caselli's claim for a refund on his 2007 Form 1040X. Caselli again petitioned the Tax Court in December 2011 for the 2007 tax year. Then, in August 2014, Caselli filed an amended petition claiming that he was also allowed to claim the FICA tip credit related to AGI for 2006.
Tax Court discussion
Caselli argued that the court should allow AGI to file amended tax returns to claim the FICA tip credit under Sec. 45B. However, since AGI had not amended it returns, Caselli was, in effect, asking the Tax Court to give an advisory opinion based on a future contingency. The Tax Court normally denies such requests, but due to the fact that very little precedent surrounds Sec. 45B, the court decided it would be beneficial to discuss the issue.
Sec. 45B allows an employer to claim a tax credit on the amount of FICA taxes paid on employee tips in excess of the minimum wage. To claim the credit, employers must have also not have claimed a deduction for these FICA payments (Sec. 45B(c)). A taxpayer claims the credit by completing and filing Form 8846.
Caselli argued that he was entitled to a proportionate share of the FICA tip credit from AGI's tax payments because he was one of its shareholders. However, Caselli and the IRS disputed whether AGI was allowed to claim the FICA tip credits for 2006 and 2007. The parties agreed that AGI employed workers who received tips from food and beverage customers and that AGI paid FICA taxes on those tips for 2006 and 2007, but disagreed on whether, by deducting the FICA taxes, AGI was prevented from now claiming the FICA tip credits.
The Tax Court found that Secs. 45B(c) and 45B(d), taken together, suggest that a taxpayer deducting the FICA taxes elects not to claim the FICA tip credit. Sec. 45B(c) states that "[n]o deduction shall be allowed under this chapter for any amount taken into account in determining the credit under this section." Sec. 45B(d) states that "[t]his section shall not apply to a taxpayer for any taxable year if such taxpayer elects to have this section not apply for such taxable year." The IRS argued that because AGI had never claimed this credit or indicated any intention of doing so, Caselli was not eligible to take a flowthrough FICA tax credit for either year, and the Tax Court agreed.
The court did note that, while Sec. 45B(d) uses the word "taxpayer," and S corporations are generally not considered taxpayers since they are flowthrough entities, the S corporation in its capacity as the employer was liable for the FICA tax payments and was the taxpayer for the purposes of those payments. Therefore, the section would still apply to AGI.
Caselli did not deny that AGI had not claimed the FICA tip credit; however, he asserted that AGI could change its election by filing amended Forms 1120S for each tax year at issue. However, no evidence showed that AGI ever did or intended to change its election. The filing period was also outside the statute of limitation, preventing an amended return from now being filed.
Caselli contended that as a shareholder, he could unilaterally change the election on AGI's behalf. The IRS countered that any change to the election by AGI relating to the Sec. 45B credit must be made by AGI and not by Caselli. Sec. 1363(c)(1) states that, except for certain elections relating to mining exploration expenditures and taxes of foreign countries and U.S. possessions, "any election affecting the computation of items derived from an S corporation shall be made by the corporation." Regs. Sec. 1.1363-1(c)(1) also further states that elections cannot be made by shareholders separately, and all corporate elections apply to all shareholders.
The Tax Court sided with the IRS, stating that it would not set a precedent that allowed individual shareholders to unilaterally change an election, since it could potentially affect other shareholders who may not have agreed with such a change. Thus, the court held that Caselli was not allowed to claim the FICA tip credit for either year.
Shareholders of S corporations need to understand that the Code and regulations explicitly require any elections to be made by the corporation and that the shareholders themselves cannot unilaterally change these elections. In the above case, it is likely if AGI had filed an amended Form 1120S for the years in issue before the statute of limitation expired, the company could have elected to take the FICA tips credit instead of deducting the FICA taxes paid. This would have given the shareholder the credit he sought.
Mark G. Cook, CPA, CGMA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-261-8600 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with SingerLewak LLP.