In Uncategorized on 04/23/2019 at 15:56

STJ Lewis (“Oh What a Name!”) Carluzzo started something in Tax Court last week, when he split the liability 50-50; see my blogpost “STJ Lew as King Solomon,” 4/18/19.

Nowise loath to pick up on the latest gambit, Judge Vasquez does the Solomonic split in Rick B. Ferguson and Deanna Ferguson, 2019 T. C. Memo. 40, filed 4/23/19. It’s Rick’s homebuilding business that’s the cause of the problem. Rick has a medley of C Corp, S Corp and he himself, but they all were targets of the first stone when some custom stonework that Rick’s S Corp produced, supplied and installed in a MacMansion, which the C Corp built as general contractor, was alleged to crack and threaten to collapse.

The vendee sued all and sundry. They settled, of course. Rick claims he lent his S Corp enough to pay the cash part of the settlement, and himself conveyed three parcels of land.

The land gets capital loss treatment, as Rick can’t prove inventory.

Rick wanted to deduct the settlement his own self, claiming damage to reputation. He did have a separate remodeling business that could have been hurt by an adverse verdict, but the C Corp and the S Corp were the real actors. Rick was only sued because he was the “face” of both Corps, and he did nothing that an officer or director of a Corp wouldn’t do. Source of claim knocks out Rick himself.

Rick’s loan gets treated as a capital contribution to the S Corp, because Rick flunks the usual tests, especially no note, no terms of payment, no interest or principal paid. And even though the C Corp was the general contractor, the S Corp was in it with the C Corp, so IRS’ attempt at sticking the whole contribution on the C Corp doesn’t fly.

So what part of the capital contribution belongs to the S Corp?

“This Court has examined lawsuit allegations to determine who, among associated businesses and individuals, may deduct legal fees incurred as joint defendants in a lawsuit.  See Hauge v. Commissioner, T.C. Memo. 2005-276, slip op. at 13, 16-18; Graphic Bus. Sys., Inc. v. Commissioner, T.C. Memo. 1982-167, 1982 Tax Ct. Memo LEXIS 583, at *14-*17.  We have also allocated deductible and nondeductible litigation expenses where appropriate.  See, e.g., Bledsoe v. Commissioner, T.C. Memo. 1995-521, slip op. at 12 (allocating business and personal expenses).

“We believe an allocation of the deduction for the settlement payment is appropriate in this case.  It is clear from the record that the lawsuit that gave rise to the settlement was partially attributable to [C Corp] and partially attributable to [S Corp].  Furthermore, the settlement was paid by Mr. Ferguson, the controlling shareholder of both corporations.  Accordingly, after a thorough review of the record, including the lawsuit pleadings and the settlement agreement, we allocate 50% of the settlement payment to [C Corp] and 50% to [S Corp].” 2019 T. C. Memo. 40, at pp. 22-23. (Footnote omitted).

So S Corp gets to deduct 50% of the settlement. What about C Corp?

“Because the remaining 50% was an expense of [C Corp], we would normally hold that this portion of the payment is not a deductible expense to petitioners but rather a capital contribution to the C corporation.  See Rink v. Commissioner, 51 T.C. at 751-752; Koree v. Commissioner, 40 T.C. at 966.  However, respondent has conceded that petitioners can deduct amounts paid on behalf of [C Corp] as unreimbursed employee business expenses.  On the basis of this concession, petitioners may deduct the remaining 50% of the settlement payment as an unreimbursed employee business expense.” 2019 T. C. Memo. 40, at p. 24.


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