Friday, August 1, 2014

Revenue Finds Taxpayer Failed to Prove Corporation's Payments were not Distributions

Excerpts of Revenue's Determination follow:

Taxpayers, husband and wife, are two shareholders of an Indiana S corporation ("Corporation"). Corporation's gain or loss passes through to Taxpayers, and Taxpayers report the income or deduct the loss in their federal and Indiana individual income tax returns according to I.R.C. § 1366 and IC § 6-3-1-3.5.

In 2013, the Indiana Department of Revenue ("Department") conducted a Sales/Use Tax audit of Corporation's business records. Pursuant to the audit, the Department found that Corporation made various payments to Taxpayers to cover Taxpayers' personal expenditures. Thus, the Department conducted a separate investigation concerning Taxpayers' individual income tax on those specific payments. As a result of the investigation, the Department determined that Corporation made additional distributions to Taxpayers. Those additional distributions reduced Taxpayers' stock basis in Corporation below zero, and, as a result, created additional taxable income that was not reported on Taxpayers' individual income tax returns for the tax years 2009 and 2010 ("Tax Years at Issue"). The Department thus assessed Taxpayers additional income tax, interest, negligence penalty and underpayment penalty.

Taxpayers, to the contrary, claimed that the Department's assessments were overstated.

In this instance, Taxpayers asserted that the Department's assessments were overstated because not all the listed payments were paid to Taxpayers for their personal expenses. In addition to copies of Corporation's unaudited qualified Accountant's Compilation Report for the Tax Years at issue ("Report"), Taxpayers submitted copies of Corporation's bank statements for its Money Market Account 101XXXXX for the Tax Years at Issue to support their protest.

Upon reviewing Taxpayers' supporting documentation, however, the Department is not able to agree that the Department's assessments were overstated. Specifically, in this instance, Taxpayers stated that since Corporation "is a small family-owned business, the owners [i.e., Taxpayers] put in money and take out money as needed all the time." Thus, there is no dispute that, during the Tax Years at Issue, Corporation made various distributions to Taxpayers when Taxpayers took out money from Corporation for their personal expenses. Also, there is no dispute as to the shareholder's basis established in Corporation's 1120S returns for the Tax Years at Issue for each of Corporation's shareholders, including Taxpayers. Rather, the Department's investigation report listed various payments made from Corporation to Taxpayers for their personal expenses, and determined that these payments, as additional distributions to Taxpayers, reduced both Taxpayers' basis in Corporation below zero. As a result, the Department's investigation report concluded that these distributions created additional taxable income to Taxpayers because the basis could not be below zero.

In this instance, Taxpayers made various statements disputing the Department's assessments in their July 23, 2013, protest letters. For example, the Department determined that Corporation made a distribution to Taxpayers, in the amount of $19,302.24, in December 2009. Taxpayers asserted that "Accounts Receivable Shareholders – 55[percent] shareholder percentage in the amount of $19,302.24 was paid back in the tax year 2010." However, Taxpayers' documentation failed to demonstrate that this payment was not distribution to Taxpayers for the Tax Years at Issue. Specifically, Corporation's unaudited qualified Report only contained Corporation's "Year-End Financial Statements," which included summaries of "Statement of Assets, Liabilities, & Equity," "Statement of Related Earnings," and "Statement of Revenue and Expenses" for the Tax Years at Issue. Corporation's Report further stated for the accountant who compiled the information for Corporation, a disclaimer, that he has "not audited or reviewed the accompanying financial statements and, accordingly, do not express an opinion or provide any assurance about whether the financial statements are in accordance with the income tax basis of accounting." Additionally, Corporation's monthly bank statements simply contained monthly summaries of check deposits, withdraws, and account balances concerning its Money Market Account 101XXXXX. Taxpayers' documentation neither explained which of Corporation's payment or payments were paid to Taxpayers for their personal expenses, nor those payments which would not have been considered as distributions to Taxpayers.

As mentioned earlier, Taxpayers bear the burden of proving that the Department's assessments are wrong and are required to provide documentation explaining and supporting their protest. Given the totality of the circumstances, in the absence of other supporting documentation, the Department is not able to agree that Taxpayers meet their burden of proof demonstrating that the Department's assessments were not correct.

In short, Taxpayers' protest is respectfully denied.