TAX+BUSINESS ALERT
News for your business and your life. | Hawkins Ash CPAs
In this Edition
August 24, 2021

The Deductibility of Corporate Expenses Covered by Officers or Shareholders

PODCAST: How the Child Tax Credit Will Affect Your 2021 Return

Possible Tax Consequences of Guaranteeing a Loan to Your Corporation

Stress Testing Your Investment Portfolio

Compiling a Marital Balance Sheet in Divorce
The Deductibility of Corporate Expenses Covered by Officers or Shareholders
Do you play a major role in a closely held corporation and sometimes spend money on corporate expenses personally?

These costs may wind up being nondeductible both by an officer and the corporation unless proper steps are taken. This issue is more likely to arise in connection with a financially troubled corporation.

Deductible vs. Nondeductible Expenses

In general, you can’t deduct an expense you incur on behalf of your corporation, even if it’s a legitimate “trade or business” expense and even if the corporation is financially troubled. This is because a taxpayer can only deduct expenses that are his own. And since your corporation’s legal existence as a separate entity must be respected, the corporation’s costs aren’t yours and thus can’t be deducted even if you pay them.

What’s more, the corporation won’t generally be able to deduct them either because it didn’t pay them itself. Accordingly, be advised that it shouldn’t be a practice of your corporation’s officers or major shareholders to cover corporate costs.

When Expenses May Be Deductible

On the other hand, if a corporate executive incurs costs that relate to an essential part of his or her duties as an executive, they may be deductible as ordinary and necessary expenses related to his or her “trade or business” of being an executive. If you wish to set up an arrangement providing for payments to you and safeguarding their deductibility, a provision should be included in your employment contract with the corporation stating the types of expenses which are part of your duties and authorizing you to incur them. For example, you may be authorized to attend out-of-town business conferences on the corporation’s behalf at your personal expense.

Alternatively, to avoid the complete loss of any deductions by both yourself and the corporation, an arrangement should be in place under which the corporation reimburses you for the expenses you incur. Turn the receipts over to the corporation and use an expense reimbursement claim form or system. This will at least allow the corporation to deduct the amount of the reimbursement. Contact us if you’d like assistance or would like to discuss these issues further. 

Contact: Colleen Scherpereel
Phone: 262.404.2115
PODCAST
How the Child Tax Credit Will Affect Your 2021 Return
Back in March, we talked about changes to the Child Tax Credit for 2021. Those checks and deposits started to arrive in July. This podcast episode explains what parents and guardians need to know about how these payments will affect their 2021 return, as it may produce some surprises.
Possible Tax Consequences of Guaranteeing a Loan to Your Corporation
What if you decide to, or are asked to, guarantee a loan to your corporation? Before agreeing to act as a guarantor, endorser or indemnitor of a debt obligation of your closely held corporation, be aware of the possible tax consequences. If your corporation defaults on the loan and you’re required to pay principal or interest under the guarantee agreement, you don’t want to be blindsided.

Business vs. Nonbusiness

If you’re compelled to make good on the obligation, the payment of principal or interest in discharge of the obligation generally results in a bad debt deduction. This may be either a business or a non-business bad debt deduction. If it’s a business bad debt, it’s deductible against ordinary income. A business bad debt can be either totally or partially worthless. If it’s a nonbusiness bad debt, it’s deductible as a short-term capital loss, which is subject to certain limitations on deductions of capital losses. A non-business bad debt is deductible only if it’s totally worthless.

In order to be treated as a business bad debt, the guarantee must be closely related to your trade or business. If the reason for guaranteeing the corporation loan is to protect your job, the guarantee is considered closely related to your trade or business as an employee. But employment must be the dominant motive. If your annual salary exceeds your investment in the corporation, this tends to show that the dominant motive for the guarantee was to protect your job. On the other hand, if your investment in the corporation substantially exceeds your annual salary, that’s evidence that the guarantee was primarily to protect your investment rather than your job.

Except in the case of job guarantees, it may be difficult to show the guarantee was closely related to your trade or business. You’d have to show that the guarantee was related to your business as a promoter, or that the guarantee was related to some other trade or business separately carried on by you.

If the reason for guaranteeing your corporation’s loan isn’t closely related to your trade or business and you’re required to pay off the loan, you can take a nonbusiness bad debt deduction if you show that your reason for the guarantee was to protect your investment, or you entered the guarantee transaction with a profit motive.

In addition to satisfying the above requirements, a business or nonbusiness bad debt is deductible only if:

  • You have a legal duty to make the guaranty payment, although there’s no requirement that a legal action be brought against you;
  • The guaranty agreement was entered into before the debt becomes worthless; and
  • You received reasonable consideration (not necessarily cash or property) for entering into the guaranty agreement.

