Tax Court in Brief | Sherwin Community Painters Inc. v. Comm’r | Business Expenses and Constructive Dividends

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The Tax Court in Brief – March 7th, 2022 – March 11th, 2022

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Tax Litigation:  The Week of March 7, 2022, through March 11, 2022

Sherwin Community Painters Inc. v. Comm’r, T.C. Memo. 2022-19 | March 9, 2022 | Goeke, J. |

Dkt. Nos. 4113-19, 4647-19 (Consolidated with Ward v. Comm’r)

Short Summary: The IRS determined separate tax deficiencies against the company (Sherwin) and its individual owners, the Robert and Swanette Ward. Issues presented to the court were (1) whether Sherwin was entitled to certain business expense deductions for office equipment and, among other things, the expense of paying for a non-employee’s (i.e., Ward’s daughter’s boyfriend) tuition for a coding course since he helped with Sherwin’s website; and (2) whether Swanette Ward received constructive dividends from Sherwin by virtue of the IRS recharacterizing a loan from Ward to Sherwin as a disallowed business expense deductions.

Primary Holdings:

Key Points of Law:

Insights: Under Section 162(a), a deductible business expense must be “ordinary” (i.e., normal, usual, or customary in the particular trade or business) and “necessary” (i.e., the expense is appropriate or helpful in carrying on that trade or business). When a company pays for a non-employee’s tuition to learn a trade that may help the business likely does not constitute a deductible business expense under Section 162, especially where that person is the boyfriend of the owners’ daughter and there is no agreement or enforceable expectation for a return benefit him. The IRS may disallow certain business expense deductions and, in the process, classify those amounts as constructive (and taxable) dividends to the benefitting shareholder when the shareholder receives an economic benefit from the expense.