Aspro, Inc. v. Comm'r of Internal Revenue

32 F.4th 673

ASPRO, INC., Appellant

v.COMMISSIONER OF INTERNAL REVENUE, Appellee

No. 21-1996

United States Court of Appeals, Eighth Circuit.

Submitted: December 14, 2021

Filed: April 26, 2022

Brian J. Brislen, Adam R. Feeney, Lamson & Dugan, Omaha, NE, for Appellant.

Robert Joel Branman, Jacob Earl Christensen, Francesca Ugolini, U.S. Department of Justice, Tax Division, Appellate Section, Washington, DC, Michael J. Desmond, U.S. Internal Revenue Service, Office of Chief Counsel, Washington, DC, Joel C. Dickens, Courtney L. Frola, M. Jeanne Peterson, Internal Revenue Service, Office of Chief Counsel, Denver, CO, for Appellee.

Before SMITH, Chief Judge, GRUENDER and KOBES, Circuit Judges.

GRUENDER, Circuit Judge.

Aspro, Inc., an asphalt-paving company, claimed tax deductions for management fees paid to its shareholders. The tax court affirmed the Commissioner's denial of the claimed deductions and granted the Commissioner's motion in limine to exclude Aspro's proffered expert witness testimony.¹ Aspro appeals, and we affirm.

I.

Aspro, Inc. is an asphalt-paving company in Waterloo, Iowa. It is incorporated under Iowa law and treated as a subchapter C corporation for federal income-tax purposes. Between 2012 and 2014, the relevant years, Aspro stock was held by: Milton Dakovich, the president of Aspro; Jackson Enterprises Corp.; and Manatt's Enterprises, Ltd. Aspro has not paid dividends since the 1970s but, except for one year,² has paid its shareholders "management fees" for at least twenty years. In addition to receiving management fees, Dakovich received a salary, director fees, and bonuses for each of the relevant years. There were no written agreements between Aspro and its three shareholders regarding fees paid for management services, nor was there an employment contract between Aspro and Dakovich. Aspro claimed deductions on its tax returns for management fees for tax years 2012 through 2014. The Commissioner denied these deductions on the ground that Aspro failed to establish that it had incurred or paid the management fees for ordinary and necessary business purposes. At the resulting tax-court proceeding, each party proffered expert witnesses. The tax court excluded the testimony of Aspro's experts and sustained the Commissioner's decision denying Aspro's claimed deductions on the ground that the fees were not paid as compensation for services but were instead disguised distributions of corporate earnings. Aspro appeals.

II.

We begin with Aspro's claim that the tax court abused its discretion in excluding the testimony of its experts, Gale Peterson, Jr. and William Kenedy. Peterson is a contractor in the highway-construction industry, and Kenedy is a certified public accountant who specializes in business valuation. They each opined that the management fees were paid for valuable services that were actually performed. We review the tax court's decision to exclude expert testimony for an abuse of discretion. See Polack v. Comm'r , 366 F.3d 608, 612 (8th Cir. 2004). Expert testimony is admissible only when the expert's specialized knowledge "help[s] the trier of fact to understand the evidence or to determine a fact in issue." Fed. R. Evid. 702(a). The expert's specialized knowledge must be "based on sufficient facts or data," be "the product of reliable principles and methods," and demonstrate that "the expert has reliably applied the principles and methods to the facts of the case." Fed. R. Evid. 702(b)-(d). "Speculative testimony should not be admitted." Junk v. Terminix Int'l Co. , 628 F.3d 439, 448 (8th Cir. 2010).

The tax court did not abuse its discretion in excluding the testimony of Peterson. His expert testimony would not help the trier of fact understand the evidence or determine a fact in issue. See Fed. R. Evid. 702(a). The tax court correctly found that Peterson's "report does not offer an opinion as to the value of the various services at issue in this case nor does he apply scientific principles and methods." Instead, as the tax court found, Peterson relied only on his personal "experience working for Aspro and his knowledge of [the] shareholders' reputation in the industry[ ] [in concluding] that the services [the shareholders] provided to [Aspro] were valuable." This does not demonstrate that Peterson "employ[ed] in the courtroom the same level of intellectual rigor that characterizes the practice of an expert in the relevant field." See Kumho Tire Co., Ltd. v. Carmichael , 526 U.S. 137, 152, 119 S.Ct. 1167, 143 L.Ed.2d 238 (1999). The tax court did not abuse its discretion when it excluded Peterson's testimony. See United States v. Strong , 826 F.3d 1109, 1115 (8th Cir. 2016) (holding that "expert-witness testimony was properly excluded" because "it was not helpful as required by Rule 702").

