Berry v. Commissioner: S corporation income attribution and §6662 penalty
Berry v. Commissioner, T.C. Memo. 2025-109, No. 10634-20., 2025 BL 376377, Court Opinion
The Tax Court held that Andrew Berry was a 50% shareholder of an S corporation in 2016 and must include his pro rata share of the corporation’s unreported income. It sustained an accuracy-related penalty subject to Rule 155 computations.
Holding
The court found that Andrew Berry owned 50% of Phoenix Construction & Remodeling, Inc. (PCR) in 2016 and must include his share of PCR’s income on Schedule E regardless of distributions.
The court sustained the IRS determinations that PCR had unreported gross receipts from customer payments, diverted receipts, and bank deposits attributed to PCR.
The court excluded petitioners’ late-produced exhibits under the Standing Pretrial Order, admitted a limited counter-exhibit under Federal Rule of Evidence 106, and concluded that the §6662 penalty applies, subject to computation.
Why It Matters
Confirms that S corporation shareholders must report pro rata income based on beneficial ownership, not officer status or distributions.
Reinforces substantiation standards for excluding deposits as loan repayments and offsetting gross receipts with costs.
Highlights consequences for violating pretrial exchange rules and the court’s discretion to exclude late or altered documents.
Clarifies that the IRS may defend against whipsaw by taking inconsistent protective positions where the same income could otherwise escape taxation.
Timeline
February 14, 2020: IRS issues notice of deficiency for 2016.
Before the trial, the IRS conceded portions of business-expense disallowances and unreported receipts; the petitioners conceded the remaining disputed Schedule C amounts.
October 21, 2025: Tax Court issues memorandum opinion after trial.
Posttrial: Court admits a limited government exhibit under Rule 106 and enters a decision under Rule 155.
Key Facts
Petitioners: Andrew and Sara Berry, California residents; pro se.
Entities: PCR (S corp. construction business), Castle Construction and Merrill & Associates Real Estate (Schedule C), Three B’s Development, LLC.
Ownership: In 2016, Andrew and Ronald Berry each owned 50% of PCR; Andrew was an authorized bank signer and worked on PCR projects.
Unreported receipts at issue:
$74,382 paid by the Canchola clients to a motorhome manufacturer rather than to PCR pursuant to a PCR change order.
$21,008 cash received from the Stroud clients for PCR change orders.
$59,000 in bank deposits, including $58,000 from Three B’s and $1,000 from the Switzers.
Returns filed: PCR filed a 2016 Form 1120-S and issued a Schedule K-1 showing Andrew as a 50% shareholder; petitioners reported a matching PCR loss on Schedule E.
Penalty approval: Supervisory approval for §6662 penalty documented on February 8, 2019.
Statutory or Regulatory Framework
Section 1366 requires S corporation shareholders to include their pro rata shares of the corporation’s income, loss, deductions, and credits. Beneficial ownership controls for income attribution. Section 6662 imposes a 20% penalty for substantial understatements and negligence or disregard of rules. Section 6751(b)(1) requires timely written supervisory approval for penalties. The Commissioner must provide an evidentiary foundation linking taxpayers to unreported income; taxpayers bear the burden to rebut determinations and to substantiate claimed offsets and loans.
Arguments
Taxpayers argued:
Andrew was removed as a PCR officer in March 2016 and should not be taxed on PCR income.
Deposits from Three B’s were repayments of a 2015 loan to PCR.
The $74,382 diverted payment and $21,008 cash were not PCR income or were offset by costs.
Income should not be attributed to them due to the potential whipsaw with Ronald and Linda Berry’s case.
Various late-produced documents supported these positions.
Government argued:
Andrew remained a 50% shareholder throughout 2016 and received a Schedule K-1, which is beneficial ownership controls.
The Three B’s deposits lacked evidence of a bona fide loan and should be treated as income.
The Canchola diversion and Stroud cash payments were PCR receipts.
Petitioners did not substantiate offsets or costs of goods sold.
Penalty approval complied with §6751(b)(1) and the understatement or negligence criteria were met.
