## Facts

- David E. Watson, P.C. (DEWPC) was an Iowa professional corporation that elected S-corporation tax status.
- David Watson was DEWPC’s sole officer, shareholder, director, and employee; DEWPC held a 25% partnership interest in an accounting firm (LWBJ).
- Watson performed accounting services full time (about 35–45 hours per week), and DEWPC’s income stemmed from his services provided through LWBJ.
- In 2002 and 2003, DEWPC reported paying Watson $24,000 per year as wages.
- In the same years, Watson received large amounts labeled as profit distributions (approximately $203,651 in 2002 and $175,470 in 2003).
- The IRS determined DEWPC underpaid FICA taxes by treating amounts that were remuneration for Watson’s services as distributions rather than wages.
- At a bench trial, the government presented expert testimony on reasonable compensation, estimating Watson’s market compensation at $91,044 per year using compensation surveys and adjustments for ownership/benefits.
- The district court found $91,044 to be reasonable wages for each year and entered judgment for unpaid FICA tax, penalties, and interest; DEWPC appealed.

## Issues

1. Whether the district court abused its discretion under Federal Rule of Evidence 702 and *Daubert* by admitting the government’s expert testimony on reasonable compensation.
2. Whether the district court applied the correct legal standard and clearly erred in finding $91,044 of payments in each of 2002 and 2003 were wages subject to FICA, despite being labeled largely as distributions.

## Decision

- The Eighth Circuit affirmed the judgment against DEWPC.
- The court held the district court did not abuse its discretion in admitting the government’s expert testimony; alleged methodological weaknesses affected weight, not admissibility.
- The court held the district court applied the correct legal standard for FICA wages and did not clearly err in setting Watson’s FICA wages at $91,044 per year for 2002 and 2003.

## Legal Principles

- For FICA purposes, “wages” broadly include all remuneration for employment; labels used by the parties (e.g., dividends, distributions, loan repayments) are not controlling.
- The proper inquiry is whether payments to a shareholder-employee are, in substance, compensation for services performed.
- A taxpayer’s asserted intent to keep wages low does not control wage characterization when the economic reality shows remuneration for services.
- Reasonable-compensation determinations are fact-intensive; appellate review generally defers to the trial court’s findings absent clear error.
- Expert testimony on reasonable compensation may be based on compensation surveys and appropriate adjustments, and challenges to calculations often go to evidentiary weight rather than admissibility.

## Conclusion

The court upheld reallocating a substantial portion of an S-corporation shareholder-employee’s distributions to wages subject to FICA because the reported salary was unreasonably low relative to the services performed and the business income generated by those services.


David E. Watson, P.C. v. United States, 668 F.3d 1008 (8th Cir. 2012)