S corporation shareholder cannot take FICA tip credit

By James A. Beavers, CPA, CGMA, J.D., LL.M.

The Tax Court held that a shareholder acting in his capacity as a shareholder in an S corporation could not unilaterally revoke the S corporation's election to deduct its FICA tip taxes so he could take a FICA tip tax credit for his portion of the taxes paid.

Background

During 2006 and 2007, Ronald Caselli was one of the three shareholders of Apple Gilroy Inc. (AGI), an S corporation that operated multiple restaurants. The restaurants owned by AGI hired "tipped employees," whose earnings came partly from customer tips, and AGI was required to pay taxes on these tips as part of its Federal Insurance Contributions Act (FICA) tax payments. Under Sec. 45B, an employer working in the food and beverage industry can claim business tax credits for the portion of the FICA taxes it paid on the employee tips (FICA tip credits).

On its 2006 and 2007 returns, AGI did not claim any FICA tip credits. Instead, it deducted its payments of the FICA tip taxes on its Forms 1120S, U.S. Income Tax Return for an S Corporation. AGI never filed an amended Form 1120S for either year.

On his 2006 and 2007 income tax returns, Caselli claimed deductions passed through from AGI. In 2010, the IRS sent a notice of deficiency to Caselli for 2006, and in response Caselli timely petitioned the Tax Court.

In September 2011, Caselli filed an amended return for 2007 claiming a refund of $65,526 deriving from AGI's 2007 FICA tip credits. With the amended return, he included a Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips, which showed him as the taxpayer electing the FICA tip credits. Caselli's 2007 amended return did not include an amended Schedule K-1, Shareholder's Share of Income, Deductions, Credits, etc., from AGI.

In October 2011, the IRS sent a notice of deficiency to Caselli for 2007. A notice of claim disallowance was attached to the 2007 notice of deficiency, which disallowed his claim for refund on his amended 2007 tax return. Caselli in response again petitioned the Tax Court. In 2014, he filed an amended petition for 2006 with the Tax Court, claiming for the first time that he was also entitled to the passthrough FICA tip credits with respect to his interest in AGI for 2006.

The legal framework

Sec. 45B allows an eligible employer, upon its election, to claim a business tax credit in the amount of FICA taxes that it paid on employee tips in excess of the minimum wage. To qualify for the FICA tip credit, an employer must have employees who receive tips from customers for providing food or beverages for consumption and must be deemed to have paid FICA taxes on the tips in excess of the minimum wage (Sec. 45B(b)). Additionally, the employer must not have already claimed a deduction for the FICA tax payment (Sec. 45B(c)). Tip credits are claimed on Form 8846.

The Tax Court's decision

The Tax Court held that Caselli was not allowed to claim any FICA tip credits passing through from AGI. The court found that, in the S corporation context, the election to take a deduction for FICA tip taxes instead of the FICA tip credit must be made by the S corporation and that an individual shareholder acting in his capacity as a shareholder cannot unilaterally change the S corporation's tax election

Caselli first claimed that as one of AGI's shareholders, he was entitled to his proportionate share of AGI's FICA tip credits. However, he and the IRS disputed whether AGI was itself entitled to the FICA tip credits for 2006 and 2007. The parties agreed that for both years, AGI had paid FICA on tips that would qualify for the credit. They disagreed, however, on whether AGI's choice to deduct its FICA tax payments for 2006 and 2007 prevented it from later claiming any FICA tip credits for either year.

The Tax Court stated that "[t]he answer seems quite straightforward." The court explained Sec. 45B(c) explicitly provided that no deduction is allowed for the FICA tax paid if the tax paid was used in determining the FICA tip credit. Sec. 45B(d) states that the credit will not apply if a taxpayer elects for it not to apply. These two provisions suggested to the court that when AGI chose to deduct its FICA tax payments, it had made an election not to claim any FICA tip credits and had never claimed, or intended to claim, FICA tip credits for 2006 or 2007. Consequently, because AGI did not claim the credits, Caselli was not entitled to any passthrough FICA tip credits for either year.

Caselli agreed that AGI elected not to claim any FICA tip credits, but he asserted that AGI sought to change its election and could do so by filing amended returns. The Tax Court, however, found that AGI did not intend to change its election and, in effect, Caselli was asserting that AGI's election could be changed unilaterally by his request made in his capacity as a shareholder. The IRS, in contrast, argued any Sec. 45B election should be made by AGI directly, not through a shareholder's request, and that Caselli, in his sole capacity as one of AGI's shareholders, could not change AGI's election of not claiming any FICA tip credits.

The Tax Court explained that, generally, under Sec. 1363(c)(1), any election affecting the computation of items derived from an S corporation is made by the corporation. Regs. Sec. 1.1363-1(c)(1) also states that individual shareholders cannot make such an election, subject to two statutory exceptions that were not relevant to a Sec. 45B election.

Sec. 45B(d) specifically provides 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." Analyzing this subsection, the Tax Court concluded that while S corporations are generally not considered to be taxpayers, employment taxes are the liabilities of the employer, which is the taxpayer in this context.

In the Tax Court's view, Caselli was essentially asking it to create a new precedent, which would endow each individual shareholder with the power to change an S corporation's tax election unilaterally. The court refused to do so because such a unilateral change, if allowed, would not only affect the tax liabilities of the requesting shareholder but could also affect the tax liabilities of the shareholders who have not consented to such a change. The court noted that Caselli himself had highlighted the danger of this approach by assuring the court that "[a]ny change to AGI's tax items for the years 2006 and 2007 will not have any effect" on other AGI shareholders because of their circumstances, and by attempting to persuade the court that there would be no unfairness in this particular case.

Reflections

Because Caselli was asking the Tax Court to hold that AGI may claim credits by filing amended returns, and AGI had not at the time of the case filed amended returns, the court found that Caselli was "essentially requesting an advisory opinion based upon a future contingency." The court stated that it would normally refuse to give an advisory opinion, but it made an exception in this case, saying that "since there is little development of the law concerning section 45B in cases or otherwise, it is useful and expedient to discuss the provision and its application to the facts before us."

Caselli, T.C. Memo. 2018-81   

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