United States: Consultant Received Guaranteed Payments From Partnership For Services Performed

In Seismic Support Services LLC et al. v. Commissioner (T.C. Memo. 2014-78), the Tax Court held that a partner who received payments for consulting services performed on behalf of the partnership was guaranteed payments under Section 707(c) and that the partner was liable for payment of self-employment taxes on such payments.

The case involved Scott A. Whittington, who was initially employed as a seismic design consultant. After his employer denied his request to change his status to that of an independent contractor, Whittington resigned from his position and attempted to concoct a plan to reduce his employment tax liabilities. He formed a new LLC, Seismic Support Services, LLC, in which he held a 95% interest, and another entity, Management Partners, LLC, owning the remaining 5% interest. Whittington performed all of the services on behalf of Seismic in 2007, 2008 and 2009. Seismic received compensation for the services performed and made payments to Whittington on bank drafts with a label of "distributions." Seismic reported gross income for the compensation received and claimed management fee deductions in each of the years at issue. Seismic did not file employment tax returns for any of the periods from 2007 through 2009.

The IRS issued final partnership administrative adjustments asserting that the payments were guaranteed payments under Section 707(c) and that Whittington was personally liable for the self-employment taxes on such payments. Whittington argued that the "payments were capital expenditures" and, thus, not subject to self-employment tax.

The Tax Court agreed with the IRS, holding that the payments made to Whittington for services performed were made without regard to Seismic's income (i.e., the payments were not distributions from Seismic to Whittington) and that there was "no basis in the record to conclude the payments were for the use of capital." Additionally, the Tax Court agreed with the IRS that an accuracy-related penalty for negligence under Section 6662(a) applied in this instance, since Whittington did not make a "reasonable attempt" to support the treatment of the deductions as management fees and Seismic "mischaracterized" the deductions to support Whittington's attempt to avoid paying self-employment taxes.

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