T.C. Memo. 1996-296
UNITED STATES TAX COURT
TERRY R. HARDTKE AND NANCY HARDTKE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13669-92.1 Filed June 26, 1996.
Terry R. Hardtke, pro se.
Allan D. Hill, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
CHIECHI, Judge: Respondent determined the following defi-
1
The proceedings herein were automatically stayed after the
trial herein when petitioners filed a petition for bankruptcy
with the U.S. Bankruptcy Court for the Northern District of
California on Sept. 30, 1993. On Oct. 18, 1995, after peti-
tioners' bankruptcy proceeding was discharged, the Court lifted
the automatic stay and ordered the parties to file simultaneous
opening briefs by Dec. 18, 1995, and simultaneous answering
briefs by Jan. 12, 1996. Petitioners did not file an opening
brief. On Jan. 17, 1996, petitioners submitted a document that
the Court had filed as their answering brief. On Jan. 18, 1996,
the Court ordered that petitioners were not allowed to file any
additional briefs in this case and that respondent was allowed to
file a reply to petitioners' answering brief, which she did on
Feb. 16, 1996.
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ciency in, and additions to, petitioners' Federal income tax:
Section Section Section
Year Deficiency 6653(a)(1)(A)2 6653(a)(1)(B) 6661(a)
1987 $13,912.00 $695.60 * $3,478.00
* 50 percent of the interest due on the portion of the underpay-
ment due to negligence. Respondent determined that the entire
underpayment was attributable to negligence.
The issues for decision are:
(1) Did petitioners have unreported income for 1987 attrib-
utable to services provided by petitioner Terry R. Hardtke (Mr.
Hardtke) to T.R. Hardtke Insurance Agency, Inc. (Agency)? We
hold that they did.
(2) Are petitioners liable for self-employment tax for
1987? We hold that they are.
(3) Are petitioners liable for 1987 for the additions to
tax for negligence under section 6653(a)? We hold that they are.
(4) Are petitioners liable for 1987 for the addition to tax
for a substantial understatement of income tax under section
6661(a)? We hold that they are.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
Petitioners resided in New Almaden, California, at the time
the petition was filed.
During 1987, Agency was a California corporation that
2
All section references are to the Internal Revenue Code in
effect for 1987. All Rule references are to the Tax Court Rules
of Practice and Procedure.
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operated a general agency specializing in brokering small group
medical insurance plans. Throughout 1987, Mr. Hardtke owned 75
percent of the common stock of Agency, and Stuart Michell (Mr.
Michell) owned the remaining 25 percent of the common stock of
Agency. During 1987, Mr. Hardtke, who already was serving as
Agency's chief executive officer (CEO), was elected its president
during a special meeting of its board of directors (board of
directors) held on March 3, 1987 (March 3, 1987 Agency board
meeting).
During 1987, Dinan, Inc. (Dinan) was a California corpora-
tion that specialized in pension administration and in the
production and marketing of computer software that compared the
costs and benefits of various group medical plans. Mr. Hardtke,
who served as CEO of Dinan during 1987, owned 42 percent of the
common stock of Dinan throughout that year until December 8,
1987, when he purchased an additional 33 percent of that stock
from Russell M. Meusy (Mr. Meusy), thereby increasing his common
stock ownership of Dinan to 75 percent. In addition to that
common stock ownership of Mr. Hardtke and Mr. Meusy, during 1987,
Mr. Hardtke's mother owned three percent, Mr. Michell owned 15
percent, and an unidentified individual owned seven percent of
Dinan's common stock.
The minutes of the March 3, 1987 Agency board meeting
provided in pertinent part:
Compensation will be earned by Mr. Hardtke and Mr.
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Michell and shall be paid directly to Dinan, Inc. as
follows:
$7,000.00 each month is payable to Dinan, Inc. as
a consulting fee for the services of Mr. Hardtke
and Mr. Michell. It will be accounted as $4,000
for Mr. Hardtke and $3,000 for Mr. Michell.
