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Taxation - Income - Deductions - Law practice.

Byline: R.I. Lawyers Weekly Staff

Where the IRS disallowed deductions on an attorney's individual tax return, that decision should be upheld, as there is no clear evidence that he operated a law practice separate from an "S" corporation.


"Defendant, the United States Government ('Government'), filed a motion for summary judgement on Plaintiff David Morowitz's ('Mr. Morowitz') claim for recovery on Internal Revenue Service ('IRS') tax and claim for recovery on penalties erroneously assessed and collected.

"Mr. Morowitz filed articles of incorporation with the Office of the Rhode Island Secretary of State and incorporated the Law Office of David Morowitz as an 'S' Corporation in 1999. ... Mr. Morowitz was the sole shareholder of that corporation at the time of incorporation. As standard practice for an 'S' Corporation, Mr. Morowitz filed a Form 1120S, U.S. Income Tax Return for an S Corporation ('Form 1120S'), to report its taxes. All income and expenses of the corporation were reported on the Form 1120S until 2009 when Mr. Morowitz brought in a new shareholder. ... At that time, Mr. Morowitz changed the name of the corporation to Morowitz & Barry, Ltd. ... When Mr. Morowitz amended the name of the corporation, he did not dissolve the original corporation, amend its corporate structure, or change its Federal Employer Identification Number ('EIN'). ... Instead, the corporation continued to operate under its amended name throughout the 2010 income tax year.

"In conjunction with Mr. Morowitz amending the name of the corporation, he entered into a Shareholder Agreement (the 'Agreement') with Patrick Barry to whom 50 shares of stock were issued. ... In that agreement, Mr. Morowitz and Mr. Barry agreed to segregate '[f]ees earned and monies paid on Mr. Morowitz's pre-existing cases,' and those fees or monies earned would not belong to Morowitz & Barry, Ltd. Id. The retainers for the pre-existing clients, however, were executed through the Law Office of David Morowitz, Ltd., prior to the Agreement.

"... Mr. Morowitz concedes that, when the corporation amended its name, the pre-existing clients did not sign a new retainer agreement with Morowitz & Barry, Ltd., nor does Mr. Morowitz offer that the pre-existing clients signed a new retainer agreement with him individually.

"On his 2010 individual income tax return, however, Mr. Morowitz tiled a Schedule C (Form I 040) claiming deductions for expenses relating to those pre-existing cases. ... The deductions include 'case costs' in the amount of $9,997 and $2,13 7, each paid out of the corporation's bank account. Id. Additionally, Mr. Morowitz claimed a deduction for $15,000 that he paid, out of pocket, to the corporation's legal secretaries for work performed on a pre-existing case. ... The IRS disallowed each of these deductions."

Judge's analysis

"Mr. Morowitz argues that he is entitled to the deductions because the payments on the pre-existing cases were not related to the corporation but, instead, were from a separate business operation that he classifies as a sole proprietorship.

"Mr. Morowitz chose to incorporate the Law Office of David Morowitz, Ltd., and elected to file with the IRS as an 'S' corporation.

"Mr. Morowitz cannot establish that he practiced as a sole proprietor entitling him to take deductions on a Schedule C (Form 1040). The corporation, the Law Office of David Morowitz, Ltd., was not dissolved when it amended its name to Morowitz & Barry, Ltd. Instead, Mr. Morowitz filed an Articles of Amendment to change the name of the law firm and to issue shares to Mr. Barry. ... The corporation continued to operate under the same EIN and continued to tile the required Form 1120S with the IRS. ... Therefore, the corporation was always operating within the elected 'S' Corporation structure. As such, a Schedule C (Form 1040) was improperly tiled and the IRS properly disallowed the deductions on that form.

"Though Mr. Morowitz contends, with respect to the pre-existing clients, that he operated a separate business apart from the corporation, he paid the fees for the pre-existing cases out of the corporation's account. Mr. Morowitz argues that he, individually, paid the case costs because the cases at issue were not associated with Morowitz & Barry, Ltd. ... The fees paid, according to Mr. Morowitz, were $9,977 for case advances on the pre-existing cases enumerated in the Agreement as well as $2,1371 for case advances on a separate case. ... As stated above, Mr. Morowtiz has failed to establish that he operated any business other than the elected 'S' Corporation he elected to incorporate. As such, payments of the expenses of a corporation by a shareholder constitute a loan or a contribution to the capital of the corporation and are deductible, if at all, not by the shareholder, but by the corporation. ... Therefore, Mr. Morowitz is not personally entitled to take deductions on case costs of cases retained, and expensed, through the corporation.

"Additionally, Mr. Morowitz contends that he is entitled to the deduction of $15,000 that he paid as bonuses to his legal secretaries because the payment was made for work separate and apart from that of the corporation. ... Mr. Morowitz offers that he personally, not the corporation, paid the secretaries and tiled the 1099's on their behalf. ... However, the clients of the pre-existing cases signed a retainer agreement with the Law Office of David Morowitz, Ltd., and the proceeds awarded from that case were deposited into the corporation's trust account and subsequently paid from that trust account. ... The fact that Mr. Morowitz paid himself those proceeds, and personally made bonus payments to his legal secretaries for work associated with the pre-existing case, is immaterial. Again, Mr. Morowitz has not operated a law practice as a sole proprietor and, therefore, cannot take deductions from his legal practice on a Schedule C. The payments, whether properly made or not, stem from the business of the corporation that has never ceased to exist/operate and '[b]ecause the expenditures in issue were made on behalf of [the corporation's] business, we conclude that petitioners may not claim these expenses as business expense deductions.'

"Further, Mr. Morowitz argues that he entered an Agreement that carved out the pre-existing cases from the benefit and the liability of the newly formed corporation. As such, he argues that the work for these pre-existing cases was conducted as a separate business from the corporation and he conducted that business as a sole proprietor entitling him to tile case fees as deductions on a Schedule C. ... However, '[a] shareholder cannot convert a business expense of his corporation into a business expense of his own simply by agreeing to bear such an expense.' ... "Therefore, '[a]greements entered into between individuals may not prevail as against the provisions of the revenue laws in conflict.' ... Parties are free to contract and, when parties agree to a transaction, federal law then governs the tax consequences of the agreement, whether contemplated or not.

"Mr. Morowitz cannot establish that he is entitled to the disallowed deductions on his Schedule C where there is no clear evidence that he operated a law practice separate from the corporation. Accordingly, this Court grants the Government's motion for summary judgment."

Morowitz v. United States (Lawyers Weekly No. 52-020-19) (8 pages) (McConnell, J.) (C.A. No. 1:17-CV-00291) (March 7, 2019).

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Title Annotation:Morowitz v. United States, U.S. District Court for the District of Rhode Island
Publication:Rhode Island Lawyers Weekly
Date:Mar 11, 2019
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