I am looking at a tax case.
It reminds me of something.
There is a too-common belief that paying an expense
through a business can somehow transmute an otherwise personal expenditure into
a tax deduction.
Here are common ways I have heard the question:
(1) My spouse is going to replace her car. Should
we buy it through the business?
(2) I run my business from my home. That makes my
home a “headquarters,” right? Can’t I deduct all the expenses related to my
business headquarters?
(3) I am going to borrow money to [go on
vacation/pay college tuition/buy a boat I’ve been wanting]. Should I have the
business borrow the money to make it deductible?
Do not misunderstand, many times there is a more
tax-efficient way to accomplish something. There may still be some tax though,
and the goal is to minimize the tax. Making it disappear may not be an option, at least for a responsible practitioner.
Let’s look at the above questions.
(1) Realistically,
if there is no business use of the vehicle, you are not allowed to deduct any
of the ownership or operating expenses of a vehicle. Despite that, does it
happen routinely? Of course. Practitioners do what they can, but it is like
fighting the tide.
(2) I consider this quackery, but it is a true
story. No, working from home does not make your house fully deductible. You
might get a home office deduction out of it, but that is a fraction of some – and
not all – expenses. No, your house is not Proctor and Gamble. Get over it.
(3) This
one might have traction, but in general the answer is no. Even if the interest
is deductible, how is the company getting you the money? Is it going to lend it
to you? If so, you will have to pay interest to the company, although you may
be able to arbitrage the rate. Will the company bonus you the money? If so, I
see FICA and income taxes in your future. Explain to me the win condition here.
Let’s look at Justin Maderia (JM).
JM lived in Florida and owned 50% of Lindy Inc
(Lindy).
Lindy must be a C corporation, which is the type that
pays its own taxes. I say this because the Court refers to earnings and profits
(E&P), which is a C corporation concept. The purpose of E&P is to track
a corporation’s ability to pay dividends. When it pays dividends, a corporation
is sharing its accumulated profits with its shareholders. The corporation has
already paid taxes on these profits (remember: a C corporation pays taxes).
When it pays dividends, you are personally taxed on that previously taxed
profit. This is the reason for “qualified dividends” in the tax Code: to cut
you a break on that second round of taxation.
The IRS was looking at JM’s 2018 personal return. It
was also looking at Lindy’s 2018 business return.
COMMENT: It is not unusual to include a closely held company with the audit of an individual tax return.
The IRS wanted to increase JM’s 2018 income by $192
grand of “stuff” that Lindy paid on his behalf.
COMMENT: Sounds to me like Lindy was paying for EVERYTHING.
Let’s talk procedure here.
The IRS identified personal transactions in Lindy.
Lindy was the type of corporation that could pay dividends, and the IRS
argument was – to the extent Lindy paid for personal stuff – that such payments
represented constructive dividends to JM.
Fair. Consider that the serve.
JM gets to return.
He would argue that the payments were not personal
because … well, who knows why.
JM did nothing.
Huh?
JM did nothing because he had a previous audit, and
the IRS never pursued the issue of Lindy payments. JM believed he was
immunized.
Mind you, there is a kernel of truth here, but JM has
googled the concept beyond all recognition.
IF the IRS looks at an issue AND makes no change to
your tax return for that issue, you can challenge a later proposed assessment
based on that same issue. You might not win, mind you, but you have grounds for
the challenge.
Is this what happened to JM?
Let’s look at it.
The IRS examined his prior year return.
Score one for JM.
The IRS never looked at Lindy.
We are done.
There is no immunity. JM cannot challenge a proposed 2018 assessment on an
issue the IRS did not examine in a prior year.
JM had to return on different grounds. He did not. He - procedurally speaking - automatically lost.
JM had $192 grand of additional income.
The IRS next wanted the accuracy-related penalty.
Well, of course they did. If they were any more
predictable, we could just put it on a calendar.
The Court said “no” to the penalty.
Why?
Because the IRS had looked at JM’s previous return.
The IRS either did not bring up or dismissed the Lindy issue, so JM kept
reporting the same way. While this would not protect him from a challenge of additional
income, it did provide a “reasonable basis” defense against penalties.
Our case this time was Maderia v Commissioner,
T.C. Summary 2024-5.
