                              T.C. Memo. 2014-184



                        UNITED STATES TAX COURT



              VANNEY ASSOCIATES, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 25684-11.                        Filed September 11, 2014.



      Thomas Martin Regan, for petitioner.

      Blaine Charles Holiday, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      BUCH, Judge: Respondent issued Vanney Associates, Inc. (Vanney

Associates), a notice of deficiency for the 2008 taxable year. Among other issues,

respondent disallowed portions of the deductions for officer compensation and

taxes and licenses. The only issue remaining for consideration is whether Vanney

Associates may deduct the portion of officer compensation related to a yearend
                                        -2-

[*2] bonus to the sole shareholder of the company that was paid by a check that

Vanney Associates could not have honored and that was returned to the company.

We hold that it may not.

                               FINDINGS OF FACT

      Vanney Associates, Inc., was incorporated in 1987. It is a personal service

C corporation that uses the cash method of accounting. Robert Vanney is a

licensed architect with over 39 years of architectural and interior design

experience. He is the sole shareholder, chief executive officer, chief financial

officer, vice president of marketing, vice president of operations, and director of

human resources of Vanney Associates. Vanney Associates employs about 25

others, but Mr. Vanney is the one responsible for marketing, bringing in new

business, and signing construction documents. At the time it filed the petition,

Vanney Associates’ principal place of business was in Minnesota.

      Karen Vanney, Mr. Vanney’s spouse, is responsible for maintaining Vanney

Associates’ books and records. Ms. Vanney is a certified public accountant with

an inactive license and is employed as the vice president of finance for a company

unrelated to Vanney Associates. She has never been a shareholder, director,
                                         -3-

[*3] employee, or independent contractor of Vanney Associates. Nonetheless, Ms.

Vanney would prepare payroll checks for Vanney Associates. Mr. Vanney would

then sign the checks on behalf of Vanney Associates and distribute them.

      In 2008 Vanney Associates paid Mr. Vanney monthly wages totaling

$240,000. At the end of each year, it was the Vanneys’ practice to determine

Vanney Associates’ remaining profit after paying any outstanding bills and paying

bonuses to employees. After determining this amount, Ms. Vanney would prepare

a check on behalf of Vanney Associates and pay the remaining profit to Mr.

Vanney as a yearend bonus. The Vanneys testified that their intent behind the

yearend bonus was only to pay out the remaining profit; it was not to zero out the

tax liability of Vanney Associates even if that was the effect.

      On December 30, 2008, Vanney Associates paid Mr. Vanney a yearend

bonus totaling $815,000. After withholding and paying to the IRS the appropriate

Federal income, Social Security, and Medicare taxes, Vanney Associates wrote a

check to Mr. Vanney for $464,183.1 Mr. Vanney signed the check on behalf of

Vanney Associates and then endorsed the check in his own name and made it




      1
          All monetary amounts are rounded to the nearest dollar.
                                      -4-

[*4] payable to Vanney Associates. He never attempted to cash the check. Ms.

Vanney recorded the payment on the books as a loan from Mr. Vanney, and

Vanney Associates repaid Mr. Vanney in March 2009.2

      Although Vanney Associates wrote Mr. Vanney a check for over $460,000,

on December 31, 2008, the total balance in Vanney Associates’ bank accounts was

$389,604; the balance was $283,033 after adjusting for outstanding deposits and

checks. Mr. Vanney testified that he “believe[d]” he knew that Vanney Associates

did not have the funds necessary to honor the check. However, he maintained that

Vanney Associates could have gotten a loan to cover the check. Further, Ms.

Vanney testified that Vanney Associates was a strong company with considerable

receivables, and although the Vanneys considered taking out a loan for Vanney

Associates, they decided not to because they personally did not need the money

and they wanted to avoid the expenses that would come with obtaining the loan.

      Vanney Associates timely filed its 2008 Form 1120, U.S. Corporation

Income Tax Return, which reflected no taxable income or tax. Vanney Associates

claimed various deductions, among them $1,055,000 for compensation of officers

and $123,191 for taxes and licenses, which included $11,818 paid for Medicare

      2
        The amount repaid to Mr. Vanney was about $20,000 less than the amount
of the original loan. The difference arose from costs incurred by Vanney
Associates on Mr. Vanney’s behalf.
                                         -5-

[*5] taxes. The IRS selected the return for examination and mailed Vanney

Associates a notice of deficiency on August 5, 2011, disallowing $815,000 of the

deduction for compensation of officers and $11,818 of the deduction for taxes and

licenses.3 The notice also made other adjustments that are not at issue. In

response, Vanney Associates timely petitioned.

                                      OPINION

I. Burden of Proof

      The Commissioner’s determinations in the notice of deficiency are generally

presumed correct, and taxpayers bear the burden of proving otherwise.4 Although

the burden may shift to the Commissioner under section 7491(a), Vanney

Associates does not claim that the burden has shifted to respondent, and likewise

we do not find it appropriate to shift the burden to respondent.