Any payment you make on a loan you guaranteed is deductible as a bad debt in the year you make it, unless the agreement (or local law) provides for a right of subrogation against the corporation. If you have this right, or some other right to demand payment from the corporation, you can’t take a bad debt deduction until the rights become partly or totally worthless.

These are only a few of the possible tax consequences of guaranteeing a loan to your closely held corporation. Contact us to learn all the implications of your situation.

Contact: Nicole Malueg, CPA
Phone: 920.684.2523
Stress Testing Your Investment Portfolio
Many banks conduct regular “stress” tests to predict the impact of adverse external events on their earnings, capital and loan portfolios. Banks use the results to shore up any revealed weaknesses. Investors should periodically perform similar stress tests on their investment portfolios.

Stress testing is the ultimate “what if” analysis. It uses modeling techniques to predict the impact of an economic downturn, financial crisis or any number of other “worst case” scenarios on your wealth. By analyzing this information, you can identify vulnerabilities in your financial plan and make changes to enhance its probability of success.

There’s virtually no limit to the scenarios you can test. Common examples include extreme market volatility, a severe or prolonged bear market, increasing inflation, and rising interest rates. Think about current events, too. How would, say, a fuel crisis is driven by a massive cyberattack affect your portfolio?

One useful exercise is to take the contents of your actual portfolio and calculate the outcome had you owned the identical investments on the eve of a historical financial crisis. Such testing can reveal potential weaknesses in your portfolio and help you pinpoint strategies to mitigate them.

For example, you might change the assumptions in your scenario analysis to see how your portfolio would respond if it were more heavily allocated to bonds rather than equities, or if it were more diversified by region, sector or other factors. While there are no guarantees, this type of stress testing can help you identify asset allocations that increase your probability of weathering various storms and ultimately meeting your financial goals.

Stress testing tends to focus on negative scenarios, but don’t ignore the positive. Incorporating positive market developments in your scenario analysis — such as the resurgence of a struggling sector or improved stability in a volatile market — can help you ensure that you’re invested in the right vehicles to maximize upside potential.

Of course, stress testing can tell investors only so much. During the recent pandemic, many stocks soared despite economic conditions that would suggest they’d be under greater downward pressure. So, talk with your financial advisors about the potential benefits — and limitations — of stress testing. The goal is to develop a resilient financial plan that’s customized to your specific circumstances and goals.
Compiling a Marital Balance Sheet in Divorce
Divorce is difficult for almost everyone. Being organized can help facilitate the process. A financial expert can help you with the first step, which is generally to compile a marital balance sheet. This document shows the assets owned and the liabilities owed by the couple.

Typical assets include the money in savings and checking accounts; vehicles and equipment; and principal residences, vacation homes and other real property. The balance sheet will also show 401(k) accounts, IRAs, pensions and other retirement savings, as well as marketable securities. In addition, jewelry, artwork, furniture and other personal assets will be listed. If either of the couple (or both) own private business interests, those will be reflected as well.

Examples of marital liabilities include credit card debt, student loans, home mortgages and lines of credit, vehicle loans, and retirement account loans. Whether the couple’s individual assets and liabilities are includable in the marital estate is generally a matter of law, which varies by state.

Values must be assigned to the assets and liabilities cataloged. The value of bank accounts, retirement accounts and debts can be taken from the latest account statement. But other items, such as real estate, collectibles and private business interests, may require an independent outside appraisal.

If the parties own an interest in a closely held business, selling usually isn’t an option. Instead, a business valuation expert should be used to determine its “fair value.” Any value not attributable to net tangible assets and identifiable intangible assets is considered “goodwill.” The treatment of goodwill in divorce varies from state to state. Ultimately, it’s critical to have a qualified financial expert determine what should and shouldn’t be includable in a marital estate based on the specific facts and circumstances.
More Resources from CPA-HQ
Reduce Your Tax Bill with the R&D Tax Credit

Many of the daily activities of companies from a wide-range of industries can qualify for federal and state tax savings high to enough to allow companies to hire new employees, invest in new products and service lines, and grow their operations. This article explains why the R&D Tax Credit is for businesses of all sizes.
Who in a Small Business Can Be Hit with the “Trust Fund Recovery Penalty?”

The IRS will impose the “Trust Fund Recovery Penalty” on certain business owners and managers personally if employment taxes aren’t paid to the government. Find out if you could be liable.
Getting a New Business Off the Ground: How Start-up Expenses Are Handled on Your Tax Return

Business applications have increased over the past year, according to the U.S. Census Bureau. If you’re launching a business, here’s how start-up expenses are treated on a federal tax return.
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