T.C. Memo. 1999-299
UNITED STATES TAX COURT
SHERYL D. BUMPUS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8507-98. Filed September 7, 1999.
Yale F. Goldberg and Mitzi L. Torri, for petitioner.
David A. Winsten, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
CARLUZZO, Special Trial Judge: Respondent determined a
deficiency of $8,041 in petitioner's 1995 Federal income tax.
The issue for decision is whether petitioner, who was an
officer and shareholder of a closely held corporation, is
entitled to a deduction for a lease cancellation fee (the fee)
paid to release the corporation from liability under a lease.
- 2 -
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
At the time the petition was filed, petitioner resided in
Glendale, Arizona.
During 1995 petitioner was employed as a sales
representative for two companies that manufactured construction
materials. She was an independent contractor for one and an
employee of the other.
With the assistance of legal counsel, petitioner and Richard
Schuster, a long-time friend with metal fabrication experience,
incorporated Drywall Cornerbead, Inc. (Drywall). According to
Drywall's Articles of Incorporation, which were filed June 9,
1995, the corporation was organized "for the purpose of
transacting any and all lawful business for which corporations
may be incorporated under the laws of the State of Arizona." Its
initial purpose was "to conduct in the State of Arizona the
business of manufacturing and distributing drywall and plastering
products."
Petitioner opened a checking account for Drywall and
deposited $100 of her money into the corporation's account. An
Arizona sales tax exemption certificate was issued to Drywall, as
was a Federal employer identification number. Drywall secured
workers' compensation insurance, although the corporation had no
employees other than its officers.
- 3 -
In June 1995, Drywall, as the lessee, and Marchant
Corporation (Marchant), as the lessor, entered into a lease
agreement for certain industrial property (the lease). The
property was to be used by Drywall for manufacturing and
distribution purposes. The term of the lease was 3 years
beginning on August 1, 1995. Base rent, which increased from
year-to-year, was initially $4,998.30 per month. A $5,664.74
security deposit was due when the lease was signed but the
deposit was not made at that time. Petitioner and Mr. Schuster
signed the lease as officers of Drywall; neither signed the lease
in an individual capacity. Corwon J. Finley, petitioner's
personal friend and business associate, was a guarantor on the
lease, as was a corporation that he apparently controlled.
By checks dated June 20, 1995, drawn on her personal
checking account and made payable to Marchant, petitioner:
(1) Made the security deposit required under the lease; and (2)
paid the first month's rent, which was due August 1. The rent
check was for $5,255.71. The parties did not explain why the
amount was higher than required under the lease.
Soon after the lease was signed, Mr. Schuster decided that
he no longer wanted to be involved with Drywall. Petitioner
believed that she could not successfully operate Drywall without
Mr. Schuster and decided to abandon the project.
- 4 -
The lease was canceled, and Drywall was released from
liability under the lease in return for the payment of $9,996.60
(the lease cancellation fee). The lease cancellation fee was
paid by cashier's check made payable to Marchant. The cashier's
check was purchased by Mr. Finley, either in his individual
capacity or as an officer of a corporation that he controlled.
Mr. Finley delivered the check to petitioner, who in turn
delivered it to Marchant.
Drywall was dissolved on August 31, 1995. Drywall did not
issue stock, conduct an organizational meeting, adopt bylaws, or
file a Federal income tax return. The balance in Drywall's
checking account (petitioner's initial $100 deposit) was
withdrawn by petitioner, and the account was closed.
Petitioner's 1995 Federal income tax return was timely
filed. On a Schedule C included with that return petitioner
reported various items attributable to her self-employment as an
independent sales representative. Relevant for our purposes, on
that Schedule C she claimed a $26,918 deduction for rent on
business property. Of this amount, $15,997 was disallowed in the
notice of deficiency because petitioner "did not establish that
the * * * expense * * * was paid or incurred during the taxable
year and that the expense was ordinary and necessary to * * *
[her] business". Other adjustments made in the notice of
deficiency have been resolved by the parties.
