                 United States Court of Appeals
                             For the Eighth Circuit
                         ___________________________

                                 No. 14-1053
                         ___________________________

                           Larry Zavadil; Diane Zavadil,

                      lllllllllllllllllllllPetitioners - Appellants,

                                           v.

                        Commissioner of Internal Revenue,

                       lllllllllllllllllllllRespondent - Appellee.
                                       ____________

                    Appeal from The United States Tax Court

                                    ____________

                             Submitted: October 8, 2014
                                Filed: July 16, 2015
                                  ____________

Before LOKEN, COLLOTON, and SHEPHERD, Circuit Judges.
                          ____________

COLLOTON, Circuit Judge.

       Larry and Diane Zavadil and the Internal Revenue Service dispute the propriety
of certain deductions that the Zavadils claimed on their personal tax returns in 2004
and 2005. The Service issued a notice of deficiency, and the dispute was aired in the
United States Tax Court. The tax court ruled for the Zavadils in part and for the
Service in part. The Zavadils appeal the adverse portion of the decision, and we
affirm.

                                           I.

      In 1981, Larry Zavadil organized American Business Forms, Inc.,which did
business as American Solutions for Business. American Solutions sold business
supplies and promotional products. Zavadil was the sole owner of the company until
2000, when he sold it to an employee stock ownership plan. In exchange for all
outstanding shares of American Solutions, the company provided Zavadil with a
$28,760,000 note, payable with interest in twenty annual installments. Zavadil
thereafter served without compensation as the company’s chief executive officer and
as a member of the board of directors.

       In 2004 and 2005, Zavadil had a financial arrangement with American
Solutions under which the company paid Zavadil’s personal expenses and Zavadil
later reimbursed the company by personal check. American Solutions recorded
Zavadil’s personal expenses on a ledger. To generate a ledger entry, Zavadil charged
an item to his American Solutions credit card or instructed an employee to direct the
finance department to issue a check. As a condition of extending credit to American
Solutions, the company’s creditors required that all ledger accounts, including
Zavadil’s, must be paid off at the end of each month. To comply, Zavadil reimbursed
the company on a monthly basis by personal check.

       At the end of certain months in 2004 and 2005, however, Zavadil’s personal
bank account had insufficient funds to reimburse American Solutions for the amount
recorded on the ledger. For those months, Zavadil and American Solutions employed
a system of advances that allowed the ledger to reflect a zero balance at the end of the
month. At the end of each month, Zavadil wrote a personal check to the company,
and the company brought the ledger balance to zero. At the beginning of the next

                                          -2-
month, however, American Solutions advanced funds to Zavadil’s personal bank
account to cover some or all of the amount of the check, recorded the advance as an
expense on the ledger, and then cashed the personal check received at the end of the
previous month.

       The tax court found that the company’s advances were used to pay some or all
of Zavadil’s ledger balance in four months in 2004 and three months in the first half
of 2005, but that as of December 31, 2004, and June 30, 2005, Zavadil fully
reimbursed American Solutions for all expenses previously recorded on his ledger.
The court also found that advances from American Solutions were used to pay some
or all of the ledger balance in each month from July through November 2005. The
ledger balance and advance for each month from July through November 2005 was
as follows:


 Month                Ledger balance and       Amount American Solutions
                      amount of Zavadil’s      advanced before cashing check
                      personal check
 July                           $1,429,372                             $587,000
 August                         $1,428,517                               $62,000
 September                      $1,258,723                           $1,371,000
 October                        $1,579,358                           $1,302,000
 November                       $1,813,757                           $1,800,000


For December 2005, the record did not show whether American Solutions advanced
funds in January 2006, but the court found that Zavadil’s bank account showed a
deposit of $1,610,000 on January 3, 2006, the same date on which the bank paid
Zavadil’s check for $1,508,316 to cover the December 2005 ledger balance.



                                         -3-
      Zavadil used the ledger system in 2004 and 2005 to make three categories of
disbursements that were later disputed by the Internal Revenue Service. In their tax
returns, the Zavadils claimed charitable deductions for 2004 and 2005. They claimed
nonpassive losses for “unreimbursed expenses,” in the amounts of $150,000 in 2004
and $75,000 in 2005, paid to a company called National Business Development &
Finance, which we will call National Business. And they listed other “unreimbursed
expenses” of $35,800 in 2004 paid to Becky DePree, the widow of Zavadil’s former
colleague Dusty DePree.

