Advisory Opinions

Whether pass-through income paid by a Subchapter-S corporation to an individual who is a registered compensated lobbyist for that corporation must be reported as compensation for lobbying by the corporation, based on the amount of time spent lobbying by that compensated lobbyist?

Indiana Lobby Registration Commission

(Vote to ratify FAO taken at public meeting of February 6, 2001)

Vote to Ratify FAO:

Chairman Abbs - absent
Vice-Chairman Krahulik - yes
Commissioner Bepko - yes
Commissioner Heeke - yes

Questions and written comments may be directed to Indiana Lobby Registration Commission, 10 W Market St, Ste 1760, Indianapolis, IN 46204
(317) 232-9860

Summary of Decision:
Pass-through income paid to a corporate officer by a Subchapter-S corporation is a reportable lobbying expenditure when the officer lobbies on behalf of the corporation, even though the pass-through income may be provided to the officer as a shareholder. The amount of pass-through income which is to be reported as a lobbying expenditure depends upon the amount of time spent lobbying and also upon whether the corporate officer receives a reasonable salary, as per the IRS definition.

The facts which brought rise to this advisory opinion are that a Subchapter S corporation, which is a registered lobbyist, employs a non-paid corporate officer. This non-paid corporate officer receives pass-through income by virtue of his standing as a corporate shareholder. He also performs lobbying services on behalf of the corporation. Those lobbying services include lobbying the Indiana General Assembly.

A "lobbyist means any person who (1) engages in lobbying; and (2) in any registration year, receives or expends an aggregate of five hundred dollars ($500) in compensation or expenditures reportable under this article for lobbying, whether the compensation or expenditures is solely for lobbying or the lobbying is incidental to the individual's regular employment." IC 2-7-1-10. "Compensation" means anything of value given as payment for doing or refraining from doing any activity. IC 2-7-1-2. The idea of "compensation", therefore, is clearly not restricted under the statute to mean only salary or payment for services.

"Payment" means a payment, compensation, reimbursement, distribution, transfer, loan, advance, conveyance, deposit, gift, pledge, subscription, or other rendering of money, property, services, or anything else of value, whether tangible or intangible, and any contract, agreement, promise, or other obligation, whether or not legally enforceable, to make a payment." I.C. 2-7-1-11.

A threshold issue is whether the agreement between the corporate officer and the corporation for lobbying services triggers a registration duty on behalf of the corporate officer. The Commission has determined that a contract to lobby is sufficient to trigger a duty to register. FAO 97-03. However, the "compensation" paid on the contract is not reportable on a lobbyist's activity report until actually made. FAO 97-03. Hence, the duty to register as a lobbyist may sometimes be different than a duty to report actual expenditures / compensation.
1999 Commentary of the Lobby Law, p. 7

The next question is whether the pass-through income received by the corporate officer is to be reported as lobbying income on a time-prorated basis. For purposes of the lobby disclosure statute, a stock is considered "anything of value." 1999 Commentary of the Lobby Law, p. 12. To the extent a stock is given in consideration for lobbying services, the value of the stock is reported as a lobbying expenditure.

The fact that a corporation is a registered lobbyist does not mean that all of its employees are lobbyists. Persons who work at influencing legislative action on behalf of the corporation are lobbyists, but the corporation's other employees who do not engage in lobbying are not lobbyists. (Informal Commission Decision: November, 1996); Comment 55, 1999 Commentary of the Lobby Law.

An employee who lobbies on behalf of an employer is a lobbyist, to the extent the employee receives greater than $500 in compensation. FAO 98-02. In determining whether an employee has met the $500 threshold, one must consider such payments as employee and fringe benefits. FAO 97-04. Comment 56, 1999 Commentary of the Lobby Law

It has been previously determined by the Commission that when an officer of a company hosts a meeting with legislators to discuss and explain the complex issues in a bill and to answer questions, that officer is engaged in lobbying, and the company and the officer must register if the $500 threshold is met. (Staff decision: September 1995; FAO 98-02).

Similarly, a chairman/president of an organization, who writes letters or calls legislators to support or protest legislation which affects that organization, is lobbying and must register if the $500 threshold is met. The $500 includes the prorated amount of any regular salary s/he receives during the time spent writing or calling.

Likewise, it was determined by the Commission in June, 1998, that when lobbying activities are conducted through an incorporated entity, expenditures must be reported when several persons join together in a common enterprise for the purpose of lobbying through the incorporated entity and when the incorporated entity has no employees. The Commissioners agreed that the incorporated entity must register both as a compensated and as an employer lobbyist. Those persons/entities who form to place, collectively, greater than $500 attributable to lobbying into the incorporated entity which conducts the lobbying must register as employer lobbyists. By analogy, this created a precedent wherein lobbying services were performed but not paid for by the lobbying entity and a reporting obligation was triggered for the corporation and for those individuals doing the lobbying.