- 5 -
OPINION
The rent deduction claimed on petitioner's return is
attributable to the lease and takes into account: (1) The
security deposit; (2) rent for the first month; and (3) the lease
cancellation fee. The balance of the deduction ($6,000) has not
been identified. The controversy between the parties focuses on
whether petitioner is entitled to include the lease cancellation
fee in the rent deduction.
Although the lease cancellation fee was paid with a
cashier's check purchased by Mr. Finley, petitioner considers
that the payment was made by her. According to petitioner, she,
in effect, borrowed the funds from Mr. Finley and repaid him over
a period of time. Petitioner contends that the deduction is
allowable under section 162,1 which, in general, allows a
taxpayer to deduct "all the ordinary and necessary expenses paid
or incurred during the taxable year in carrying on any trade or
business."
Respondent argues that petitioner is not entitled to a
deduction for the lease cancellation fee because the fee was not
paid by her. According to respondent, the fee was paid by Mr.
Finley as the guarantor on the lease. Respondent further argues
that the fee, even if paid by petitioner, was an expense of
1
Section references are to the Internal Revenue Code of
1986, as amended and in effect for the year 1995. Rule
references are to the Tax Court Rules of Practice and Procedure.
- 6 -
Drywall, and, if deductible, could only be deducted by Drywall.
Because we agree with respondent on this point, we need not
address the controversy between the parties as to whether the
lease cancellation fee should be considered to have been paid by
petitioner or Mr. Finley.
A corporation formed for legitimate business purposes is an
entity separate from its shareholders. See Moline Properties,
Inc. v. Commissioner, 319 U.S. 436 (1943). Furthermore, the
business of a corporation is separate and distinct from the
business of its shareholders. See id.; Deputy v. du Pont, 308
U.S. 488, 494 (1940); Crook v. Commissioner, 80 T.C. 27, 33
(1983), affd. without published opinion 747 F.2d 1463 (5th Cir.
1984). Consequently, a shareholder generally is not entitled to
a deduction for the payment of corporate expenses. See Deputy v.
du Pont, supra; Hewett v. Commissioner, 47 T.C. 483 (1967).
Petitioner agrees with these general legal principles but argues
that the principles do not apply because Drywall's existence
should be disregarded for Federal income tax purposes. According
to petitioner, Drywall did not take sufficient, if any, action to
further its corporate business purpose. We disagree.
A corporation will be recognized for Federal income tax
purposes as a taxable entity separate from its shareholders if
(1) the purpose of incorporation was the equivalent of business
activity, or (2) the corporation carried on business after
- 7 -
incorporation. See Moline Properties, Inc. v. Commissioner,
supra.
Drywall's corporate existence was effective as June 9, 1995,
the date that its articles of incorporation were filed. See
Ariz. Rev. Stat. sec. 10-056 (1995) (repealed, effective January
1, 1996). Drywall was incorporated in connection with
petitioner's intention to start a business. Her decision to
conduct the business in corporate form was deliberate, reasoned,
and made with the assistance of legal counsel. Thereafter,
Drywall opened a checking account, obtained an Arizona sales tax
exemption certificate, was issued a Federal employer
identification number, and secured workers' compensation
insurance. Through the lease Drywall arranged for a physical
plant that furthered its manufacturing and distribution
objectives.
The obligation to make the lease cancellation fee arose
under the lease. Because petitioner did not sign the lease in
her individual capacity, she enjoyed the limited liability aspect
of the corporate form of business, which, no doubt, was one of
the reasons that Drywall was established. Any obligation, legal
or otherwise, that petitioner might have owed to Mr. Finley in
connection with the lease cancellation fee did not arise from the
lease.
- 8 -
Having elected to conduct the business in corporate form,
petitioner is bound by the Federal income tax consequences of
that election. See Higgins v. Smith, 308 U.S. 473 (1940).
Drywall's corporate existence cannot be disregarded for Federal
income tax purposes, and petitioner's argument that it should be
is rejected. Because the lease cancellation fee was an expense
of Drywall, petitioner is not entitled to include the payment of
the fee in the rent expense deduction claimed on her return.
Respondent's determination in this regard is sustained.
To reflect the foregoing and the concessions of the parties,
Decision will be entered
under Rule 155.