      Zavadil asserts that the payments to National Business were compensation for
consulting services that National Business provided to the Zavadils’ other wholly-
owned businesses. Zavadil contends the payments to DePree were a death benefit for
Dusty that American Solutions had agreed to pay, but which the company later
refused to fund.

       In 2010, the Internal Revenue Service issued the Zavadils a notice of
deficiency for the 2004 and 2005 tax years, disallowing $358,472 of charitable
deductions claimed in 2004 and $333,672 of the charitable deductions claimed in
2005. The Service also disallowed the Zavadils’ claims for the payments to DePree
and National Business.

        The Zavadils challenged the notice of deficiency in the tax court. As relevant
to this appeal, the tax court ruled in favor of the Zavadils on charitable contributions
made prior to July 2005, ruling that they were deductible because Zavadil reimbursed
American Solutions for those contributions and thus bore the economic burden. The
tax court, however, disallowed charitable deductions made from July 2005 through
December 2005, because the Zavadils did not demonstrate that they—not American
Solutions—bore the economic burden of those contributions. Because the record did
not establish that Zavadil bore the economic burden of paying the entire ledger
balance in any of those months, the court found that the Zavadils failed to prove

                                          -4-
“what portion, if any, of the charitable contributions made after June 2005 Mr.
Zavadil effectively paid with his own funds and not funds advanced by [American
Solutions].” The court also found no evidence that the ledger account balance at the
end of 2005 represented bona fide indebtedness of Zavadil.

       The tax court disallowed the Zavadils’ claimed unreimbursed expenses for
payments to National Business, finding they failed to introduce credible evidence
regarding the nature and purpose of the payments. The tax court also disallowed the
claimed deduction for the payments to DePree, concluding that Zavadil failed to
prove he made the payments to promote his business. The tax court then assessed
deficiencies against the Zavadils: $101,674 with a $20,334.80 penalty for tax year
2004, and $113,668 with a $22,733.60 penalty for tax year 2005.

                                          II.

      Generally, “an income tax deduction is a matter of legislative grace and . . . the
burden of clearly showing the right to the claimed deduction is on the taxpayer.”
INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992) (internal quotation omitted). The
burden shifts to the Service in some circumstances, see 26 U.S.C. § 7491(a)(1);
Blodgett v. Comm’r, 394 F.3d 1030, 1035 (8th Cir. 2005), but the Zavadils do not
dispute the tax court’s determination that the burden in this case remains with them.
This court reviews the tax court’s legal conclusions de novo and its factual
conclusions for clear error. DKD Enters. v. Comm’r, 685 F.3d 730, 734 (8th Cir.
2012).

                                          A.

      We consider first the charitable deductions. 26 U.S.C. § 170(a) provides a
deduction for “any charitable contribution . . . payment of which is made within the



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taxable year.” To qualify for a deduction, the charitable contribution must be
“actually paid during the taxable year.” Treas. Reg. § 1.170A-1(a).

       The parties agree that a taxpayer may make a deductible contribution with
borrowed money, and that such a payment is deductible in the year the payment is
made, not when the loan is repaid. Rev. Rul. 78-38, 1978-1 C.B. 67, 68; see Crain
v. Comm’r, 75 F.2d 962, 964 (8th Cir. 1935); Granan v. Comm’r, 55 T.C. 753, 755
(1971). A contribution made by credit card, for example, is deductible by the
cardholder when charged, because the contribution “creates the cardholder’s own
debt to a third party.” Rev. Rul. 78-38, 1978-1 C.B. at 68. A charitable contribution
also may be effected through an agent acting on behalf of the donor. Weitz v.
Comm’r, 56 T.C.M. (CCH) 1422, 1426-27 (1989); Skripak v. Comm’r, 84 T.C. 285,
318 (1985); Rev. Rul. 80-335, 1980-2 C.B. 170. The economic substance of a
transaction, rather than its form, determines the proper characterization. See Weitz,
56 T.C.M. (CCH) at 1425; see also Estate of Sachs v. Comm’r, 856 F.2d 1158, 1164
(8th Cir. 1988). Under this framework, the tax court found that Zavadil properly
claimed charitable deductions for amounts that American Solutions contributed in
2004 and the first half of 2005, because Zavadil had fully reimbursed the company
as of December 31, 2004, and June 30, 2005.

