For all clients who use a multiple corporation set up, they are aware that they must submit invoices for services performed.  The services must be actually performed and at an arm’s length pricing. The contract between the companies must be in writing and should also be approved within the minutes of the company paying for such services.  Further, if questioned the client must be able to establish the essentials of an arm’s length agreement.  Yet notwithstanding specific direction on how to determine an arm’s length price, having and following a written agreement, some companies do NOT follow the basic requirements to have this type of strategy successfully implemented.

In Aspro Inc. v. Commissioner, 2021 TCM 8, is a recently decided case where a corporation deducted “management fees” paid indirectly to its shareholders through their personally owned corporations.  The Court did not rule that management fees paid to a related party shareholder is not deductible, but did rule on the underlying factors to analyze if a deductible fee is paid to a related party, versus a non- deductible dividend. ( Aspro was a $23,000,000 year company)

Let us look at some of the essential factors.

Aspro Inc. had three shareholders who had management fees paid to their individually owned corporations in approximately the same percentage as their ownership in Aspro.

No dividends were ever paid from Aspro.

There was not a written management agreement setting the terms of engaging the management team, nor structured fees for what services would be performed and at what price.

Invoices were not submitted by each of the individually owned corporations for the services rendered.

Management fees were paid after the year end, in lump sums, rather than as services were performed.

Miraculously the management fees appeared to zero out the corporate income each year.

Aspro could not explain how the management fees were determined and bargained for.

Aspro’s president conceded that he was performing only services as Aspro’s president and could not determine what his company did to earn management fees.

The court determined that the payments were not ordinary and necessary and were also not reasonable pursuant to IRC § 162(a)(1) and Treas. Reg. § 1.162-7(a).

Aspro did not use an expert witness to justify any payments made to is shareholders corporations, nor the reasonableness of such costs and fees.  Yet the IRS did use an expert to allege such payments were not reasonable, ordinary or necessary.

Aspro was a large enough company where the cost of compliance was not a major component of this failure to adhere to the basic context of what is needed to be successful on a related party management transaction.  But size of course is not the determining factor.

Lets look at an older case with similar results.

WILEY M. ELICK DDS, INC. V. CIR, No. 13-73071 (9th Cir. 2016).

Dr. Elick with a professional’s advice set up a management company to manage his dental practice as well as an ESOP.  As we are addressing usage of a related C Corporation for management of a related party company we will not address any of the ESOP issues. After denial of the deductions at the tax court level, an appeal was heard in the 9th circuit court of appeals.

The court initially had to determine whether the management fees were ordinary and necessary business expenses within IRC §162.  Per the Court

Tax deductions are a matter of legislative grace, and taxpayers must satisfy the specific statutory requirements for the item claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Generally, a taxpayer may deduct ordinary and necessary business expenses paid or incurred during the taxable year in carrying on a trade or business. Sec. 162(a). Whether an expense satisfies section 162 is generally a question of fact. Commissioner v. Heininger, 320 U.S. 467, 475 (1943).

An expense is ordinary if it is customary or usual within a particular trade, business or industry or relates to a common or frequent transaction in the type of business involved. Deputy v. du Pont, 308 U.S. 488, 495 (1940). A necessary expense is appropriate and helpful to the operation of the taxpayer’s trade or business. See Commissioner v. Tellier, 383 U.S. 687, 689 (1966); Carbine v. Commissioner, 83 T.C. 356, 363 (1984), aff’d, 777 F.2d 662 (11th Cir. 1985).

The court has in some cases allowed the deduction of management fees, but looks closely at the reasonableness factor in related party cases. Fuhrman v. Commissioner, T.C. Memo. 2011-236.

The Commissioner contends that the management fees were unnecessary because SDG, the management company, did not provide any management services. Dr. Elick offered no documentation reflecting that SDG performed any services, even though the corporation agreed to provide various services that were never demonstrated it received, Further, Dr. Elick acknowledged that third parties provided services SDG was to provide and never provided any contemporaneous records corroborating it received any services whatsoever. The Dr. did provide the written management agreement, but a written contract does not demonstrate the services were actually performed.  Additionally the written agreement was not followed in most areas, such as invoicing monthly.  In fact SDG did not follow the terms of the agreement.

The only alleged performance was by the Dr.’s bookkeeper who performed the exact same services before and after the contractual agreement.  In fact the court held that Dr. Elick did not prove that his management company, SDG, performed any services. Some services were performed by petitioner’s employees or third parties, not the management company.

The payments to the management company of almost three quarters of a million dollars, (actually $733,000) were held to not have been rendered, were not ordinary and necessary and that there was no correlation between the management fees, and the services purportedly performed.

Again with related parties closer scrutiny of the transaction will mean that the taxpayer should have third party, arm’s length quotes to perform the same or similar services.  The agreement should be in writing, followed and the services must be performed.  Additionally if the contract requires monthly invoicing, invoice monthly!  If you have a written contract, and you should, you MUST follow the contract and perform the services at issue, priced at a third party cost.

Richard M. Colombik, J.D., C.P.A., is an honors graduate from the University of Illinois, Chicago Law School, as well as a licensed C.P.A. He has been a member and has chaired Bar Association Taxation Committees on a national, local and state basis, as well as being the former liaison to the Commissioner of the Internal Revenue Service.   His law firm emphasizes income tax planning for closely held businesses and their owners, tax defense, and asset protection.  He has published over 120 articles and has taught in excess of 100 seminars on business, estate, income tax  and asset protection  planning issues.  Mr. Colombik has been a member of the American Bar Association captive insurance subcommittee as well as the asset protection committee.  He is  an author of the best-selling book on small business tax planning, “Keep It” with Chauncey Hutter and honored as a Lawyer of Distinction.  He can be reached at or by phone at 630-250-5700 or