Entities and the Performance of Personal Services: Berry

Owners of legal entities typically establish those entities to achieve certain planning goals, be them tax, asset protection, contract management, or other reasons. Key to accomplishing those goals is that courts respect the entity planning structure that is established. In the recent Tax Court opinion of Berry v. Commissioner[1], we see a taxpayer who intended to operate his race car driving operation through an S corporation. By not having sufficient evidence to prove that his car racing activities were performed by his S corporation, the Tax Court saw those activities as being individually performed. The result is that Mr. Berry was personally liable for 100% of the income from those activities rather than dividing that income with the other 50% S corporation shareholder, his father.

Facts and Law

The facts of this case are straight forward. Andrew Berry and his father, Ronald Berry, were equal shareholders of Phoenix Construction and Remodeling, Inc. (“Phoenix”) which was taxed as an S corporation. The primary business activity of Phoenix was construction in San Louis Obisbo, California. Additionally, Andrew entered drag racing tournaments. Andrew assigned his income from tournaments to Phoenix and Phoenix paid his racing expenses.

Two of the issues identified for resolution by the court were whether: (1) car racing income should be reallocated from Phoenix to Andrew; and (2) Phoenix is entitled to deduct expenses of Andrew’s car racing activities. In addressing deductions, the court cited to certain standard legal principles:

  • “Deductions are a matter of legislative grace, and a taxpayer must prove his or her entitlement to a deduction.”[2]
  • “A taxpayer claiming a deduction on a Federal income tax return must demonstrate that the deduction is allowable pursuant to a statutory provision and must further substantiate that the expense to which the deduction relates has been incurred.”[3]
  • “A taxpayer may not determine the nature of his or her income merely by using a particular form, or by labeling it as he or she wishes, but must report his or her income according to the economic realities of the situation.”[4]

To support his position that income from racing was properly allocable to Phoenix, and not Andrew personally, Andrew testified that Phoenix paid his race entry fees, he raced under the name “Berry Racing” which was on shirts worn by his crew and described his team as a “family drag racing team” on Facebook. Notwithstanding this testimony, the Tax Court found there was insufficient evidence to prove that car racing was part of Phoenix’ business. Specifically, the Tax Court stated “because income earned by petitioner husband as a race car driver is not income derived from Phoenix’s business of remodeling and construction, it cannot be included in Phoenix’s gross receipts.”

Although not the subject of this writing, the Tax Court also addressed the IRS’ denial of a number of deductions taken by Phoenix, including for Andrew’s car racing. In each instance, the Tax Court agreed with IRS. The problem for Andrew was that he produced insufficient evidence, other than his own testimony (some of which contrasted with evidence produced by the IRS) to substantiate the expenses and/or the purpose for the expense. Once again, a taxpayer’s inadequate records cost them valuable deductions.[5]


As stated above, taxpayers generally create planning structures and take tax positions to accomplish their particular planning goals. Failing to properly operate that structure, to properly document the structure, and to maintain adequate records is often a taxpayer’s undoing. That certainly appears to be the case here. And, as cited above, has been the subject of another recent case involving deductibility of expenses.[6]

There are several cases specific to S corporations where similar issues have been present. I have previously written about some of these[7], stating:

  • In Smith, the Court addressed whether certain payments made to an S corporation should be allocated directly to the shareholders rather than the S corporation. The shareholders alleged that services they performed were on behalf of their 100% owned S corporation. Invoices were on the S corporation’s letterhead and most payments were by checks made out to the S corporation. Also, at least one service recipient issued a 1099-MISC to the corporation. However, the Tax Court noted that: (1) no employment agreement existed between the S corporation and the shareholders (which was specifically contemplated in the bylaws); (2) the S corporation’s return did not show any compensation paid to the shareholders; (3) there was nothing showing that the service recipients intended to hire the S corporation versus the shareholders individually; and (4) although checks were written to the S corporation they all were deposited directly in the taxpayers’ bank account. In the end, the taxpayers lost largely due to failure to properly deposit payments into the S corporation’s account and to produce adequate documentation at trial.[8]
  • In a case out of the Rhode Island U.S. District Court, the Court sustained the IRS’ denial of a personal-injury attorney’s expense deductions following admission of a new partner to his law firm. Mr. Morowitz formed his firm in 1999, electing taxation as an S corporation. In 2009, he admitted a second partner. Expenses and fees for preexisting clients were to remain with Morowitz. However, they did little to effectuate this agreement. The clients did not sign a new engagement letter with Morowitz, certain client fees were paid by the firm, client funds were deposited into the firm’s trust account, etc. Morowitz filed a personal income tax return claiming personal deductions for expenses related to preexisting clients. The IRS denied his deductions claiming they belonged to the firm and had to be handled pro rata between Morowitz and his partner per the requirement that S corporation tax items be handled pro rata. All that appears to have been needed was for Morowitz and his partner was to properly plan for, document, and act in conformity with their intentions. Once again, while they were not the only factors, depositing funds into the wrong account and failure to provide substantiating evidence at trial was the taxpayer’s undoing.[9]
  • In Meruelo[10], involving S corporation basis, the court stuck the taxpayer with the form of the transactions as he documented those transactions – brother-sister loans rather than deemed distributions to the shareholder by one entity followed a loan creating basis to the other. Although end of the year reconciliations corrected the intended treatment for bookkeeping purposes, the Court relied on records contemporaneous with the transactions and how the funds actually flowed.

In each of these cases, the issue was whether the structure purported by the taxpayer would prevail. While the tax issues were different in each case, the overarching question in each related to respecting the form of the entity structure and/or transactions within that entity structure. Clearly, given that taxpayers choose the form of transactions they use and are in control of whatever documentation and substantiation they keep, they will be held to a high standard to produce affirmative evidence which proves what they purport (usually other than self-serving testimony which is not otherwise substantiated).


There is nothing especially unique about the Berry case. Further, the written opinion reads like many other opinions. However, understanding the issues raised in Berry and other, similar cases can be an important step in understanding what taxpayers should do to ensure respect for the entity and transactional structures they intend. Once again in Berry, as in hundreds (if not thousands) of Tax Court cases, substantiation is where the taxpayer lost. As lawyers, we routinely recommend to our clients that they analyze the most beneficial structure and fully document transactions effectuating that structure. Cases like Berry, the other cases referenced in this writing, and many others, prove that recommendation to be valuable.

[1] Berry v. Comm’r, TC Memo 2021-52

[2] Citing INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992) and New colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934)

[3] Citing IRC § 6001 and Hradesky v. Comm’r, 65 T.C. 87, 89-90 (1975)

[4] Citing Walker v. Comm’r, 101 T.C. 537, 544 (1993)

[5] For discussion of a recent case involving similar lack of substantiation, see Charles J. Allen, “Insult to Injury – Properly Documenting and Taking Bad-Luck Deductions,” May 13, 2021, https://esapllc.com/baum-2021/

[6] Id.

[7] See S. Gray Edmondson, “Higher Scrutiny for Tax Professionals: In re Benavides,” Sept. 24, 2019, https://esapllc.com/in-re-benavides/ and “Substance Over Form: No Friend of the Taxpayer,” Jan. 15, 2020, https://esapllc.com/messina9thcir/

[8] Discussing Smith v. Comm’r, TC Memo 2018-170

[9] Discussing Morowitz v. U.S. 2019 WL 1077284 (D. Rhode Island 2019)

[10] Meruelo v. Comm’r, 923 F.3d 938 (11th Cir. 2019)


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