Late or altered documents should be excluded under the Standing Pretrial Order.
Court’s Reasoning
Shareholder status: Even if true, officer removal did not alter Andrew’s beneficial ownership. The K-1 and petitioners’ own Schedule E loss reporting confirmed his 50% ownership for 2016.
Evidentiary foundation: The IRS linked the unreported items to PCR through ledgers, bank records, invoices, emails, and client change orders, satisfying the Ninth Circuit threshold for unreported income cases.
Deposits from Three B’s: Petitioners failed to prove a bona fide loan. The proffered document was untimely and, even if considered, showed no interest, repayment schedule, or balance-sheet reporting consistent with a loan. The deposits were included in income.
Diverted Canchola payment: The payment arose from PCR services and was taxable to PCR under the assignment-of-income doctrine, regardless of diversion to a third party for a motorhome. No credible evidence established a loan to Ronald or an offsetting expense.
Stroud cash: Emails and change orders showed the payments related to PCR work. Petitioners did not prove otherwise or substantiate any offset.
Pretrial compliance: Petitioners’ night-before and day-of-trial production violated the 14-day exchange rule, prejudiced the IRS, and contained inconsistencies and alterations. The court excluded untimely exhibits, admitted limited material under Rule 106 to provide completeness, and gave diminished weight to altered invoices even when admitted.
Whipsaw: The petitioners provided incomplete materials and did not establish that Ronald and Linda had already been taxed on the income. The whipsaw defense failed.
Penalty: The IRS met its burden of production, including §6751(b)(1) approval. Petitioners neither disputed the penalty nor showed reasonable cause. The penalty applies if the Rule 155 computation shows a qualifying understatement, and alternatively, for negligence given recordkeeping failures.
Forward-Looking Implications
S corporation owners should confirm year-end beneficial ownership and ensure K-1 reporting aligns with substance to avoid attribution disputes.
Payments rerouted to third parties remain gross receipts to the service provider if tied to earned income; diversion does not change the earner.
Deposits labeled “loan repayments” require contemporaneous loan documents, commercial terms, and consistent financial-statement reporting.
Strict adherence to pretrial exchange deadlines is critical; late or altered documents risk exclusion and reduced evidentiary weight.
Practitioners should document supervisory approval timing for penalties and evaluate reasonable-cause defenses early.
Result
Decision will be entered under Rule 155 sustaining the IRS’s determinations on shareholder attribution, unreported income, and the §6662 penalty, with amounts to be computed.
The Takeaway
Ownership drives S corporation income inclusion. Without credible substantiation for loan treatment or offsets, deposits and rerouted payments tied to the corporation’s work are income, and penalties follow when records and procedures fall short.
List of Citations
Helvering v. Horst, 311 U.S. 112: Assignment of income principle applied to diverted customer payment.
Weimerskirch v. Commissioner, 596 F.2d 358: Evidentiary foundation requirement for unreported income.
Hardy v. Commissioner, 181 F.3d 1002: Ninth Circuit standard for linking taxpayer to unreported income.
Walker v. Commissioner, 544 F.2d 419; Hoffman v. Commissioner, 47 T.C. 218: Beneficial ownership governs shareholder income attribution.
Dunne v. Commissioner, T.C. Memo. 2008-63: Shareholders include pro rata S corporation income regardless of distribution.
Berry v. Commissioner, T.C. Memo. 2018-143; Berry v. Commissioner, T.C. Memo. 2021-52: Recordkeeping, substantiation, and COGS principles; negligence under §6662.
Frost v. Commissioner, 154 T.C. 23: Supervisory approval requirement under §6751(b)(1).
Maggie Mgmt. Co. v. Commissioner, 108 T.C. 430; Powell v. Commissioner, 91 T.C. 673; Holdner v. Commissioner, T.C. Memo. 2010-175: Whipsaw context and the Commissioner’s ability to take protective inconsistent positions.
Lucas v. Commissioner, 58 T.C. 1022; Schulz v. Commissioner, 294 F.2d 52: Strong proof rule for timing of stock ownership transfer relative to stated agreement date.