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Morowitz v. United States Government

United States District Court, D. Rhode Island

March 7, 2019



          John J. McConncll, Jr., United States District Judge.

         Defendant, the United States Government ("Government"), filed a motion for summary judgement on Plaintiff David Morowitz's ("Mr. Morowitz") claim for recovery on Internal Revenue Service ("IRS") tax and claim for recovery on penalties erroneously assessed and collected, ECF No. 7. Mr. Morowitz filed an objection to the motion for summary judgement and the Government filed a reply. ECF No. 16. At issue for this Court is whether Mr. Morowitz is entitled to a reimbursement of the assessment of taxes, penalties, and fees when the IRS disallowed filed deductions on his individual tax return.

         I. BACKGROUND

         Mr. Morowitz filed articles of incorporation with the Office of the Rhode Island Secretary of State and incorporated the Law Office of David Morowitz as an "S" Corporation in 1999. ECF No. 8 at 1. Mr. Morowitz was the sole shareholder of that corporation at the time of incorporation. Id. As standard practice for an "S" Corporation, Mr. Morowitz filed a Form 1120S, U.S. Income Tax Return for an S Corporation ("Form 1120S"), to report its taxes. Id. Ail income and expenses of the corporation were reported on the Form 1120S until 2009 when Mr. Morowitz brought in a new shareholder. Id. at 2. At that time, Mr. Morowitz changed the name of the corporation to Morowitz & Barry, Ltd. Id. When Mr, Morowitz amended the name of the corporation, he did not dissolve the original corporation, amend its corporate structure, or change its Federal Employer Identification No. ("EIN"). Id. Instead, the corporation continued to operate under its amended name throughout the 2010 income tax year. Id.

         In conjunction with Mr. Morowitz amending the name of the corporation, he entered into a Shareholder Agreement (the "Agreement") with Patrick Barry to whom 50 shares of stock were issued. ECF No. 13 at 2-3. In that agreement, Mr. Morowitz and Mr. Barry agreed to segregate "[f]ees earned and monies paid on Mr. Morowitz's pre-existing cases," and those fees or monies earned would not belong to Morowitz & Barry, Ltd. Id. The retainers for the pre-existing clients, however, were executed through the Law Office of David Morowitz, Ltd., prior to the Agreement. ECF No. 12 at 1. Mr. Morowitz concedes that, when the corporation amended its name, the preexisting clients did not sign a new retainer agreement with Morowitz & Barry, Ltd., nor does Mr. Morowitz offer that the pre-existing clients signed a new retainer agreement with him individually. Id.

         On his 2010 individual income tax return, however, Mr. Morowitz filed a Schedule C (Form 1040) claiming deductions for expenses relating to those pre-existing cases. ECF No. 8 at 3-4. The deductions include "case costs" in the amount of $9, 997 and $2, 137, each paid out of the corporation's bank account. Id. Additionally, Mr. Morowitz claimed a deduction for $15, 000 that he paid, out of pocket, to the corporation's legal secretaries for work performed on a pre-existing case. Id. The IRS disallowed each of these deductions


         "Summary judgment is appropriate where 'the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law.'" Rivera-Fhres v. Bristol-Myers Squibb Caribbean, 112 F.3d 9, 13 (1st Cir. 1997) (quoting Fed. R. Civ. Pro. 56). The substantive law identifies the facts that are material and "[o]nly disputes over facts that might affect the outcome of the suit under the governing law will properly preclude the entry of summary judgment." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). In a refund action under 26 U.S.C. § 7422(a), the complaining taxpayer bears the burden of proving that the challenged IRS tax assessment was erroneous. Webb v. IRS, 15 F.3d 203, 205 (1st Cir. 1994). As such, the taxpayer who seeks a refund has the burden of proving: his right to a deduction; the amount of the deduction; and, as the nonmoving party, definite and competent evidence to survive summary judgment. Great N. Nekoosa v. United States, 711 F.2d 473, 475 (1st Cir. 2009); see also Webb, 15 F.3d at 205 (citing Bonilla-Aviles v. Southmark San Juan, Inc., 992 F.2d 391, 393 (1st Cir.1993)).

         III. ANALYSIS

         A. Mr. Morowitz was Never a Sole Proprietor and not Entitled to Take Personal Deductions from Payments Associated with the Corporation.

         Mr. Morowitz argues that he is entitled to the deductions because the payments on the preexisting cases were not related to the corporation but, instead, were from a separate business operation that he classifies as a sole proprietorship. ECF No. 12 at 3. In so arguing, Mr. Morowitz identifies the steps he took to separate this business from the corporation. Mr. Morowitz states that, though there was no formal dissolution of his corporation prior to the name change, there was a withdrawal of all funds, an insertion of new funds, new stock issued to an additional stockholder, and an additional officer was added to the corporation. Id. at 4. However, though Mr. Morowitz claims those fees and monies belong to him personally, and not the corporation, he admits that the funds were deposited into, and paid from, the corporation's IOLTA account. Id. at 7. Further, Mr. Morowitz admits that that the clients of the pre-existing cases signed retainer agreements solely with his corporation. Id. at 1, Essentially, Mr. Morowitz offers that, "although technically not a new entity for purposes of registering with the Secretary of State, the intent was the start of a new firm." /rf. at 11.

         This Court is mindful of the intentions of Mr. Morowitz. However, a corporation exists for tax purposes if formed for a business purpose or if it carries on business after incorporation. Motive Props. V. Comm'r., 319 U.S. 436, 238-39 (1943). The choice of the advantages of incorporation to do business require the acceptance of the tax advantages and disadvantages. Id.; see Burnet v. Commonwealth Imp. Co., 287 U.S. 415, 419-20 (1932). While a taxpayer is free to organize her business as she chooses, once having done so, she must accept the tax consequences of her choice, whether contemplated or not, and may not enjoy the benefit of some other route she might have chosen to follow but did not. Comm V v. Nat 7 Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149(1974).

         Mr. Morowitz chose to incorporate the Law Office of David Morowitz, Ltd., and elected to file with the IRS as an "S" corporation. ECF No. 8 at 1. "S" corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. When the shareholders of a corporation make a Subchapter S election, they switch from a multiple-level taxation system to a flow-through taxation system under which income is subjected to only one level of taxation. Gitlitz v. Comm'r, 531 U.S. 206, 209 (2001). The corporation's profits and losses pass through directly to its shareholders on a pro rata basis and are reported on the shareholders' individual tax returns allowing "S" Corporations to avoid double taxation on its corporate income. Id. The IRS requires "S" Corporations to file a Form 1120S to report its income, gains, deductions, and credits. S Corporation, IRS,

         Since incorporation, Mr. Morowitz has properly filed a Form 1120S to report the corporation's income, gains, deductions, and credits. ECF No. 8 at 2, Mr. Morowitz, in 2009, added a shareholder, amended the name of the corporation, and continued to file a Form 1120S Form with the same BIN. Id. In 2010, however, Mr. Morowitz filed a Schedule C (Form 1040) claiming deductions from pre-existing case costs stemming from clients retained through the Law Office of David Morowitz, Ltd. Id. at 3-4. In filing a Schedule C (Form 1040), Mr. Morowitz attempted to report income or loss stemming from a business operated, or a profession practiced, as a sole proprietor. A sole ...

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