Joseph Radtke, SC v. United States
712 F. Supp. 143, 63 A.F.T.R.2d (RIA) 1469, 1989 U.S. Dist. LEXIS 5408 (1989)
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Rule of Law:
Payments designated as 'dividends' to a shareholder-employee of a closely held corporation will be recharacterized as 'wages' subject to FICA and FUTA taxes when the shareholder-employee performs substantial services for the corporation but does not receive reasonable compensation in the form of a salary. The substance of the transaction, rather than its form, determines the tax treatment of the payments.
Facts:
- In 1979, Joseph Radtke incorporated his law practice as Joseph Radtke, S.C., a Subchapter S corporation.
- Radtke was the corporation's sole shareholder, director, and incorporator.
- In 1982, Radtke served as the firm’s president and treasurer and was its only full-time employee.
- An employment contract between Radtke and the corporation stipulated his annual base salary was $0.
- Throughout 1982, Radtke devoted all his working time to providing legal services for the corporation's clients.
- Whenever the corporation had funds available, Radtke would cause its board of directors (himself) to declare a dividend.
- In 1982, Radtke received $18,225 from the corporation, which was characterized as 'dividends'.
- The corporation did not file federal employment tax returns (Form 941) or unemployment tax returns (Form 940) and did not pay FICA or FUTA taxes on the payments made to Radtke.
Procedural Posture:
- The Internal Revenue Service (IRS) assessed deficiencies against Joseph Radtke, S.C. for unpaid FICA and FUTA taxes, plus interest and penalties, for the 1982 calendar year.
- The corporation paid the full FUTA assessment ($366.44) and a portion of the FICA assessment ($593.75).
- The corporation then filed a claim with the IRS for a refund of the taxes paid, which was not granted.
- Joseph Radtke, S.C. (plaintiff) filed suit against the United States (defendant) in the U.S. District Court for the Eastern District of Wisconsin seeking a refund of the taxes.
- Both the plaintiff and defendant filed cross-motions for summary judgment.
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Issue:
Do payments designated as 'dividends' by a Subchapter S corporation to its sole shareholder, director, and employee constitute 'wages' subject to FICA and FUTA taxes when that individual performs substantial services for the corporation but receives a salary of $0?
Opinions:
Majority - Terence T. Evans
Yes, payments designated as dividends constitute wages under these circumstances. Courts must look to the substance, not the form, of transactions, particularly in the context of closely held corporations. The statutory definition of 'wages' for FICA and FUTA purposes is broad, covering 'all remuneration for employment.' Since Joseph Radtke was an employee who performed substantial services for the corporation and received no salary, the payments he received, though labeled 'dividends,' were in substance remuneration for his employment and thus are subject to employment taxes. To allow an employer to evade FICA and FUTA taxes by simply characterizing all of an employee’s remuneration as something other than wages would contravene the purpose of the tax code.
Analysis:
This decision reinforces the 'substance over form' doctrine in tax law, specifically for closely held corporations. It prevents shareholder-employees of S-corporations from avoiding employment taxes by paying themselves exclusively in dividends while foregoing a reasonable salary. The case establishes a clear precedent that the IRS can recharacterize such payments as wages, ensuring that compensation for labor is taxed appropriately. This ruling has a significant impact on tax planning for small business owners, requiring them to pay themselves a reasonable salary for services rendered before distributing profits as dividends.
