Self-Charged Fees Produce Taxable Income - Brief Article

California CPA, July, 2001 by Stuart R. Josephs

David Hillman owned substantially all the stock of an S corporation that charged real estate management fees to approximately 90 other passthrough entities involved in real estate rental activities. Hillman also owned interests in these other entities. He materially participated in the corporation's management activities but did not participate in the entities' activities.

Hillman included his share of the corporation's nonpassive fee income in his gross income. He then offset this income by his share of the entities' passive fee expenses.

The IRS disallowed the offset, which the Tax Court overruled. In April, the Fourth Circuit Court of Appeals, reversed the Tax Court and sustained the IRS--even though Hillman essentially paid these fees to himself.

In contrast, Prop. Regs. Sec. 1.469-7 allows self-charged interest expense to be offset against the corresponding interest income.