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Elmer v. Indiana Department of State Revenue

Tax Court of Indiana

January 4, 2018

PAUL J. ELMER and CAROL A. N. ELMER, Petitioners,




          FISHER, Senior Judge.

         Paul J. Elmer and Carol A. N. Elmer have challenged the Indiana Department of State Revenue's assessments of Indiana adjusted gross income tax (AGIT) for the 2005 through 2008 tax years (the "years at issue"). The issue for the Court to decide is whether the Elmers established that two of Mr. Elmer's businesses were entitled to certain expense deductions. Upon review, the Court finds that they did not.


         The Elmers, a married couple of 37 years, live in Fishers, Indiana. (Trial Tr. at 11-12.) Mr. Elmer is a licensed pharmacist. (Trial Tr. at 12-13.) He began his career at a hospital in Kentucky, but when he discovered that job was "not what [he] wanted to do[, ]" he obtained a new job at Hook's Drugs Stores. (Trial Tr. at 13.) After leaving Hook's, Mr. Elmer managed a friend's long-term care pharmacy and, then, the friend's mail order pharmacy. (See Trial Tr. at 13-15.) Mr. Elmer subsequently "took [a] leap of faith" and started his own pharmacy-related businesses. (See Trial Tr. at 12-13, 15.) Two of these businesses, both S-Corporations, are involved in this matter: Pharmakon Long Term Care Pharmacy, Inc. (f/k/a Liberty Express Scripts, Inc.) and Hamilton Consulting Group, Inc. (See Trial Tr. at 7; Confd'l Am. Stipulated Facts & Exs. ("Stip.") ¶¶ 2-3.)

         Pharmakon was established in February of 2003. (Trial Tr. at 15.) Initially, the business operated a mail order pharmacy, with four employees in the basement of a building owned by Mr. Elmer's friend. (See Trial Tr. at 15-17.) As the business developed, it transitioned into an institutional pharmacy that sold prescription drugs and medical supplies primarily to long-term care facilities (e.g., psychiatric facilities, assisted-living facilities, and nursing homes) and their patients. (See Stip. ¶ 11; Trial Tr. at 15-16, 24-25.) During the years at issue, Pharmakon served as the primary pharmacy[2] for 41 long-term care facilities that were operated by affiliates of Magnolia Health Systems, Inc., several separate businesses (i.e., Magnolia and the Magnolia affiliates) owned primarily by a long-time acquaintance of Mr. Elmer, Stuart Reed. (See Stip. ¶ 12, Confd'l Ex. 10, Confd'l Ex. 19 at Pet'rs' Ex. 2 ¶¶ 4-6; Trial Tr. at 25-26.)

         Messrs. Elmer and Reed, representing Pharmakon, Magnolia, and the Magnolia affiliates, conducted business with little formality, meeting periodically to "talk through things and . . . agree on how [they] were going to do [things.]" (See Trial Tr. at 27-28; Stip., Confd'l Ex. 19 at 21.) Accordingly, unless specifically mandated by law, the two did not memorialize the contours of their business relationships with written contracts. (See, e.g., Trial Tr. at 27 ("I would call him, but it was never where I would have a contract saying[, ] 'In this contract you have to do this, ' no, that's not the way I do business").) Beginning in 2007, some of Pharmakon's customers, including many of the Magnolia affiliates, failed to pay Pharmakon for amounts invoiced. (See, e.g., Stip., Confd'l Exs. 12-12(11).) By the end of 2008, those uncollected amounts totaled approximately $650, 000. (See Trial Tr. at 49-50; Stip., Confd'l Exs. 12-12(b), Confd'l Ex. 19 at Pet'rs' Ex. 2 ¶¶ 6-8.) At some point, the companies stopped doing business together, but it is not clear when their business relationship was terminated. (See Trial Tr. at 27.)

