Glass Warehouse: Owners’ “Subcontractor” Fees on Top of W-2 Wages Were Not Deductible Without Proof

Can a corporation deduct “subcontractor” fees it paid its own owners on top of their W-2 wages? In Glass Warehouse, LLC v. Commissioner, T.C. Memo. 2026-111 (Nov. 2, 2026), the Tax Court said not on this record: the company offered no evidence of what separate services those payments bought, so it could not deduct the $118,302 the IRS disallowed for 2019, $109,819 of which it said went to the owners. The court also sustained a 2018 accuracy-related penalty, holding that a return signed by an outside CPA firm did not by itself show reasonable cause.

Judge Fung wrote this memorandum opinion, decided on the trial record. Absent a stipulation otherwise, an appeal would go to the Ninth Circuit.

Two owners, two kinds of pay

Glass Warehouse is a closely held C corporation, based in San Diego, that sells glass shower doors and enclosures through third-party retail platforms. It had $4.1 million in gross receipts for its tax year ended June 30, 2019 (the opinion’s “2019”). Its two shareholder-officers, Ryan Thatcher (80%) and Nidal Hanna (20%), were married to each other and ran the business full time, handling sales, inventory buying, staff and customers.

For 2019 the company issued Forms W-2 showing wages of $92,712 to Mr. Thatcher and $73,962 to Ms. Hanna. It also deducted $173,974 in subcontractor fees. That figure, the court said, presumably included $109,819 that the owners themselves reported as subcontractor fees: $98,774 for Mr. Thatcher and $11,045 for Ms. Hanna. The company issued neither of them a Form 1099 for those amounts. On their joint return, the owners reported the $109,819 as “Other income” and paid employment taxes on it.

The IRS notice, issued August 18, 2022, disallowed $118,302 of that deduction for lack of substantiation and determined accuracy-related penalties for both years. After the parties settled every other 2018 issue and the IRS conceded the 2019 penalty, two questions remained: the 2019 deduction and the 2018 penalty.

The corporation carried the burden

A notice of deficiency is generally presumed correct, and the company had to prove the deduction with records showing the nature, amount and purpose of the expense. It said testimony, accounting records and a payee statement did that, but at trial it offered none of them showing subcontractor services in 2019, so the burden stayed with the company.

No evidence of separate subcontractor services

Section 162(a)(1) allows a reasonable allowance for compensation for services “actually rendered.” The IRS conceded that the amounts were reasonable and had disallowed the deduction only for lack of substantiation. Because the company failed to substantiate it, the court did not need to decide whether the payments were meant as compensation.

The company’s only witness was its accounting manager, Mallory Copeland. Her description of Mr. Thatcher’s work was his ordinary management role: “manag[ing] every aspect of the company, customers, inventory buying, all of it.” She offered nothing specific about Ms. Hanna’s services, saw neither owner do anything beyond day-to-day operations, and knew of no subcontractor agreement with either one. By contrast, when she had issued Forms 1099 to other workers, she knew what subcontractor work they had done. The W-2 wages, the court observed, presumably already paid for the work she described.

The court accepted that a corporation may structure its pay as it likes, including extra payments to officers for additional services actually performed. Its problem was proof: “The record does not contain any documents or any testimony showing that such an arrangement existed.” Glass Warehouse “failed to produce any business records, payroll records, contracts, invoices, Forms 1099, or other reliable documents in support of its position.” The company never addressed the remaining $8,483 of the $118,302, and the court found that amount unsubstantiated as well.

The IRS also argued that the payments were disguised dividends, citing ledger entries that reclassified shareholder distributions as contract labor. The court did not rely on those entries. It noted that the payments closely tracked the owners’ ownership percentages but could draw only a limited inference, and said, “We express no view on the proper characterization of the payments.”

The owners’ own return did not prove the deduction

Glass Warehouse argued that the owners’ reporting of the $109,819, with employment tax paid, proved its deduction. The court disagreed: “How a shareholder reports an item on a personal tax return does not control how the corporation reports that same item on its own tax return,” because a corporation is generally a taxpayer separate from its shareholders. The owners’ tax position had no bearing on the corporation’s deduction.

A worker-misclassification argument under section 3509 also failed: that section sets employment-tax liability, not deductions, and there was no evidence either owner was misclassified.

The 2018 penalty: a named CPA was not reasonable cause

The penalty concerned 2018, not the 2019 owner payments: the IRS had conceded the 2019 penalty, and the 2018 tax was recomputed from the parties’ settlement of the other 2018 issues. The tax shown on the 2018 return was $92,775; the tax required to be shown was $107,775. The resulting understatement exceeded both 10% of the correct tax and $10,000, so it was substantial under section 6662(d)(1)(B), the rule for C corporations.

Two procedural points mattered. First, section 7491(c), which puts the burden of producing penalty evidence on the IRS, applies only to individuals, so the IRS had no such burden against a corporation. Second, a penalty approval form signed by the immediate supervisor before the notice issued was in evidence; the company did not contest section 6751(b), and the court agreed it was met.

That left reasonable cause, which the company had to prove. Its brief asserted reliance on the qualified adviser named in the return’s signature block. But no witness testified about any interaction with the preparer, Ahuja & Clark; there was no evidence that the company gave the firm the relevant facts, that the firm gave any advice, or that the company relied on it in good faith. Statements in briefs are not evidence. In the court’s words, “Simply hiring a tax preparer does not insulate a taxpayer from the consequences of the tax positions on its return.” The court sustained the 20% penalty on the substantial-understatement ground and did not reach the IRS’s alternative negligence ground.

Result and what it means

The court held that Glass Warehouse may not deduct $118,302 in subcontractor expenses for 2019 and is liable for the 2018 accuracy-related penalty. Decision will be entered under Rule 155, meaning the parties will compute the final amounts from the court’s rulings and the settled issues.

Our reading: the case turned on a missing record, not on a rule against paying owners both wages and fees. A closely held company that pays an owner-officer beyond W-2 wages should be able to show what extra work was done, under what arrangement, at what price, and how it was reported, through documents and a witness with first-hand knowledge. The owner’s personal return will not fill that gap. And when a penalty is at stake, a corporation should expect to prove what it told its preparer and what advice it received. For the practical side of documenting owner payments, see our guide for owners paid on both a W-2 and a 1099.