       Zavadil contends that he also is entitled to deduct the charitable contributions
that he caused American Solutions to make from July 2005 through December 2005.
The record does not establish that Zavadil fully reimbursed the company for these
contributions, but Zavadil argues that he is entitled to deductions, because he was
required to reimburse the company for those contributions. The tax court rejected
Zavadil’s plea, finding that he presented “no credible evidence” that the payments
from July through December 2005 represented “bona fide indebtedness” for which
the Zavadils were required to repay American Solutions. The court found that the
company’s practice of advancing Zavadil the funds he used to pay off his monthly
ledger balance was a “circular flow of funds [that] resulted in [the company’s]

                                         -6-
assumption of most, if not all, of the economic burden of the charitable contributions
. . . after June 2005.”

       Zavadil submits that the finding was clear error and relies principally on three
pieces of evidence: (1) his repayment of advances made by American Solutions
before July 2005; (2) his testimony that he was required to repay the company, and
that the company’s third-party lenders required that his “ledger would be at zero at
the end of every fiscal month”; and (3) testimony of Colette Carlson, Zavadil’s
accountant, that Zavadil would “bear the economic cost” of the expenses reflected in
the ledger by paying the balance at the end of each month. Zavadil also argues
American Solutions’ awareness that Zavadil had the means to repay the
advances—based on the company’s obligation to make annual payments to Zavadil
on the $28,760,000 note—is evidence of an agreement between Zavadil and the
company that Zavadil would repay the advances.

       The court’s finding that Zavadil did not incur bona fide indebtedness to
American Solutions for ledger balances between July and December 2005 was not
clearly erroneous. There was no written agreement between American Solutions and
Zavadil that required repayment, no evidence that interest was charged, no sign of
collateral to secure payment, and no record of a due date. See Rolwing-Moxley Co.
v. United States, 589 F.2d 353, 355 (8th Cir. 1978) (per curiam); Caligiuri v. Comm’r,
549 F.2d 1155, 1157 (8th Cir. 1977); Rife v. Comm’r, 356 F.2d 883, 888 (5th Cir.
1966). The tax court was not required to credit Zavadil’s say-so in the face of
conflicting circumstantial evidence. See Blodgett v. Comm’r, 394 F.3d at 1036;
Banks v. Comm’r, 322 F.2d 530, 537 (8th Cir. 1963).

       That Zavadil repaid all funds in the first half of 2005 did not necessarily show
that he was obliged to do so, especially when there was no evidence that he did so in
the second half. The court permissibly declined to accept accountant Carlson’s
testimony, given that the system of advances undermined the claim that Zavadil

                                          -7-
actually repaid the company in full at the end of every month. The requirement
imposed by creditors that the company show a zero ledger balance at the end of each
month did not exclude the possibility that American Solutions nonetheless bore the
economic burden by reimbursing Zavadil for some or all of his end-of-month
payments through advances at the beginning of the next month. And the company’s
obligation to make installment payments to Zavadil in exchange for his sale of the
company does not establish that Zavadil was required to repay the advances. Zavadil
points to no evidence that the company deducted the advances from its installment
payments on the note, or that the note was designated as collateral for the advances.
It was not clear error for the tax court to find Zavadil’s evidence wanting.

                                          B.

      Zavadil next asserts the tax court erred in denying his deduction for the
$35,800 he paid to Becky DePree in 2004. Zavadil claimed this amount as a business
expense under 26 U.S.C. § 162(a). He says the payments were made to DePree as a
death benefit for her late husband, Dusty, who was Zavadil’s former colleague at
American Solutions.

      To qualify for a deduction under § 162(a), a taxpayer must show that the
expense was (1) “paid or incurred during the taxable year,” (2) for “carrying on any
trade or business,” and (3) an “ordinary” and “necessary” expense. Comm’r v.
Lincoln Sav. & Loan Ass’n, 403 U.S. 345, 352 (1971) (internal quotation omitted).
Generally, a taxpayer is not entitled to deduct his payment of another party’s business
expense, even when the payments are made for the development of the taxpayer’s
reputation and goodwill. Welch v. Helvering, 290 U.S. 111, 114 (1933).

