In Hardy v. Commissioner, an important, recently decided tax case, the Tax Court found that the share of income received by a doctor due to his ownership in a surgery center may not be subject to self-employment tax.
Dr. Hardy was a plastic surgeon specializing in pediatric reconstructive surgery. He bought a minority interest in a surgery center run through an LLC. The opinion in the case held that he did not have self-employment income on his share of the center’s income.
It found that Hardy had no meaningful non-surgery related service responsibilities with the surgery center and never managed it, having no day-to-day responsibilities there. He did not have any input into management decisions such as who to hire or fire.
While Hardy performed some of his surgeries at the surgery center, he had no obligation to do so. The opinion mentions that patients pay surgeons directly for their surgery procedures. They pay the surgical facility separately for the use of its facilities. An important fact in the case was that the nature of Hardy’s interest was more like that of a passive investor, with Hardy’s share of the LLC income related to the fees patients paid for the use of the centers. His cut was not directly tied to surgeries that he performed and he had no management duties and responsibilities at the surgery center.
The LLC income was due to Hardy independent of any services or surgical procedures he chose to perform at the center: He did not have any minimum surgery requirement to receive his distribution.
The Court found therefore that the LLC income he made was not subject to self-employment tax:
Keep in mind, however, that when the income seems more connected to the services that the members of an LLC perform, it is treated as self-employment income. In this regard, the Court distinguished Hardy from the 2011 Tax Court case Renkenmeyer v. Commissioner, involving partners in a law firm. In that case, the Tax Court concluded that because the “revenue was derived from legal services performed by the partners in their capacity as partners, they were not acting as investors in the law firm.” In Hardy, the Court said that unlike the lawyers “practicing law and receiving distributive shares based on those fees from practicing law, Dr. Hardy is receiving a distribution based on the fees that patients pay to use the facility.”
Hardy will now be used as precedent in cases involving self-employment tax, particularly in those whose members’ income is tied to a capital investment, rather than services the members respectively perform.
Nawrocki Smith LLP
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Melville, New York 11747
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