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No deduction for 100% penalty

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in Small Business Tax,Small Business Tax Deduction Strategies

The “100% penalty” is one of the most treacherous provisions in the tax code. Essentially, a responsible party is personally liable for 100% of the amount of federal payroll taxes that were withheld from employee paychecks and then willfully not paid over to the government.

And it doesn’t take much for the IRS to say a failure is “willful.” If you knew about the problem—or should have known about it—you could be on the hook.

In a new decision, the owner of a defunct S corporation tried to mitigate the tax damage by deducting the 100% penalty payment as a business expense. But the Tax Court shot down the argument. (Brown, TC Memo 2017-18, 1/24/17)

Facts of the case: A taxpayer owned a limited liability company (LLC) and a separate S corp in Arizona. For a three-year period—from 2000 through 2002—the S corp failed to pay its payroll taxes. Eventually, the IRS hit the taxpayer with the 100% penalty.

The S corp didn’t file any tax returns after 2002. In 2007, it was officially dissolved by the state of Arizona. It had no income or activity after that point.

The taxpayer arranged to have the LLC send $215,000 from its bank account to the trust account of his attorney in 2012. Then the attorney sent a certified check for that amount to the IRS, representing it to be the unpaid payroll tax liability on behalf of the S corp. On its 2012 tax return, the S corp claimed a deduction for the payment as a business expense that was passed through to the taxpayer’s personal return.

Not so fast: The IRS objected to the deduction, and now the Tax Court has agreed. It ruled that the S corp couldn’t deduct the payroll tax payment supposedly made in 2012 on its behalf because it didn’t legally exist at the time. What’s more, there’s no evidence to support a payment from the S corp. As a result, the deduction was denied.

Finally, the Tax Court said this issue was a moot point, because the 100% penalty isn’t deductible in any event.

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