S Shareholder Can't Unilaterally Elect FICA Tax Credit on S Corporation's Behalf

(Parker Tax Publishing July 2018)

The Tax Court held that a shareholder of an S corporation that operated restaurants and whose employees' earnings came partly from customer tips could not elect on the S corporation's behalf to take the Code Sec. 45B credit for social security and Medicare taxes that the S corporation paid on its employees' tip wages by filing amended individual returns to claim flowthrough deductions from the credits. The Tax Court reasoned that the S corporation was considered the taxpayer for purposes of the Code Sec. 45B election and that permitting individual shareholders to unilaterally change an S corporation's tax election would affect the tax liabilities of shareholders who did not consent to the change. Caselli v. Comm'r, T.C. Memo. 2018-81.

Ronald Caselli was one of three shareholders of Apple Gilroy, Inc. (AGI), an S corporation operating multiple restaurants. AGI's restaurants hired employees whose wages came partly from customer tips, and AGI was required to pay Federal Insurance Contribution Act (FICA) taxes on the tips.

Under Code Sec. 45B, an employer in the food and beverage industry is allowed to claim a credit for a portion of the FICA taxes it pays on employee tips. On its 2006 and 2007 Forms 1120S, U.S. Income Tax Return for an S Corporation, AGI did not claim any FICA tax credits or file a Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips. Instead, it deducted its payments of the FICA tip taxes. AGI never amended its returns for either year.

Caselli claimed flowthrough deductions from AGI on his returns for 2006 and 2007. In 2010, the IRS sent Caselli a notice of deficiency for 2006 determining a deficiency of approximately $261,000. Caselli filed an amended return for 2007 on Form 1040X, Amended U.S. Individual Income Tax Return, claiming a refund of over $65,000 deriving from AGI's 2007 FICA tip credits. Caselli attached a Form 8846 to his Form 1040X showing himself as the taxpayer electing the FICA tip credit. His amended return did not include an amended Schedule K-1, Shareholder's Share of Income, Deductions, Credits, etc., from AGI. In 2011, the IRS sent a notice determining a deficiency of approximately $204,000 for 2007 and disallowing Caselli's refund claim. Caselli petitioned the Tax Court with respect to the 2007 deficiency in 2011. In 2014, he filed an amended petition for 2006, claiming that he was also entitled to flowthrough FICA tip credits for that year.

Code Sec. 45B allows an employer to elect a credit in the amount of the FICA taxes it paid on employee tips in excess of the minimum wage. To qualify, the employer must have employees who receive tips from customers for providing food or beverages for consumption. The employer cannot elect the credit if it has taken a deduction for the FICA tax payment. Form 8846 is the form for eligible employers to claim FICA tax credits.

Caselli argued that he was entitled to a proportionate flowthrough of AGI's FICA tax credits and that AGI could claim the credits by his unilaterally filing amended returns as a shareholder. Caselli recognized that the election could affect other shareholders, but argued that due to the special circumstances of the other AGI shareholders, any change to AGI's tax items for the years at issue would have no effect on them, and therefore no unfairness would result. The IRS argued that the Code Sec. 45B election had to be made by AGI directly, not by Caselli.

The Tax Court held that Caselli was not allowed to claim FICA tip credits from AGI because only AGI could elect to take the credits. First, the Tax Court noted that because AGI never filed amended returns, Caselli was essentially requesting an advisory opinion based on a future contingency, which ordinarily the court would decline. However, as there was little development of the law concerning Code Sec. 45B, the court determined it would be useful to discuss the provision and its application in this case.

The Tax Court found that under Code Sec. 1363, any election affecting the computation of items derived from an S corporation must be made by the corporation, and that Reg. Sec. 1.1363-1(c)(1) specifically states that shareholders are not permitted to make such elections. While this general rule is subject to exceptions (for example, elections under Code Sec. 617 to recapture mining expenditures and elections under Code Sec. 901 relating to foreign tax credits), the court found that the Code Sec. 45B election was not one of them.

Next, the court reasoned that under Code Sec. 45B(d), the FICA tax credit does not apply if the taxpayer elects to have the credit not apply. While S corporations are generally not considered taxpayers, the court found that employment taxes are liabilities of the employer, which was the S corporation taxpayer in this context. Thus, Caselli's position was foreclosed by the plain text of Code Sec. 1363 and Code Sec. 45B, in the view of the Tax Court.

The Tax Court explained that Caselli was essentially asking it to create a new precedent which would endow each individual shareholder with the power to unilaterally change an S corporation's tax election. If allowed, such a change would affect not only the tax liabilities of the requesting shareholder but could also affect the liabilities of shareholders who have not consented to such a change. The court noted that Caselli himself highlighted the danger of this approach by assuring the court that, due to special circumstances, the other shareholders of AGI would be unaffected by the change. The Tax Court declined to create a new precedent.

For a discussion of the credit for FICA taxes paid on employee tips, see Parker Tax ¶105,901.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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