By other analogy, under the federal tax law, S corporations are generally exempt from income taxation and the net earnings of the corporation are attributed to the individual shareholders for income tax purposes. The shareholders are then not required to pay income tax when these earnings are distributed as dividends on the corporation's stock. Because compensation paid to employees is subject to social security and federal unemployment taxes, shareholder-employees of S corporations have an incentive to enter into arrangements with their corporations under which money paid to the shareholders by the corporation is characterized as dividends on their stock rather than compensation for services.

The IRS has a long-standing position that amounts paid to a shareholder of an S corporation as dividends in lieu of reasonable compensation for services performed for the corporation are really wages paid to an employee for services and therefore subject to FICA tax. See Rev. Rul. 74-44, 1974-1 C.B. 287. The Service's position has been upheld by the courts. For example, in Joseph Radtke, S.C. v. United States, 895 F.2d 1196 (7th Cir. 1990), a lawyer who was the sole shareholder of a subchapter S professional corporation was paid $18,225 in dividends in 1982, but nothing for the services he performed for the corporation that year. The court upheld a determination by the Service that these payments were actually wages paid for services and therefore subject to FICA and FUTA taxes.

Radtke was followed by the Ninth Circuit in Spicer Accounting, Inc. v. United States, 918 F.2d 90 (9th Cir. 1990), which involved an accountant who was the president, treasurer, and director of an S corporation owned 50% each by him and his wife. He did not have a formal employment agreement with the corporation and was not paid a salary as such. Instead, he purportedly donated his services to the corporation and, in his capacity as a stockholder, withdrew earnings in the form of dividends. Siding with the IRS, the court concluded: AMr. Spicer clearly performed substantial services for [the corporation], and accordingly, these >dividends' were in reality remuneration for employment and therefore subject to FICA and FUTA.@

The foregoing demonstrates that there is precedent for treating dividends paid to S corporation shareholders as compensation for services if the shareholders do not otherwise receive reasonable compensation for services performed for the corporation. An important factor for non-family owned corporations may be whether the amount distributed to the shareholder performing services is disproportionately larger than distributions to the other shareholders. Even if the distributions are proportionate to stock ownership, however, there is some precedent for treating dividends as compensation for services if no other compensation was paid. See Dunn & Clark, P.A. v. Commissioner, 853 F. Supp. 365 (D. Idaho 1994), aff'd, 57 F.3d 1076 (1995) (unpublished opinion) (dividends paid to attorneys practicing through an S corporation recharacterized as wages).

This issue generally hasn't arisen in connection with partnerships because partners are subject to different rules with respect to social security taxes. Partners are ordinarily not considered to be employees of their partnerships for income tax purposes, Rev. Rul. 69-184, 1969-1 C.B. 256, but they are subject to the tax on self-employment income under IRC ' 1401. General partners must include both guaranteed payments for services and their distributive shares of partnership income from any trade or business carried on by the partnership, in their net earnings from self-employment under IRC ' 1402(a). Thus, it doesn't matter for purposes of this tax whether a general partner who performs services in connection with a partnership's business is paid a guaranteed amount or simply given a share of the partnership's net income.

In the case of a limited partner, however, IRC ' 1402(a)(13) provides that the partner's share of partnership income is not subject to the tax on self-employment income except to the extent the partner receives a guaranteed payment for services rendered to the partnership. At the time this rule was enacted, it applied only to limited partners in a limited partnership. With the advent of limited liability companies (LLCs), which are treated like partnerships for tax purposes, there is currently uncertainty about whether members in these organizations should be viewed as limited partners or general partners. If a member performs services for his LLC and is properly viewed as a limited partner, then the issue could arise whether some or all of the member's share of income is actually compensation for services.

In this regard, IRC ' 707(a)(2)(A) provides that allocations of income and distributions to a partner who performs services for a partnership may be treated as if it were a payment by the partnership to someone who is not a partner if Athe allocation and distribution, when viewed together, are properly [so] characterized. . . .@ The legislative history of this provision indicates that one of the most important factors in determining whether a partner is receiving an income allocation and distribution in his capacity as a partner is whether the amount of the payment is subject to the entrepreneurial risks of the business. Thus, the IRS could take the position that part or all of a limited partner's share of partnership income is really compensation for personal services, particularly where the amount of the payment is essentially fixed.

The corporation which provides a non-paid corporate officer with pass-through shareholder income from a Subchapter S corporation should report a portion of the pass-through income as a lobbying expense. The formula which should be applied is: [percentage of time spent lobbying] x [IRS definition of income imputed onto a non-paid corporate officer who receives shareholder income].