      3
       Vanney Associates did not address respondent’s adjustment to the
deduction for taxes and licenses in its petition, at trial, or on brief. Accordingly,
we deem this issue conceded. See Rule 34(b)(4). Unless otherwise indicated, all
Rule references are to the Tax Court Rules of Practice and Procedure, and all
section references are to the Internal Revenue Code in effect for the year at issue.
      4
          Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
                                        -6-

[*6] II. Deductibility of Officer Compensation

      Income tax deductions are a matter of legislative grace, and the burden of

proving entitlement to any claimed deduction rests on the taxpayer.5 The Code

allows a deduction for “ordinary and necessary expenses paid or incurred during

the taxable year in carrying on any trade or business”.6

      A payment by check is known as a conditional payment because it is subject

to the condition subsequent that the check be paid upon presentation to the

drawee.7 Once the condition subsequent is fulfilled, it is generally reasonable to

conclude that the payment relates back to the time when the check was given.8




      5
       INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); see also Rule
142(a).
      6
          Sec. 162(a).
      7
       Estate of Hubbell v. Commissioner, 10 T.C. 1207, 1208 (1948) (quoting
Eagleton v. Commissioner, 35 B.T.A. 551, 558 (1937), aff’d, 97 F.2d 62 (8th Cir.
1938)).
      8
       Estate of Spiegel v. Commissioner, 12 T.C. 524, 527 (1949); Estate of
Hubbell v. Commissioner, 10 T.C. at 1208 (quoting Eagleton v. Commissioner, 35
B.T.A. at 558). But see Estate of Newman v. Commissioner, 111 T.C. 81, 90
(1998) (“[T]he relation-back doctrine does not apply to checks representing
noncharitable gifts which were [signed and dated before D’s death but] accepted
and paid by the drawee after decedent’s death.”), aff’d, 203 F.3d 53 (D.C. Cir.
1999).
                                        -7-

[*7] Thus, the allowance of a deduction is dependent on proper payment of the

check.9 We have previously disallowed a deduction where a check was not

ultimately paid because of insufficient funds.10 Further, we have also held that the

relation-back doctrine is inapplicable where the payee knows the payor has

insufficient funds and therefore refrains from cashing the check.11

      Transactions between related entities are subject to special scrutiny.12 The

economic reality of a transaction will prevail over its form, and a finding of

economic reality depends on whether the transaction would have followed the

same form if the parties were unrelated.13 Further, we have previously disallowed

deductions where there was no actual economic outlay and the payments were

“wholly circular”.14


      9
          Springfield Prods., Inc. v. Commissioner, T.C. Memo. 1979-23.
      10
       See Pike v. Commissioner, 78 T.C. 822, 849 (1982), aff’d without
published opinion, 732 F.2d 164 (9th Cir. 1984); Steinberg v. Commissioner, T.C.
Memo. 1995-116.
      11
           Blumeyer v. Commissioner, T.C. Memo. 1992-647.
      12
           Weaver v. Commissioner, 121 T.C. 273, 278 (2003).
      13
     Ang v. Commissioner, T.C. Memo. 2014-53; Estate of Rosen v.
Commissioner, T.C. Memo. 2006-115.
      14
        Oren v. Commissioner, T.C. Memo. 2002-172, aff’d, 357 F.3d 854 (8th
Cir. 2004). Because respondent did not raise a substance-over-form argument, we
                                                                    (continued...)
                                         -8-

[*8] Mr. Vanney was the sole shareholder of Vanney Associates. Ms. Vanney,

as Vanney Associates’ bookkeeper, knew or should have known that Vanney

Associates did not have the funds to cover the bonus check to Mr. Vanney, and

Mr. Vanney testified to having at least some idea of this as well.

      Vanney Associates argues that the payment was unconditional and payment

occurred when Mr. Vanney took possession of the check. Vanney Associates cites

O’Connor v. Commissioner, T.C. Memo. 1954-90, where this Court held that

“[t]he essential element is that the control of property distributed by way of a

dividend must have passed absolutely and irrevocably”. The Court in O’Connor

also relied on the fact that the payee had “unrestricted use” of the money and the

“amount was unqualifiedly his, to do with as he wished.” That is not the case

before us. If anything, Mr. Vanney had only restricted use of the check. He could

not cash it at the bank, use it to pay a debt, or use it to make a loan to someone

other than to Vanney Associates. In fact, Mr. Vanney’s only option to make use of

the money at that time was to lend it back to Vanney Associates because the check

could not be honored. Additionally, we have previously held that although a

taxpayer maintains possession of a check, the amount of the check may not be


      14
        (...continued)
will not address it here.
                                        -9-

[*9] treated as a distribution or may not be included in gross income when the

account has insufficient funds to honor the check.15

      Accordingly, respondent’s disallowance of a portion of the deduction for

officer compensation is sustained.

III. Conclusion

      On the basis of our examination of the record before us and the parties’

arguments at trial, we find that Vanney Associates is not entitled to deduct the

portion of officer compensation relating to Mr. Vanney’s yearend bonus. Vanney

Associates did not have the funds to cover the check when it was presented to Mr.

Vanney. Accordingly, the check could not have been paid, and respondent’s

determination to disallow the deduction is sustained.

      We have considered the parties’ arguments and, to the extent not addressed

herein, we find them to be irrelevant, moot, or without merit.




      15
        See Fountain v. Commissioner, 59 T.C. 696, 702 (1973) (holding that
checks were not treated as distributions of money when the accounts had
insufficient funds and the payees treated the checks as notes payable); see also
Johnston v. Commissioner, T.C. Memo. 1964-323 (holding that a check was not
included in gross income during the previous year even though the payor dated the
check for the previous year because the payor told the payee that sufficient funds
would not be available to satisfy the check until the later year).
                                       - 10 -

[*10] To reflect the foregoing and the concessions of the parties,


                                                Decision will be entered for

                                      respondent.
