What the Indictment of ‘The Situation’ Tells Us About the Tax Code

Somehow, the most shocking thing about the indictment of Michael Sorrentino for tax fraud is not that the “Jersey Shore” star may have been less than punctilious about paying the taxman. After all, Mr. Sorrentino, known as “The Situation,” has never projected the levelheaded public image you’d associate with careful income tax compliance. (Here is a video in which he slams his head into a wall. Here is the 911 call from when he was in a brawl at a tanning salon).

The first surprising thing is that over a four-year period from the start of 2010, Mr. Sorrentino and his brother Marc are said, in the United States District Court indictment, to have earned $8.9 million. Not bad for a reality show personality whose main talent seems to be maintaining impressive abdominal muscles.

The second surprising thing is what the case shows about a basic fairness problem in the tax code. Mr. Sorrentino did plenty of things to avoid taxes that were perfectly legal, showing how those with the resources to hire accountants and lawyers can end up with lower tax bills than people with a regular job.

Mr. Sorrentino and his brother funneled their income from nightclub appearances and other sources (“a partnership interest in a vodka company, ownership of an online clothing business, publication of an autobiography and a comic book featuring defendant MICHAEL SORRENTINO as a superhero, and endorsements of products such as vitamins, DVDs, clothing lines, jewelry, tuxedos, and sunglasses”) into two corporate entities they controlled, M.P.S. Entertainment L.L.C. and Situation Nation Inc.

But that’s not what they got in trouble for. Many rich, and even not-so-rich, people funnel their income through a corporate entity. Essentially, from the tax code’s point of view, Mr. Sorrentino was the C.E.O. of an entertainment-and-endorsement company. It brought in money from his various ventures, paid expenses tied to fulfilling those ventures, and paid out the rest to him and his brother as income.

Both were pass-through entities under I.R.S. rules, meaning that they didn’t incur any tax obligations of their own, but rather passed their profits on to their owners, who then owed tax as personal income.

But it’s obvious where that creates opportunity for tax avoidance. If the corporate entities were to pay for things for Mr. Sorrentino that were not legitimate business-related expenditures, but rather just paying for Mr. Sorrentino’s living expenses, it would essentially allow him to avoid taxes on that portion of his income entirely.

And that is what the prosecutors allege happened. They say that he and his brother engaged in a conspiracy to pay for personal items, including luxury vehicles, designer clothing and “personal grooming expenses,” from the corporate entities, and to hide those purchases from their accountants. (The indictment does not specify whether that grooming includes tanning salons, but it seems a reasonable guess the answer is “yes.”)

What makes this a broader story about tax policy is that, while tax law aims to be black-and-white about what constitutes a deductible expense for people like the Sorrentinos who manage their affairs through corporate entities, in practice there are shades of gray.

Suppose you are a well-compensated strategy consultant and you run your income through an entity like the one the Sorrentinos used. You have a big dinner with a bunch of college buddies who all work in the corporate world. Good luck to the I.R.S. trying to prove that that was a personal meal rather than a good-faith effort to build relationships with potential clients.