Nor did the tax court abuse its discretion in excluding the testimony of Kenedy. As the tax court noted, Kenedy did not "articulate what principles and methods he used, if any, to conclude that ‘valuable services’ were provided." We agree with the tax court that Kenedy's report "merely summarizes the facts in a light favorable to [Aspro], advocates for [Aspro's] position, criticizes [the Commissioner's] position, and makes statements regarding the law." Revealingly, Kenedy admitted that his findings were "[b]ased on [a] lack of documentation and lack of a scientific method to assess the value" of the services. As the tax court suggests, this is an indication that his conclusions are based on personal belief rather than an expert analysis. See Long v. Cottrell, Inc. , 265 F.3d 663, 669 (8th Cir. 2001). Therefore, the tax court did not abuse its discretion in excluding Kenedy's testimony. See Ackerman v. U-Park, Inc. , 951 F.3d 929, 933 (8th Cir. 2020) ("In the absence of any record evidence that [the expert] used reliable principles and methods or applied them reasonably to the facts of this case to form his opinion ... [, t]he district court did not abuse its considerable discretion in excluding [the] expert opinion.").

III.

Next, we consider Aspro's challenge to the tax court's holding that none of the management fees paid by Aspro was deductible because they were instead disguised distributions of profits. See United States v. Ellefsen , 655 F.3d 769, 779 (8th Cir. 2011) (explaining that distributions of profits are not deductible). Whether payments made to shareholders are distributions of profits rather than compensation for services is a factual determination. Heil Beauty Supplies, Inc. v. Comm'r , 199 F.2d 193, 194-95 (8th Cir. 1952). We review the tax court's factual determinations for clear error and "must affirm unless left with a conviction that the tax court has committed a mistake." Keating v. Comm'r , 544 F.3d 900, 903 (8th Cir. 2008). We consider all the facts and circumstances when determining whether the compensation paid to a corporation's shareholders is actually a distribution of profits. See Heil Beauty Supplies , 199 F.2d at 195 ; Charles Schneider & Co. v. Comm'r , 500 F.2d 148, 151 (8th Cir. 1974). Aspro bore the burden of proving its entitlement to the deductions. See T.C.R. 142(a)(1).

Corporations must pay federal income tax on their taxable income, 26 I.R.C. § 11(a), which is gross income less allowable deductions, § 63(a). Under § 162(a)(1), deductions are allowed for expenses that are "ordinary and necessary" in carrying on a trade or business, including "reasonable allowance for salaries or other compensation for personal services actually rendered." "Ordinary has the connotation of normal, usual, or customary," and describes expenses arising from transactions "of common or frequent occurrence in the type of business involved." Deputy v. du Pont , 308 U.S. 488, 495, 60 S.Ct. 363, 84 L.Ed. 416 (1940). Necessary means appropriate and helpful to the development of the business. See Comm'r v. Heininger , 320 U.S. 467, 471, 64 S.Ct. 249, 88 L.Ed. 171 (1943) ; Welch v. Helvering , 290 U.S. 111, 113, 54 S.Ct. 8, 78 L.Ed. 212 (1933).

"As the language of § 162(a)(1) suggests, a deduction may be made if salary is both (1) ‘reasonable’ and (2) ‘in fact payments purely for services.’ " David E. Watson, P.C. v. United States , 668 F.3d 1008, 1018 (8th Cir. 2012) (quoting Treas. Reg. § 1.162–7(a) ); see also Wy'East Color Inc. v. Comm'r , 71 T.C.M. (CCH) 2501, 1996 WL 119492, at *6 (1996) ("A taxpayer may deduct payments for management services under section 162 if the payments are for services actually rendered and are reasonable in amount."). "Usually, courts only need to examine the first prong," although "in the rare case where there is evidence that an otherwise reasonable compensation payment contains a disguised dividend, the inquiry may expand into compensatory intent apart from reasonableness." David E. Watson , 668 F.3d. at 1018 (brackets omitted). However, "[t]he inquiry into reasonableness is a broad one and will, in effect, subsume the inquiry into compensatory intent in most cases." Id. In general, reasonable compensation is limited to "such amount as would ordinarily be paid for like services by like enterprises under like circumstances." Treas. Reg. § 1.162-7(b)(3) ; see also Home Interiors & Gifts, Inc. v. Comm'r , 73 T.C. 1142, 1155-56 (1980).

"[C]orporations are not allowed a deduction for dividends paid to the shareholders," Ellefsen , 655 F.3d at 779, including distributions that are disguised as compensation. Treas. Reg. § 1.162-7(b)(1) ; Charles Schneider , 500 F.2d at 152-53. Compensation paid by the corporation to shareholders is closely scrutinized to make sure the payments are not disguised distributions. Heil Beauty Supplies , 199 F.2d at 194 ("Any payment arrangement between a corporation and a stockholder ... is always subject to close scrutiny for income tax purposes, so that deduction will not be made, as purported salary, rental or the like, of that which is in the realities of the situation an actual distribution of profits.").

A.

Here, even though Aspro...