The only persons present at the March 3, 1987 Agency board
meeting were Mr. Hardtke, Mr. Michell, and petitioner Nancy
Hardtke (Ms. Hardtke).
Agency's books of account for the period February 28, 1987,
through February 28, 1988, show entries reflecting that Agency
paid a total of $74,000 to Dinan as "consulting fees".3 Its
books of account for the period January 1, 1987, through December
31, 1987, do not contain any entries showing that compensation
was paid to Mr. Hardtke during 1987.
The books and records of Dinan for the period January 1,
1987, through December 31, 1987, do not contain any entries
showing that compensation was paid to Mr. Hardtke during 1987.4
Mr. Hardtke received the following compensation from Agency
and Dinan for the years 1986 and 1988:
Year Agency Dinan
1986 $3,000 $56,500
1988 65,600 38,535
3
It is not clear from the record whether all of those payments
were made during 1987.
4
Although during all relevant times Dinan used a fiscal year
that ended on the last day of February, the parties stipulated to
Dinan's books and records for the period Jan. 1, 1987, through
Dec. 31, 1987, when agreeing that those books and records do not
show any compensation paid to Mr. Hardtke during that year.
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OPINION
Petitioners bear the burden of proving that respondent's
determinations in the notice of deficiency are erroneous. Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Unreported Income
Respondent determined that Mr. Hardtke had $44,000 of
unreported compensation income from Agency during 1987. Although
Agency made no payments to Mr. Hardtke during that year, respon-
dent argues that the amounts that Agency paid to Dinan during
1987 with respect to services provided by Mr. Hardtke were income
earned by Mr. Hardtke that is includible in petitioners' income
for that year. Petitioners argue that during 1987 Mr. Hardtke
provided services to Agency as an employee of Dinan pursuant to a
consulting agreement between Agency and Dinan and that he did not
provide services to Agency in any other capacity.
It is well established that income must be taxed to the
actual earner of that income. Lucas v. Earl, 281 U.S. 111
(1930). "In the corporate context, however, the actual earner
test may be inadequate because a corporation can earn income only
through the personal services of its employees and agents." Haag
v. Commissioner, 88 T.C. 604, 611 (1987), affd. without published
opinion 855 F.2d 855 (8th Cir. 1988). "In numerous instances, a
corporation is hired solely in order to obtain the services of a
specific corporate employee." Johnson v. Commissioner, 78 T.C.
882, 891 (1982), affd. without published opinion 734 F.2d 20 (9th
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Cir. 1984). As a result, this Court applies a two-prong test to
determine whether a corporation or its employee is the actual
earner of the income in question:
First, the service-performer employee must be just
that--an employee of the corporation whom the corpora-
tion has the right to direct or control in some mean-
ingful sense. Second, there must exist between the
corporation and the person or entity using the services
a contract or similar indicium recognizing the corpora-
tion's controlling position. [Id.; citations omitted.]
With respect to the first prong of the foregoing test,
although Mr. Hardtke was an employee of Dinan during 1987, he
also was an employee of Agency during that year. Thus, not only
Dinan, but also Agency, had the right to control or direct Mr.
Hardtke in some meaningful sense as its employee.
With respect to the second prong of the test set forth in
the Johnson case, we find that petitioners failed to prove that a
contract existed between Dinan and Agency during 1987 under which
Dinan was to provide its services to Agency through its employee,
Mr. Hardtke. Except possibly for the minutes of the March 3,
1987 Agency board meeting, the only evidence of the existence of
such an agreement between Dinan and Agency is the self-serving
testimony of Mr. Hardtke on which we are unwilling to rely.
With respect to the March 3, 1987 Agency board minutes, they
provide in pertinent part:
Compensation will be earned by Mr. Hardtke and Mr.
