The Tax Court in Brief – September 19th – September 22nd, 2022

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Tax Litigation: The Week of September 19th, 2022, through September 22nd, 2022

Vorreyer v. Comm'r / Thoma v. Comm'r / Dowson v. Comm'r, T.C. Memo 2022-97| September 21, 2022 | Greaves, Judge | Dkt. Nos. (Consolidated) 27314-16, 27846-16, 2634-19, 2636-19, 2666-19, 2670-19

Summary: Petitioners operated an Illinois family farm individually and through several related entities, including C&J Farms and Prairieland. In 2012 C&J Farms was an S corporation for federal income tax purposes and owned equally by petitioners Chris and John Dowson. In 2014 Prairieland was treated as a general partnership for federal income tax purposes and owned equally by petitioners Lisa Dowson, Chris Dowson, Darrel Thoma, and Amy Thoma. In tax year 2012 C&J Farms owed a total of $108,9654 in property taxes, and $20,866 in utility expenses to a power company. Shareholders Chris and John Dowson directly paid these costs in 2012 on behalf of C&J Farms in proportion to their respective ownership interests in C&J Farms. Both Chris and John Dowson claimed section 162 deductions on their 2012 Forms 1040 Income Tax Return, for their respective payments. In tax year 2014 Prairieland purchased two semi-trucks for a total of $70,126 (truck expenses). Prairieland included the truck expenses as part of its claimed repairs and maintenance expense deduction on Schedule F, Profit or Loss From Farming, of its 2014 Form 1065, U.S. Return of Partnership Income. Following an audit of petitioners' 2012 to 2014 returns, the IRS determined more than $14 million in collective deficiencies in petitioners' income tax and over $2.8 million in penalties. The IRS then issued petitioners notices of deficiency with respect to the determined deficiencies and penalties which, among other things, disallowed the deductions for the property taxes and utility expenses on Chris and John Dowson's 2012 individual returns and the deduction for the truck expenses as a repair expense on Prairieland's 2014 return. Petitioners filed eight Petitions with the Tax Court seeking redetermination of the deficiencies and penalties. Following the consolidation of these eight cases, the parties filed their respective Motions for Partial Summary Judgment.

Key Issues:

(1) Whether petitioners John C. Dowson (Chris Dowson) and John J. Dowson (John Dowson) are entitled to passthrough deductions on their 2012 individual income tax returns for certain property taxes and utility expenses they paid on behalf of Chris & John Farms, Inc. (C&J Farms)?

(2) Whether expenses incurred by Prairieland Farms (Prairieland) related to the purchase of semi-trucks in tax year 2014 are fully deductible by Prairieland under section 179.2?

Primary Holdings:

(1) No. The passthrough deductions are not permitted in the S Corp scenario presented.

(2) No. A taxpayer must make an election to take advantage of a section 179 deduction with respect to qualifying expenses and that Prairieland did not make such an election on its 2014 return for the truck expenses.

Key Points of Law:

Summary Judgment Standard The purpose of summary judgment is to expedite litigation and avoid costly and unnecessary trials. FPL Grp., Inc. & Subs. v. Commissioner, 116 T.C. 73, 74 (2001). The Tax Court may grant a motion for partial summary judgment regarding an issue when there is no genuine dispute of material fact and a decision may be rendered as a matter of law. The court construes the facts and draw all inferences in the light most favorable to the nonmoving party to decide whether summary judgment is appropriate. Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994). The nonmoving party may not rest upon the mere allegations or denials in its pleadings but must set forth specific facts showing that there is a genuine dispute for trial. Rule 121(d).

Business Expenses – Property Taxes and Utility Expenses. A taxpayer may deduct ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. 26 U.S.C. § 162(a). Deductions for personal, living, or family expenses are prohibited. Id. at § 262(a).

Deductions for Others. A taxpayer cannot deduct expenses paid on behalf of another taxpayer. Deputy v. du Pont, 308 U.S. 488, 493–99 (1940); Columbian Rope Co. v. Commissioner, 42 T.C. 800, 815 (1964). This principle extends to corporations as a corporation's business is distinct from its shareholders. Westerman v. Commissioner, 55 T.C. 478, 482 (1970). A shareholder may not deduct as personal expenses those expenses that further the business of the corporation. Id.; Kahn v. Commissioner, 26 T.C. 273, 274–75 (1956). Although there is a recognized exception to this rule, see, e.g., Lohrke v. Commissioner, 48 T.C. 679, 684–85 (1967) (allowing a deduction by a shareholder on behalf of a corporate taxpayer for an expenditure the corporation was financially unable to pay to "protect or promote" the business), petitioners in this case do not contend that the present situation should fall within this limited exception. See Interstate Transit Lines v. Commissioner, 319 U.S. 590, 593 (1943); Int'l Trading Co. v. Commissioner, 275 F.2d 578, 584 (7th Cir. 1960) ("[U]nless the claimed deductions come clearly within the scope of the statute, they are not to be allowed."), aff'g T.C. Memo. 1958-104.

C Corp versus S Corp. Unlike income (or loss) of a C corporation, income (or loss) of an S corporation escapes corporate-level taxation and gets "passed through" to the shareholder on a pro rata basis. See 26 U.S.C. §§ 1363(a), 1366(a)(1); Mourad v. Commissioner, 121 T.C. 1, 3 (2003), aff'd, 387 F.3d 27 (1st Cir. 2004); Berry v. Commissioner, T.C. Memo. 2021-52, at *5. Although an S corporation's income or loss eventually flows through to the shareholders, a corporation "remains a separate taxable entity [from its shareholders] regardless of whether it is a subchapter S corporation or a subchapter C corporation." Russell v. Commissioner, T.C. Memo. 1989-207, 1989 Tax Ct. Memo LEXIS 207, at *10. This means that the business expenses of an S corporation cannot be disregarded at the corporate level for section 162 purposes. The income of an S corporation must be matched at the corporate level against the S corporation's expenses that were incurred to produce that income before the net income or loss amount can flow through to the shareholders. See 26 U.S.C. § 1366(a)(2) (generally defining the income or loss that flows through to an S corporation shareholder as the S corporation's "gross income minus the deductions allowed to the [S] corporation".

Truck Expenses. A taxpayer may elect under section 179 to deduct as a current expense the cost of certain property acquired and used in the active conduct of a trade or business and placed in service during the taxable year. 26 U.S.C. § 179(a), (c); Treas. Reg. § 1.179-5. A taxpayer must make an election to take advantage of a section 179 deduction with respect to qualifying expenses and that Prairieland did not make such an election on its 2014 return for the truck expenses. A taxpayer's request that the Tax Court grant retroactive relief on principles of equity will likely fail because the Tax Court is not a court of equity. See Commissioner v. McCoy, 484 U.S. 3, 7 (1987); Patton v. Commissioner, 116 T.C. 206, 211 (2001).

Insights: This opinion on the issues presented provides guidance and deductibility issue-spotting for a shareholder of an S Corp and C Corp for deduction of corporate expenses paid by an individual shareholder. Such expenses paid on behalf of an S Corp may be denied deduction to the individual shareholder that pays for the expense. Limited exceptions apply, and no exception applied to this opinion. As for Prairieland's truck expenses, Prairieland had opportunities to properly trigger deduction under section 179, but Prairieland failed to do so. And, the Tax Court is not a court of equity to grant retroactive relief on principles of equity.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.