You’ve made your bed, now lie in it! This is the conclusion that the Tax Court came to in the case of (Rochlani v. Commissioner, TCM, Dec. 60,397(M)). The Taxpayers (husband and wife) had an unincorporated business but then incorporated the business. Ignoring their C Corporation legal entity, they deducted their business expenses on Sch. C on their personal income tax return as they had done in prior years. The IRS denied their Sch. C deductions and the Tax Court ruled in favor of the IRS.
Why? Because it is clear that a taxpayer may not deduct an expense of a separate and distinct taxpayer. Although business expenses should not be co-mingled with personal expenses, and business expenses should be paid by the business and personal expenses need to be paid from the individual’s personal banking accounts, the Rochlanis ignored such formalities. The taxpayers used personal credit cards to make all business purchases. They paid all expenses from and deposited all business income into their personal bank accounts. The corporation has a business bank account but never used it and closed the account. The taxpayer’s argument was that since they failed to follow the formalities of a corporation, they should be allowed to deduct those expenses on Sch. C. The Tax Court concluded that once a valid corporation is created under state law, the taxpayers could not disregard the corporate form for tax purposes, despite their failure to follow corporate formalities. The Court ruled that once the corporate form is adopted, a taxpayer is not permitted to claim individual deductions for paying corporate expenses. A taxpayer’s choice to adopt the corporate form requires the acceptance of its tax disadvantages.
The Court also concluded that the taxpayers were liable for the 20-percent accuracy-related penalty, but only if there was a substantial understatement of tax.
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