Tax News

CCH (cch.taxgroup.com) reports:

  An individual acting as a branch manager and a member of a broker-dealer company's branch office servicing day traders could deduct as ordinary and necessary business expenses commission rate adjustments paid to his brother's limited liability company (LLC). The taxpayer negotiated the commission rate adjustments with all the customers, including his brother's LLC, which was the branch office's biggest customer, at arm's-length to keep the customers when they complained of the untimeliness of the broker-dealer company's commission rebates. It was a common practice in the day trading industry to lower commissions to attract and retain customers, and the broker-dealer company offered commission rebates to customers upon requests by branch managers. Whether the taxpayer or the broker-dealer company paid the commission rebates did not change the economics. Because the commission rate adjustments were expenses that would be expected of someone trying to increase and maintain business in the highly competitive world of day trading and were appropriate and helpful to keep customers trading through the branch office, they qualified as ordinary and necessary business expenses.

  The court rejected the IRS's alternative argument that the commission rate adjustments were illegal payments under Code Sec. 162(c)(2) made in violation of federal law implemented by NASD Rule 2110. The payments were not commission-sharing payments made in return for referrals of business, and the IRS failed to show that they would be classified as such by the NASD or that the payments would result in the taxpayer's being subject to a civil or criminal penalty or losing his license. Such payments were also not illegal per se since the IRS could not cite any statute or regulation specifically prohibiting them.

  The IRS's argument that the taxpayer's payments to his brother's LLC lacked economic substance since they were returned to the taxpayer in later years was also rejected since the later payments represented repayment of a principal and interest on a loan extended by the taxpayer to the LLC and a share of the LLC's profits made in the years when the taxpayer became responsible for operating and maintaining a new trading software at the LLC. The IRS also could not establish that the commission rate adjustment arrangement was not an arm's-length arrangement. These payments were necessary and legitimate business expenses, indistinguishable from those made to unrelated parties, and resulted in net commissions to the LLC comparable to those the LLC could have negotiated directly with the broker-dealer company or any other broker-dealer.

  Further, the taxpayer did not have to include in gross income trading gains generated from a subaccount with his brother's LLC since he had no ownership interest in, or rights to, the subaccount and never received any funds from the subaccount. The taxpayer did not have an agreement with the LLC giving him rights to a share of the subaccount gains while traders who were entitled to subaccount gains had written agreements with the LLC setting the terms of the profit splits and also received Schedules K-1 reflecting their portions of the subaccount gains. The subaccount belonged to the LLC and all the gains generated in the subaccount were ultimately passed to the taxpayer's brother.

  Since all of the taxpayer's records were accurate and thorough, except for two commission rate adjustments that were mistakenly deducted in the tax year at issue even though they were not, in fact, paid until the following year, the taxpayer was not liable for the accuracy-related penalty for negligence under Code Sec. 6662(a).

J.T. Manning, TC Memo. 2009-157, Dec. 57,876(M)

Other References:

 
Code Sec. 61

  CCH Reference - 2009FED ¶5504.198

  CCH Reference - 2009FED ¶5504.20

 
Code Sec. 162

  CCH Reference - 2009FED ¶8520.517

  CCH Reference - 2009FED ¶8858.01

 
Code Sec. 6662

  CCH Reference - 2009FED ¶39,651G.31

  Tax Research Consultant

  CCH Reference - TR INDIV: 6,050

CCH Reference - TRC BUSEXP: 3,100
CCH Reference - TRC PENALTY: 3,106