Lessons from the Tax Court: Keep it strictly business

If you are a self employed individual, you can deduct your “ordinary and necessary” business expenses. But you must operate in a businesslike fashion and keep proper records to segregate business income and expenses from personal income and expenses. Strategy: Don’t commingle your personal funds with your business funds. This could lead to a heap of tax trouble. In a new case, a self-employed was hit with a huge unexpected tax bill for a mistake in judgement. (Boles, TC Memo 2019-42, 4/25/19)

Facts of the new case: The self-employed taxpayer, a resident of Oklahoma, ran a masonry business. During the tax year in question, he did some masonry work on his own house, which had been damaged by a casualty. At first, the taxpayer reported gross receipts of about $20,000 on Schedule C for his masonry business for 2010. But an IRS exam showed that he received gross receipts of around $30,000 for that year. Subsequently, the IRS added another $10,000 to this figure. When the case went to trial, the IRS introduced into evidence the taxpayer’s business and personal bank statements for much of 2010. The IRS asserted that all the checks deposited into the business account constituted income to the taxpayer even though the taxpayer claimed that these amounts were payments for other purposes. This included several checks deposited by the taxpayer’s nephew who controlled the business account.

Absent other proof, the IRS assumes that the amounts that are deposited into a business account constitute taxable business income. It is up to the taxpayer to rebut this presumption. In this case, the taxpayer asserted that the unreported deposits were related to the sale of the damaged property.

But the facts didn’t back up the taxpayer’s claims. First, there was no transfer of title to the property. Second, the taxpayer’s own testimony indicated that the difference as taxable income. The Tax Court had no recourse but to rule that the taxpayer had an additional income of $10,000 that was subject to tax. The lesson to be learned is clear. Self-employed should keep a separate bank account for the business. Then, use that account for business purposes only. Don’t just treat it as a dumping ground for any payment. Tip: Commingling funds can cause other problems such as liability to creditors.

Small Business Tax Strategies
July 2019