Brinks Gilson & Lione Case Study

Brinks Gilson & Lione is a law firm that employs attorneys in which some are also shareholders. The employee shareholders hold shares in the corporation in connection with their employment and are required to sell back their shares upon termination. They receive compensation each year in proportion to the shares owned. Employee shareholders would receive only a percentage of his or her expected compensation and then receive a bonus at year-end. This bonus calculated at year-end always amounted to an amount that would zero out book income. In its tax returns, Branks Gilson & Lione always included the year-end bonuses as a deduction for officer compensation however after review, the IRS disallowed the deductions claiming they should be treated as nondeductible dividends. The issue that remained and that was discussed in this case was whether the petitioner was liable for accuracy-related penalties on the underpayments of tax relating to the deduction of year-end bonuses. After consideration the court ruled that the petitioner failed to show it had reasonable cause for deducting the year-end bonuses nor did it act in good faith claiming the deductions. The petitioner never had substantial authority for the deduction and the treatment of the bonus resulted in a substantial understatement, so the accuracy-related penalty was applied.
The first section I enjoyed learning more about was the application of the independent investor test. The courts used the independent investor test in order to determine whether an independent investor would tolerate the practice of paying compensation that zeroed out income. The amounts deducted for compensation eliminated income and left shareholder attorneys with no return on invested capital. Any independent investor would not tolerate this kind of practice, making the petitioner fail the independent investor