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IF YOU INCORPORATE YOUR BUSINESS, USE THE CORPORATE CHECKBOOK
October 25, 2007
If you have a business, run it like a business. A sad Tax Court case yesterday shows how expensive being casual with your business records can be.
John Meyer is an Orange, California engineer and software developer. He started a corporation called Pacific Payment Systems, a C corporation, to develop and market a bar-code based billing software. He worked full time on the project in 2002, when he spent $47,521 in business expenses out of his own pocket, which he deducted on his schedule C. That turns out to be a false move.
The Tax Court explained that if the business is the corporation's business, the expenses for the business can only be deducted by the corporation:
Consequently, a shareholder is not entitled to a deduction for the payment of corporate expenses. Deputy v. du Pont, 308 U.S. 488, 494 (1940). Rather, the corporate expenditures that were not reimbursed constitute capital contributions and increase the cost basis of the shareholder's stock to the extent that they can be substantiated. See Ward v. Commissioner, 20 T.C. 332, 334 (1953), affd. 224 F.2d 547 (9th Cir. 1955).
Had Mr. Meyer paid the expenses out of the corporation's bank account, the corporation would have been entitled to the deduction to offset its own income. If Mr. Meyer wanted the benefit of the deductions on his 1040, he should have made an S corporation election and paid the expenses out of the corporation account. By paying the expenses personally, the deductions here are just wasted.
The moral? If you incorporate your business, run it like a business. The corporation pays the corporations bills. And if you want to deduct corporate expenses on your own return, file a timely Form 2553 to elect to be an S corporation
Cite: Meyer T.C. Summary Opinion 2007-181
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Comments
There is another option, too: have an accountable reimbursement plan. The owner can pay expenses out of pocket, "turn in receipts" to the company, and get reimbursed.
Posted by: Ryan Ellis | October 25, 2007 1:59 PM
Ryan, that's an excellent point. By having the company reimburse documented expenses, they get to the company checkbook and are clearly deductible on the corporate return.
Posted by: Joe Kristan | October 25, 2007 8:05 PM
Not to lead people astray, the reimbursement plan may run into snags on things like home office expenses, car expenses, per diems, 50% of entertainment rules, etc. The bottom line is that the tax rules must be followed, and will often limit how much can be legally reimbursed to the owner.
However, once that's done, you can feel free to set up an accountable plan. Personally, I put everything on my personal credit card (getting the frequent flier miles), and reimburse myself for the expenses. You can do all of this in Excel, even.
Posted by: Ryan Ellis | October 26, 2007 9:41 AM