         Hamilton was established a year after Pharmakon in 2004 to expand Pharmakon's footprint within the pharmaceutical industry. (See Stip. ¶ 3; Trial Tr. at 35, 37-39.) During the years at issue, Hamilton's business address was at Mr. Elmer's residence and it had no employees. (See Trial Tr. at 56.) Hamilton (via Mr. Elmer) initially conducted a few educational seminars on behalf of different pharmaceutical companies to introduce pharmacists to new products and treatments for certain ailments. (See Trial Tr. at 35-37.) Once those opportunities "fizzle[d] out[, ]" Hamilton (again via Mr. Elmer) verbally agreed to coordinate the provision of certain respiratory care services to long-term care facilities for Pharmakon. (See Trial Tr. at 36-38, 56-57; Stip. ¶ 14.) At that time, Pharmakon had at least one "account" with a non-Magnolia affiliated nursing home and employed at least one respiratory therapist to provide the services. (See Trial Tr. at 37-38.) When Mr. Elmer determined that his customer base prevented Pharmakon from employing respiratory therapists any longer, he sought out the advice of Mr. Reed. (See Trial Tr. at 37-38, 43-44.) Messrs. Elmer and Reed verbally agreed that: 1) Augusta Corporation, another of Mr. Reed's companies, would provide licensed respiratory therapists to administer the respiratory care services; 2) Augusta would order all medications and supplies used to provide its services from Pharmakon; and 3) Hamilton would continue to coordinate the provision of all those services on behalf of Pharmakon. (See, e.g., Trial Tr. at 38-45, 57-58; Stip. ¶ 17.) Thereafter, Hamilton also began to provide similar services to Magnolia-affiliated long-term care facilities. (See Trial Tr. at 40-41.)

         Throughout the 2005 through 2007 tax years, Pharmakon was Hamilton's only customer. (See Trial Tr. at 40-41; Stip., Confd'l Ex. 2 at 7.) Pharmakon paid Hamilton approximately $9 million for "contract labor" services during all the years at issue, and Hamilton, in turn, paid Augusta about $7 million for "consulting" services. (See Stip. ¶¶ 14, 20-21, Confd'l Ex. 1 at 7-8, Confd'l Ex. 2 at 8, 11, Confd'l Ex. 11; Trial Tr. at 48-49.)

         The Department subsequently audited Pharmakon and Hamilton for the years at issue. (See Stip. ¶ 5, Confd'l Exs. 1-2.) On September 15, 2010, the Department issued separate Audit Summary Reports to Pharmakon and Hamilton that disallowed some of their expense deductions because the Elmers had not demonstrated that the requirements for deductibility were met. (See Stip. ¶¶ 5-6, Confd'l Ex. 1 at 6-10, Confd'l Ex. 2 at 6-10.) Specifically, Pharmakon's Audit Summary Report stated that the Department disallowed: 1) contract labor expenses of about $9 million; 2) car allowance and vehicle depreciation expenses totaling over $50, 000; and 3) uncollectible debt expenses of about $650, 000. (See Stip. ¶¶ 14, 26-28, Confd'l Ex. 1 at 7-10.) In contrast, Hamilton's Audit Summary Report provided that the Department disallowed: 1) consulting expenses of about $7 million; 2) vehicle expenses of about $9, 000; 3) a management fee of approximately $700, 000; and 4) a variety of other expenses (e.g., depreciation, contract labor, meals/entertainment, office equipment/supplies, and dry cleaning) that totaled over $100, 000. (See Stip. ¶¶ 20-24, Confd'l Ex. 2 at 7-11, Confd'l Ex. 11.)

         On December 17, 2010, the Department issued Proposed Assessments to the Elmers imposing over $400, 000 of additional AGIT, interest, and penalties for the years at issue. (See Stip. ¶ 7, Confd'l Exs. 3-7.) See also Riverboat Dev., Inc. v. Indiana Dep't of State Revenue, 881 N.E.2d 107, 109 n.4 (Ind. Tax Ct. 2008) (explaining that the income and losses of an S-Corporation are passed through to its owners (i.e., shareholders) who, in turn, report their pro-rata shares on their individual tax returns), review denied. On April 19, 2011, the Elmers protested the Proposed Assessments, and on August 31, 2011, the Department issued a Letter of Findings that ultimately denied their protest. (See Stip. ¶¶ 8-9, Confd'l Exs. 8-9.) See also Elmer v. Indiana Dep't of State Revenue, 42 N.E.3d 185, 188 n.2 (Ind. Tax Ct. 2015).

         On October 25, 2011, the Elmers initiated this original tax appeal. On January 23, 2017, after the Department's motion for summary judgment was denied, (see generally id.), the Elmers' appeal proceeded to trial. The Court heard oral ...

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