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ACCT 451 Business Taxation

Spring 2016

Memorandum Project
Case Name: Thomas A. Curtis, M.D., INC. v. Commissioner
Case Citation: TC Memo 1994-15, RIA TC Memo P 94015, 67 CCH TCM 1958
1. Facts: Thomas A. Curtis, MD, Inc. was a professional/medical corporation
duly formed and organized under the laws of the State of California in
1973. Situated in California, the corp. specialized in conducting
medical psychiatric practices such as psychiatric evaluations and
caring of patients involved in workers compensation cases. Dr.
Thomas A. Curtis immigrated from Winnipeg Canada to the U.S. after
graduating from the University of Manitoba with an M.D. honors degree
in 1967. Forming the corp. in 1973, he focused mainly on general
psychiatry until 1983. Ms. Ellen Barnert Curtis joined the corp. in 1983
as a registered nurse since the age of 22. After pitching the idea for a
workers compensation psychiatric practice to Dr. Curtis, she was
appointed vice president and owner of one-third of the outstanding
stock. Ms. Curtiss efforts resulted in a lot of success for the corp. Later
on, she made the decision to lower the corporation's operating
expenses by utilizing leased employees and independent contractors
(psychologists) with herself working more than 60 to 70 hours per
week supervising all the departments set up within the corporation.
Ms. Curtis was very keen about the changes made to the laws for
workers compensation. She had spent a lot of effort in creating an
efficient system that would generate high quality reports for workers
compensation. Since, the report serves in the place of in-court
testimony and is sought after by attorneys to win money for their
injured clients, these high quality reports resulted in a lot of success for
the corporation. The corp. however, had no official or written
compensation policy. Ms. Curtis did not have an employment contract
setting the rate of pay or containing any noncompete provisions.
Although their salaries were not initially equal, after several years of
working together Ms. Curtis and Dr. Curtis began receiving equal
salaries from the corporation. The amount of accounts receivable and
the long-term financing arrangements evidenced the growth of the
corporation and Ms. Curtis solely initiated and maintained the
corporations banking relationships.
2. Issues: The corporation had only two shareholder-employees, Dr.
Thomas Curtis and Ms. Ellen Barnert Curtis. For two consecutive years
from1988 to1989, the corporation paid an unreasonable compensation
amount to its employees without distributing any dividend to the
shareholders. In this case, the shareholders and employees happened
to be the same two people. During the years in issue, in 1988, the
corporation paid them each $431,500 in compensation. And in 1989,

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ACCT 451 Business Taxation
Spring 2016
they each received $510,500 in compensation. In addition to a salary,
the corporation provided Ms. Curtis a 1986 Mercedes Benz, medical
insurance, life insurance, a pension plan, and rent on a personally
owned condominium used for business purposes. No dividends were
paid during either year in issue. Therefore, by paying Dr. Curtis and Ms.
Curtis exclusively as compensation, the Corporation converted the nondeductible shareholder dividends to salary and understated its tax
3. Conclusions: After considering the factors relevant to deciding reasonable compensation
for Ms. Curtis, based on all the evidence, the reasonable compensation for Ms. Curtis for
April 30, 1988 of $227,000 and for April 30, 1989, of $239,000 were held. 1988, was
$227,000 and for FYE April 30, 1989, was $239,000. There was also a tax amount equal
to 5 percent of the entire underpayment. An addition to tax equal to 50 percent of the
interest payable under section 6601 with respect to the portion of the underpayment due
to negligence. Petitioner was liable for the addition to tax under section 6661(a) for both
years in issue.
4. Analysis: The issue at hand was whether the amounts paid by petitioner to Ms. Curtis as
compensation for the years in issue were reasonable within the meaning of section 162(a)
(1) and thus deductible. In order to do that, they had to carry out a deductibility test. The
test of deductibility in the case of compensation payments is twofold: Whether the
amount of the payment is reasonable in relation to the services performed (amount test),
and whether the payment is in fact made for services rendered (intent test). Since neither
party suggested that the payments to Ms. Curtis were made for anything other than
services she actually performed, only the first element of the deductibility test was
conducted, that is whether the amounts of the payments were reasonable. Five factors
were considered by the Court of Appeals for the Ninth Circuit to determine reasonable
compensation: (a) Ms. Curtis role in the company which was unquestioned and was a
factor in favor of her; (b) External compensation which did not favor each party because
of inflated and unsupported factual findings; (c) The companys character and condition
which was slightly in the petitioners favor due to the success and revenue of the
company; (d) Conflict of interest which was present since the corporation did not pay
dividends which further affirms a practice by petitioner of disguising nondeductible
corporate distributions as salary which turned out to be a big factor in favor of the
respondent; (e) Internal consistency which was not directly applicable or helpful because
of the corporation's unique structure of having only two employee-shareholders and the
remainder of the staff's being leased through a management company.

1. ThomasA.Curtis,M.D.,Inc.,TCMemo199415.,CodeSec(s)162.