Taxing Lessons From Court Decisions

Decisions — Adopting the corporate form

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Image source: Free Picture: Business TeamID: 284202© Dawn Hudson Dreamstime Stock Photos
Image source: Free Picture: Business TeamID: 284202© Dawn Hudson Dreamstime Stock Photos

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When you incorporate your business, the corporation is a separate taxable entity and you’re generally not allowed to claim the corporation’s expenses on your personal tax return. That’s true even if the corporation does not keep account books or records, maintain separate bank accounts or credit cards, or own any assets. A business you incorporate under state law is treated as a corporation for federal tax purposes unless it is a sham or unreal.

In T.C. Memo. 2015-174 (Rochlani), the taxpayer started a sole proprietorship to buy and resell sporting, concert, and other tickets. That same year (2006), the taxpayer’s minor son incorporated the business using an online service without the taxpayer’s knowledge or permission. When the taxpayer learned of the incorporation, the taxpayer began filing corporate annual reports with the appropriate state agency as required.

During 2008 and 2009, the taxpayer traveled to various locations around the country to buy and resell sporting, concert, and other tickets. During the same period, he worked full time as an engineer. The taxpayer used personal credit cards to make all purchases related to the business because the business did not have a credit card. All business expenses were paid from, and business income was deposited into, the taxpayer’s personal bank accounts. The company had its own bank account for business expenses, but the taxpayer closed the account because he never used it.

The taxpayer prepared and timely filed his personal income tax returns for 2008 and 2009. He attached Schedule C, Profit or Loss From Business, to each return and identified the principal business as “Sell Goods” in 2008 and “Sell Goods and Tickets” in 2009.

The taxpayer reported Schedule C losses of $41,610 for 2008 and $44,066 for 2009. The reported business expenses included: business use of home, supplies, office expenses, legal and professional expenses, advertising, travel, car and truck expenses, other expenses, contract labor, depreciation and section 179, and commissions and fees. The taxpayer did not keep logs or calendars for travel-related expenses or other expenses. He retained credit card statements that he later used to reconstruct those expenses.

The IRS agreed the business was organized to buy and resell sporting, concert, and other event tickets and that it had a bona fide business purpose. However, the IRS adjusted the taxpayer’s returns to reflect removal of the Schedules C, saying the business was a corporation for federal income tax purposes.

The taxpayer said he was not bound by his minor son’s unauthorized act of registering the business as a corporation. In addition, the taxpayer said the incorporation should be disregarded because he did not maintain separate corporate books or accounts.

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions. The full case may include facts and issues not presented here. Please use the link provided in the post to read the entire case.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!
For the IRS.

The evidence is clear that the taxpayer’s minor son was not authorized or instructed by the taxpayer to register the business as a corporation. But upon learning that it had been registered, the taxpayer did nothing to undo what his son had done. In fact, the taxpayer ratified his son’s act.

Under Michigan law, unauthorized acts may be ratified explicitly or implicitly. And the unauthorized acts of an agent are ratified if the principal accepts those acts with knowledge of the material facts. While the son’s act of incorporating the business was unauthorized, the taxpayer thereafter respected, at least in part, the corporate form by filing annual reports with the appropriate state department. In doing so, he recognized and ratified the corporate form.

The taxpayer points us to the failure to maintain corporate books or accounts. The Supreme Court addressed the significance of such facts in Moline Props. Inc., where the court determined that the corporate existence could not be ignored as merely fictitious even though the corporation “kept no books and maintained no bank account during its existence and owned no other [significant] assets.”

Because the business was a corporation, the taxpayer is not entitled to deduct losses from the business on his personal 2008 and 2009 returns. The taxpayer’s ratification and adoption of the corporate form requires the acceptance of its tax disadvantages.

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