The Perils of Misguided Tax Strategies

The Case of Aspro Inc.: A Lesson in Compliance

In the recent case of Aspro Inc. v. Commissioner (2021), we see a classic example of how not to play the game. Aspro Inc., a $23 million company, paid “management fees” to corporations owned by its shareholders, aiming to cleverly reduce its taxable income. Sounds smart, right? Wrong. The IRS wasn’t amused, especially since Aspro Inc. failed to provide a written management agreement, proper invoicing, or any semblance of a reasonable method to determine these fees. In short, they missed nearly every rule in the IRS’s playbook.

Documentation: The Bedrock of Compliance

One of the first rules in protecting your clients’ multi-corporation strategy is the art of documentation. The IRS loves a good paper trail, and so should you. Every transaction between related parties must be backed by a written contract that not only exists but is followed religiously. It should detail the nature of services, the basis for pricing (ah, the mystical “arm’s length” standard), and be ratified in the corporate minutes. Remember, if it’s not written down, in the eyes of the IRS, it might as well not have happened.

Arm’s Length Pricing: The Magic Wand of Compliance

Setting prices between related entities can sometimes feel like choosing a wand in Ollivanders’ shop—complicated, and yet, it must choose you (or rather, it must be justifiable). Pricing should be comparable to what would be charged in a deal with an unrelated third party. The IRS scrutinizes these transactions intensely; a misstep here can turn your strategic tax planning into an expensive lesson in compliance.

Invoicing: Your Fiscal Fairy Tale’s Gingerbread Crumbs

Invoices are the breadcrumbs that lead back to the legitimacy of transactions between related entities. Each service provided must be invoiced promptly and paid accordingly—no lump sums thrown at year-end to magically zero out corporate income, as was unfortunately the case with Aspro. These should be your narrative of compliance, clear and consecutive.

Reasonableness: The Glass Slipper of Deductions

Just because a payment can be justified doesn’t mean it’s reasonable. Aspro’s management fees, which conveniently zeroed out income, failed the reasonableness test. Each fee and payment must fit your business as perfectly as a glass slipper: necessary, ordinary, and helping your business run smoother.

The Experts’ Role: Your Fairy Godparent

Sometimes, even the best-laid plans need a touch of magic—or expert testimony. In complex arrangements, having an expert can make the difference between a deduction held up in court and one that falls like a house of cards. Don’t be like Aspro, who went into battle without an expert, while the IRS had one.

Surviving an IRS Scrutiny: More Than Just Luck

When facing IRS scrutiny, luck favors the prepared. Aspro learned the hard way that unprepared defenses crumble. If you’re claiming deductions for management fees, be ready with all the documentation, from contracts to invoices and even third-party comparisons, to prove these were no fairy tale deductions.

Learn from Dr. Elick’s Misadventures

In a similar case involving Dr. Wiley M. Elick, a dentist who created a management company, the IRS disallowed the management fees paid due to lack of proper invoicing and substantiation of services. Despite having a written agreement, failure to demonstrate actual services and adhere to invoicing terms was his downfall. Take this as a script on what not to do: if your strategy includes a management agreement, following it to the letter is non-negotiable.

Conclusion: Play by the IRS’s Rules

Navigating the maze of IRS rules requires not just strategic acumen but meticulous adherence to compliance. Whether it’s maintaining crystal-clear documentation, ensuring arm’s length transactions, or wielding expert opinions wisely, remember that in the great chess game of tax planning, every move counts.

Every sound tax plan should include a robust documentation strategy and consistent compliance checks. Just as surgeons monitor recovery post-operation, tax professionals should regularly review clients' compliance to avoid costly pitfalls. Let’s take a page from their book and put our clients’ tax plans on life support!

Key Takeaways from the Aspro Case

• The court did not rule out deducting management fees to related party shareholders but stressed the need for proper substantiation.

• Documentation and adherence to written agreements are crucial.

• Payments must be ordinary, necessary, and reasonable.

• Experts can provide crucial testimony to support deductions, but their opinions must be well-founded.

By following these guidelines, you can ensure your multi-business strategy remains robust and IRS-compliant.