Doc Gale was an optometrist, whose practice, between slow-pay insurance reimbursements and internet competition, was going south. He did pay employees first, rent second, and himself third. We all did that when we owned businesses. And, like us, Doc Gale definitely paid FICA/FUTA/ITW ahead of everyone else.

But he wrote checks to himself and Mrs. Doc Gale for the wages they would have gotten, based on the withholdings, except he didn’t sign some of the checks or cash any, signed or unsigned. And his business, which was a C Corp, deducted the amount of the unsigned and uncashed checks.

IRS allowed the C Corp’s deduction, hitting Doc Gale for those amounts as unreported income. Except Doc Gale never got the money.

This is a natural case for Judge Mark V. Holmes. And he deals with it in an off-the-bencher, Gale Stead, Docket No. 15925-21, filed 6/26/24.

The statutes are ambiguous, and the caselaw mostly involves solvent C Corps and their owners. While Doc Gale’s operation isn’t shown to be insolvent, cashing those checks might just put it there.

Judge Holmes takes a novel tack. Unfortunately, once again the Genius Baristas have made it impossible for me to cut-and-paste the language.

In short, there is no obligation from the C Corp to Doc Gale, no employment contract, declared dividend, or self-rental. But what would happen if a receiver, or bankruptcy trustee, or lien creditor succeeded to Doc Gale’s rights? Could they just sign and cash the checks for any amount? No, but they could cash the signed checks.

So Doc Gale has income to the extent of FICA/FUTA/ITW which the C Corp paid for him, and for any checks signed but uncashed. Unsigned, uncashed checks, no, not income.

Rule 155 to sort this all out.

Taishoff says this is the right emotional result. Fortunately, IRS can’t appeal, because if the C Corp was solvent when the unsigned checks were drawn, IRS could argue there was income and an immediate, nondeductible capital contribution. And I bet IRS would so argue in a similar case that is not a small-claimer.