Disguised Distributions and Management Fees: Aspro Revisited

Jun 23, 2022

This month we follow up on the appeal of a Tax Court decision that we first examined in October 2021.¹ In Aspro, the taxpayer challenged the IRS’s determination that the “management fees” it paid were not deductible because they were disguised corporate distributions of profits. Our initial analysis focused on the pending appeal by the Eighth Circuit Court,² which, on April 26, released its opinion, upholding the Tax Court’s decision.³ This is the first time a case we have examined in Blue J Predicts has been decided by an appellate court since we began the column in mid-2021.

So we now consider the Eighth Circuit’s concerns with Aspro’s management fee arrangements. While the Eighth Circuit did not rule on whether the expenses were ordinary and necessary and proceeded directly to considering whether the expenses were reasonable and payment for services, our examination suggests that there is a significant overlap between the factors that drive the ordinary and necessary analysis and the reasonable compensation analysis in determining the deductibility of business expenses. Our review demonstrates that the taxpayer would have benefited from considering all the factors identified by Blue J’s algorithm at the tax-planning stage.

Although we did not render a prediction in our previous Aspro column on the deductibility of the expenses in dispute, we did examine how machine learning could be used to assess the likelihood of whether the payments in question were ordinary and necessary expenses. Recall that a payment must not only be (1) ordinary and necessary to be deductible, but must also be (2) reasonable and purely for services (that is, the payment cannot be found to be a disguised distribution of profits). The Tax Court denied the deduction of all the management fee payments — holding that the payments made to corporate shareholders were not ordinary, necessary, and reasonable — while payments made to the individual shareholder satisfied the ordinary and necessary test, but were not reasonable.

1 Benjamin Alarie and Christopher Yan, “Would Management Fees by Any Other Name Still Be Deductible?” Tax Notes Federal, Oct. 25, 2021, p. 499.

2 Aspro Inc. v. CommissionerT.C. Memo. 2021-8.