Supporting Management Fees Charged by Affiliates

Supporting Management Fees Charged by Affiliates

The IRS recently won a decision that should be reviewed by all companies that charge management fees to affiliates (Fuhrman v. Commissioner of Internal Revenue Service, U. S. Tax. Ct., Sep. 29, 2011, TC Memo 2011-236).

Legal Case for Supporting Management Fees

The taxpayer owned a trucking business through a group of affiliated entities. It charged management fees to those affiliates. There was no written contract among the entities and there was no documentation of how the management fee was calculated. The IRS questioned whether the management fee was properly deducted as an ordinary and necessary business expense.

The Court sided with the Internal Revenue Service. The burden of proof for substantiating the amount and purpose of management fees is on the taxpayer. The Court stated that the documetnation should include “credible evidence” that the expenses are ordinary and necessary business expenses.

What should you take away from this? Management fees should be supported by a written agreement between the entities. Moreover, the calculation of the management fee should be supported by a robust analysis of the expenses related to providing the services used by the affiliates.

Although not addressed in this decision, the IRS could also raise other issues related to management fees between affiliates. Those issues could include supporting corporate earnings and profits if a subsidiary leaves a consolidated group, separate return loss year net operating losses, and the appropriate tax basis of a subsidiary or partnership. Also consider the impact on state income tax audits.

As always, please contact us if you have any questions regarding this update or need assistance in analyzing your position.