September 21, 2020
No shareholders, no S corporation, no losses. One big attraction of setting up a corporate business as an S corporation is the possibility of deducting business losses on a personal tax return. For a new business, S corporation start-up losses can generate tax savings right away by reducing their shareholders' taxes. "C" corporations, which pay their own taxes, can't deduct early losses until they generate their own income to absorb the losses.
But what happens if there are no shareholders? The Tax Court faced that unusual question last week with respect the president of a Kentucky non-profit corporation, Waterfront Fashion Week, Inc. The corporation's articles of incorporation provide:
This Organization shall be a nonprofit corporation organized for all lawful charitable purposes. The primary mission of the Organization is to raise money for the conservation and maintenance of the Waterfront Park located in Louisville, Kentucky, to provide economic development opportunities for various local, regional, and national fashion industry designers, to provide a platform for women to embrace their own personal styles and explore new style avenues, and to enhance the quality of life and the economic vitality, all in partnership with government and private business concerns.
These are apparently expensive goals, expenses that exceeded income by up to $280,000 in the first two years. Maybe it seemed a shame to waste all of those potential deductions. The corporation president signed and filed a late S corporation election on October 28, 2014 "retroactively as of the date of its incorporation, May 8, 2012," and claiming to own 100% of the stock. The president then filed late S corporation and personal returns claiming about $280,000 in tax losses from the corporation.
Alert readers may have already spotted some problems. S corporation elections are due 2 1/2 months into the year for which the election is meant to be effective, so the election was late. But Tax Court Judge Thornton notes some more fundamental problems:
As a Kentucky nonstock, nonprofit corporation subject to the provisions of the Act, Waterfront had no stock and could issue no stock. Consequently, petitioner does not fall within the four corners of the regulation which “[o]rdinarily” treats as an S corporation shareholder “the person who would have to include in gross income dividends distributed with respect to the stock of the corporation (if the corporation were a C corporation)”.
Furthermore, petitioner did not otherwise possess an ownership interest in Waterfront equivalent to that of a shareholder. Because he was president and a director of Waterfront, the Act, along with Waterfront's articles of incorporation, expressly prohibited any part of Waterfront's income or profit from being distributed to him or inuring to his benefit. See Ky. Rev. Stat. Ann. sec. 273.237. In the light of this nondistribution constraint, treating petitioner as a shareholder of Waterfront would be fundamentally incompatible with the purpose and operation of subchapter S, which generally taxes an S corporation's income currently at the shareholder level.
The corporation president tried a fallback argument: the non-profit thing was all a big mistake, a crazy misunderstanding:
Invoking the doctrine of substance over form, petitioner urges that we should disregard Waterfront's form as a nonprofit corporation and instead should regard it, in substance, as a for-profit entity. He asserts that he intended Waterfront to be a for-profit entity and “objectively operated” it “consistently with it being a for-profit entity that he owned entirely.”
Judge Thornton was unmoved:
Taxpayers are generally bound by the form of the transaction they choose. As the Supreme Court has stated: “[W]hile a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not.”
Decision for IRS: No deduction.
Lessons? A lot went wrong here. The late S corporation election combined with the late-filed returns made it unlikely that this would all slip by the IRS unnoticed. It's not clear that the president had invested any personal funds in the business, and therefore had no basis to deduct losses against. But the most important problem was using an entity without owners.
The moral? Carefully consider what sort of entity you want to lose. As the taxpayer here learned, if you make your bed as a non-profit corporation, you have to sleep in it.
Link to opinion: 155 T.C. No. 8
Nonprofit Corporation Could Not Issue Stock, Thus No S Election Was Possible - Ed Zollars, Current Federal Tax Developments.
An extension of up to three months to file and pay taxes or fees is available for the following CDTFA administered programs:This relief is offered to any taxpayer who was directly affected by the disasters in the listed counties, and who, as a result, cannot meet their filing and payment deadlines. The CDTFA may also extend the deadline for filings that were delayed by disruption of service from the United States Postal Service or private mail and freight companies.
Automatic relief from federal filing deadlines is available for taxpayers in Butte, Lake, Monterey, Napa, San Mateo, Santa Cruz, Solano, Sonoma and Yolo counties.
Oregon fire victims' tax deadlines pushed to Jan. 15, 2021 - Kay Bell, Don't Mess With Taxes. "This tax and payment extension includes people and businesses in the Oregon counties of Clackamas, Douglas, Jackson, Klamath, Lane, Lincoln, Linn and Marion."
New Census Data Shows States Beat Revenue Expectations in FY 2020 - Jared Walczak, Tax Policy Blog. "New U.S. Census data shows state tax collections down 5.5 percent in FY 2020, driven by a dismal final quarter (April through June) as states began to feel the impact of the COVID-19 pandemic. After accounting for revenues shifted into the current fiscal year due to delayed income tax filing and payment deadlines, all indications are that the overall decline was in the low single digits—not desirable, certainly, but far better than many feared."
Taxing Times to Be a Telecommuter: Convenience Rules During COVID-19 - Timothy P. Noonan, Doran J. Gittelman, Tax Notes. "First and foremost, keep track of your days and communicate with your employer or tax adviser. Regardless of what state you are in, track where and when you worked, and why you worked remotely."
Related: Business Considerations with a Remote Workforce 2020/5
Lesson From The Tax Court: Receipts Are Not Enough - Bryan Camp, TaxProf Blog. "In Anna M. Armstrong v. Commissioner, T.C. Sum. Op. 2020-26 (Sept. 17, 2020), Judge Panuthos teaches that substantiation does not just mean showing the amount of an expense; it means showing entitlement to deduct that expense."
Need a Tax Return Preparer? Don’t Use a Current IRS Employee - Jim Maule, Mauled Again. "It never occurred to me, until now, to suggest that taxpayers ask their potential preparers if they are current IRS employees. If the answer is yes, stop and go find someone else. On the other hand, if the person is a former IRS employee, they can offer expertise and experience that is helpful."
After Man Shoots Fiancee’s Parents, Bloody Footprints Lead To Tax Charges - Kelly Phillips Erb, Forbes. "According to United States Attorney David J. Freed, while securing the residence after the shooting, police officers observed bloody footprints leading through the house to an outside pool house. So off they went to investigate. Inside the pool house, they found a garbage bag which contained a large amount of bundled United States currency."
This week in history. In 1893, Charles Duryea and his brother road test "the first American made gasoline powered automobile." (Hemmings.com).
This is a roundup of tax news and opinion. Any opinions expressed or implied are those of the author and not necessarily those of Eide Bailly. Opinions found in linked items are those of the authors of the linked item, not of your bloggers or of Eide Bailly. “$” means link may be behind a paywall. Items here do not constitute tax advice.