Dental Practice Denied Management Fee Expense

This dental practice corporation was denied the business expense deduction for management fees it paid to a related organization.  The reasons IRS and the Court denied the expense are important when working with clients who also have management arrangements.

Facts:

1. The dental practice’s two shareholders were Dr. & Mrs. Elick. They were also on the dental practice’s payroll.  Another employee, Ms. McGee, was the bookkeeping and office manager.
2. The practice explored creating an employee benefit plan.  A professional advised Dr. Elick to establish a managment company to manage the dental practice.  The management company would set up an ESOP and purchase all of Dr. Elick’s stock in the management company.  The fees the management company generated would fund the ESOP.  This would give a deduction to the dental practice and theoretically shelter the funds from tax until they were eventually paid out to the ESOP beneficiaries.
3. The dental practice had a signed agreement with SDG, a management services company created and owned by Dr. & Mrs. Elick.  SDG was to perform various activities including annual capital, operating and cashflow budget plans; investigate and document in writing customer complains, develop policies and procedures; recruit, supervise and train petitioner’s employees; perform fiscal services; and ensure regulatory compliance.  The fee for these services was set between 1% and 25% of the dental practice’s monthly receipts, to be paid monthly.
4. Dr. Elick and Ms. McGee testified they provided many of these management services to the dental practice on behalf of SDG but SDG did not have any payroll for the years at question.  There was no record of Dr. Elick’s or Ms. McGee’s duties for SDG nor the hours they performed such duties.
5. The dental practice did not provide any documentation showing that SDG performed any of the contracted services.  The dental practice acknowledged that third parties provided services SDG was supposed to provide.
6. The dental practice never received monthly invoices nor did it pay monthly.  The management fees were paid near the end of each year and amounted to about 10% of gross receipts (roughly $430,000 in one year and $303,000 in the next).  Nothing was provided to show how this percentage was determined.
7. A dental surgery business also owned by the Elicks entered into a similar agreement with SDG.  It paid a fee of $20,000 in one year and nothing in the next.  Again it was unable to show any services were actually provided.
8. The terms of the management agreement appears to have been mostly disregarded.

Wiley M Elick DDS, Inc, TC Memo 2013-139

This text has been shared with you courtesy of:  David & Mary Mellem, EAs & Ashwaubenon Tax Professionals, 920-496-1065 (920-496-9111).  davidmellem@yahoo.com, davidmellemea@yahoo.com, marymellem@yahoo.com,marymellemea@yahoo.com.