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Deduction for Year-End Bonus Denied Because Company Could Not Honor Check.
(Parker Tax Publishing October 6, 2014)

A corporation could not deduct compensation paid to its sole shareholder because the company had insufficient funds to honor the check. Vanney Assoc. v. Comm'r, T.C. Memo. 2014-184 (9/11/2014).

Robert Vanney was the sole shareholder and executive of the architectural firm Vanney Associates. Robert's wife prepared the payroll checks for the company, although she was not an employee or otherwise connected to Vanney Associates. It was common practice at the end of the year to pay a bonus to Robert consisting of the profit remaining in the corporation. At the end of 2008, Vanney Associates paid a year-end bonus to Robert of $815,000. At the time the check was written, the corporate bank account for Vanney Associates had insufficient funds to honor the check. The company filed its income tax return, reporting no taxable income for 2008 and claimed a deduction for compensation to officers, including the $815,000 bonus. The IRS issued a notice of deficiency to Vanney Associates, disallowing deductions claimed for compensation, taxes, and licenses.

Reasonable compensation is deductible under Code Sec. 162. In Springfield Prods., Inc. v. Comm'r, T.C. Memo. 1979-23, the Tax Court held that deductions of payments made by check are dependent on the proper payment of the check. Additionally, in Steinberg v. Comm'r, T.C. Memo. 1995-116, the Tax Court disallowed a deduction where a check was not paid because of insufficient funds.

The sole issue before the court was whether Vanney Associates could deduct the year-end bonus to Robert when the firm had insufficient funds to honor the check. Vanney Associates argued that the payment was unconditional and was made when Robert Vanney took possession.

The Tax Court disallowed the deduction because no proper payment of the check had occurred. The court explained that a check is a contingent payment that is only fulfilled when the funds are actually paid. As such, a deduction for compensation is allowed only when there is actual payment. The court noted that because the check could not be honored at a bank or otherwise used due to the lack of funds, Robert could only loan it back to the company and no actual payment of the amount could be made. Thus, the Tax Court upheld the IRS's disallowance of the compensation deduction.

For a discussion of deductible compensation, see Parker Tax ¶91,101. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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