Michell and shall be paid directly to Dinan, Inc. as
follows:
$7,000.00 each month is payable to Dinan, Inc. as
a consulting fee for the services of Mr. Hardtke
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and Mr. Michell. It will be accounted as $4,000
for Mr. Hardtke and $3,000 for Mr. Michell.
The first clause of the March 3, 1987 Agency board minutes quoted
above unequivocally provides that Mr. Hardtke was to earn compen-
sation and that that compensation was to be paid by Agency to
Dinan. Although those minutes further provide that Agency was to
pay Dinan for Mr. Hardtke's services, they do not establish that
a contractual relationship existed during 1987 for Dinan to
provide its services to Agency through its employee, Mr. Hardtke.
Even assuming arguendo that we were to read the second
clause of the March 3, 1987 Agency board minutes quoted above as
providing that Dinan was to earn compensation for rendering its
services to Agency through its employee, Mr. Hardtke, --a reading
that we find to be quite strained--we would be left in equipoise
as to the intended meaning of those minutes. This is because, on
the one hand, they provide that Mr. Hardtke was to earn compensa-
tion and that that compensation was to be paid to Dinan, and, on
the other hand, under that assumed reading, they provide incon-
sistently that Dinan was to earn compensation for rendering its
services to Agency through its employee, Mr. Hardtke. Conse-
quently, petitioners would have failed to establish that Dinan,
and not Mr. Hardtke, was to earn the compensation in question.
Based on the entire record before us, we find that petition-
ers failed to prove that Mr. Hardtke did not earn the income that
Agency paid to Dinan with respect to Mr. Hardtke's services to
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Agency during 1987. We therefore sustain respondent's determina-
tion on that issue.5
Self-Employment Tax
Respondent determined that petitioners are liable for self-
employment tax of $5,387 for 1987. In order to refute that
determination, petitioners rely on the evidence they presented
and the argument they make with respect to whether Mr. Hardtke
had compensation income from Agency for 1987. We have found that
petitioners failed to satisfy their burden of proof on the
compensation issue. Consequently, they have failed to meet their
burden of proving error in respondent's determination regarding
petitioners' liability for self-employment tax for 1987. See
Rule 142(a); Welch v. Helvering, 290 U.S. at 115. Accordingly,
we sustain that determination.
Additions to Tax
Respondent determined that petitioners are liable for 1987
for the additions to tax for negligence under section
5
Although respondent argues that certain amounts that Mr.
Hardtke received during 1987 from Dinan that were characterized
on the books and records of Dinan as "Loan Payable-Officers"
actually represented, at least in part, indirect payments of
compensation from Agency and petitioners argue that those amounts
were in fact repayments of loans, and not compensation, we need
not decide that dispute. This is because resolution of that
dispute is not necessary to our conclusions herein. All that is
necessary is whether the compensation that Agency paid during
1987 to Dinan for services performed by Mr. Hardtke was earned by
Mr. Hardtke, rather than by Dinan, under the two-prong test
enunciated in Johnson v. Commissioner, 78 T.C. 882, 891 (1982),
affd. without published opinion 734 F.2d 20 (9th Cir. 1984).
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6653(a)(1)(A) and (B) and the addition to tax for a substantial
understatement of income tax under section 6661(a). Petitioners
presented no evidence and make no argument regarding the addi-
tions to tax under section 6653(a)(1)(A) and (B) and section
6661(a) for 1987. Consequently, petitioners have failed to
satisfy their burden of proof on those issues. See Rule 142(a);
Niedringhaus v. Commissioner, 99 T.C. 202, 220-222 (1992); Crown
Income Charitable Fund v. Commissioner, 98 T.C. 327, 339 (1992),
affd. 8 F.3d 571 (7th Cir. 1993). Accordingly, we sustain
respondent's determinations that petitioners are liable for 1987
for the additions to tax under section 6653(a)(1)(A) and (B) and
section 6661(a).
To reflect the foregoing,
Decision will be entered
for respondent.