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Lessons From the Tax Court

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in Small Business Tax

Tax-bill compromises are binding. Don't sign an "offer in compromise" with the IRS unless you plan on following through with it. Reason: Once accepted, such deals—signed by taxpayers who aren't able to pay their full bill—are governed by the general principals of contract law.

Recent case: While a taxpayer argued that his offer in compromise should be voided because of a mutual mistake with the IRS, the Tax Court found no such mistake and made the taxpayer follow through. (Dutton, 122 TC, No. 7)

Beat back IRS challenge on company loans. It's vital to dot every i and cross every t when taking a loan from your corporation. Treat it as you would a bona fide third-party loan, including a promissory note and repayment schedule. By leaving a clear paper trail of records and motives, you can defeat any IRS attack.

Recent case: When a construction company owner began branching into other fields, he used money borrowed from his C corporation to fund his new ventures. His construction company carried the advances on its books as loans and the owner wrote promissory notes for the money. The IRS slapped him with an $800,000 tax bill, claiming the advances amounted to "constructive dividends." But the Tax Court sided with the business owner, citing his extensive paperwork and persuasive testimony that showed he intended to repay the money. (Byorick, TC Memo 88-252)

Don't let compensation deduction slip away. The IRS says money paid to employees for their services counts as compensation. That's true even if the amount isn't cited in a paycheck but the employee simply charges his or her personal expenses to the company. Just make sure you deduct that compensation accordingly.

Recent case: The Tax Court said a company was not due an expense deduction for a worker who charged personal expenses on the company credit card in lieu of pay. Reason: While the company claimed the charges were intended as additional compensation, the amounts weren't included on the employee's W-2 form. (Troutman, TC Memo, 2004-32)

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