      The tax court has recognized an exception to the general rule. A taxpayer’s
payment of another’s business expense is deductible, if (1) the taxpayer’s primary
motive was to “protect or promote” his own business, and (2) the expense was an

                                         -8-
ordinary and necessary expense of the taxpayer’s trade or business. Lohrke v.
Comm’r, 48 T.C. 679, 688 (1967); see Bone v. Comm’r, 324 F.3d 1289, 1295 (11th
Cir. 2003); Capital Video Corp. v. Comm’r, 311 F.3d 458, 464 (1st Cir. 2002). The
tax court has ruled that, in certain circumstances, a taxpayer may satisfy the first
element of this exception—motive to “protect or promote” his own business—by
showing that his purpose was to protect his own pre-existing “standing and
reputation” in his business community. See Conley v. Comm’r, 36 T.C.M. (CCH)
1644, 1648 (1977); see also Allen v. Comm’r, 283 F.2d 785, 790-91 (7th Cir. 1960).
The burden is on the taxpayer to show “a direct nexus between the purpose of the
payment and the taxpayer’s business or income producing activities.” Dietrick v.
Comm’r, 881 F.2d 336, 339 (6th Cir. 1989) (internal quotation omitted); see Bone,
324 F.3d at 1296.

       Zavadil argues that he made the payments to DePree for the purpose of
protecting his and Mrs. Zavadil’s business reputations. The tax court found to the
contrary. The court reasoned that Zavadil promised to pay the death benefit to
DePree as additional compensation for Dusty’s work at American Solutions. After
the employee stock ownership plan acquired the company, the company declined to
continue making payments to DePree. The board of directors concluded that the
death benefit was Zavadil’s personal obligation, and that the new owner should not
be burdened with the payments on top of its other debt. The tax court also observed
that Zavadil never claimed in testimony that his motive for the continued payments
was to protect his business reputation. The court thus concluded that the Zavadils
failed to establish that the payments were deductible business expenses.

       Zavadil responds that he paid the death benefit in order to fulfill an obligation
to “the family of one of [American Solutions’] most well-loved, well-known, and
longest-serving employees,” and that he thereby acted to protect the Zavadils’
business reputations. In support, he points to testimony that he was the
uncompensated CEO of American Solutions, that Mrs. Zavadil owned a company

                                          -9-
engaged in the same business as American Solutions, and that Dusty had been a
valuable salesperson and vice president at American Solutions. Zavadil also asserts
that some of Dusty’s work had been uncompensated, and that he initially pledged to
pay the death benefit “to do something for Dusty for all of his work and all of his
effort.”

       Zavadil never testified, however, that he continued to pay DePree because he
was concerned about his business reputation. Zavadil did not testify about his
reasons for continuing to pay DePree after American Solutions decided to cease the
payments, how the payments affected his business reputation, or how non-payment
might damage the Zavadils’ reputation. Zavadil’s testimony about motive speaks
only to his intention to compensate Dusty for his previous work. It does not address
whether Zavadil was motivated by a desire to protect his business reputation when
he paid DePree. In light of the record as a whole, the tax court did not clearly err in
finding that Zavadil failed to prove that his payments to DePree were deductible.

                                          C.

      Zavadil’s final contention is that the tax court erred by disallowing his claimed
deduction for $225,000 in payments to National Business. The tax court found that
the Zavadils introduced no credible evidence regarding the nature and purpose of the
payments, and thus denied the claim that they were ordinary and necessary business
expenses.

       Zavadil concedes that the only evidence to support the deduction was his
testimony about the nature of the payments. Zavadil testified that Curt Briggs,
National Business’s owner, provided consulting services to Zavadil at unspecified
times in the past. He asserted that the payments to National Business in 2004 and
2005 were in exchange for “a lot of personal things for [Zavadil], on [his] personal
side, and personal investments,” including consulting services for the Zavadils’ other

                                         -10-
businesses. But Zavadil provided only vague testimony that the payments were for
consulting services. Briggs did not testify, and no documents were introduced about
consulting services.

       The tax court reasonably found that Zavadil did not explain the nature of the
consulting services in sufficient detail to establish that the payments were for carrying
on Zavadil’s trade or business or that the amounts were ordinary and necessary
business expenditures. Given the paucity of evidence, it was not clearly erroneous
for the tax court to find that the Zavadils failed to satisfy their burden on this point.

                                   *       *       *

      The judgment of the tax court is affirmed.
                     ______________________________




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