Company's Payments for Coding Class Tuition Were Not Deductible Business Expenses

(Parker Tax Publishing March 2022)

The Tax Court held that a corporation could not deduct tuition it paid for a coding course taken by an individual who was dating the daughter of the corporation's owner and who, after completing the course, used the skills he learned to update the corporation's website. The court rejected the taxpayer's contention that it received website services in exchange for the tuition and instead found that the tuition was paid without any expectation of a return and thus did not have a business purpose as required by Code Sec. 162(a). Sherwin Community Painters, Inc. v. Comm'r, T.C. Memo. 2022-19.

Background

Sherwin Community Painters, Inc. (Sherwin) is a C corporation owned by Swanette Ward, a resident of Illinois. Sherwin is a commercial painting contractor for commercial warehouses, residential complexes, and multipurpose high rise buildings. Both Swanette and her husband, Robert, work for the business.

For its 2016 tax year, Sherwin claimed a business expense deduction for the costs of a coding course at Northwestern University for Lucas Kocemba. The Wards met Kocemba in 2016 when he was dating their daughter. Kocemba expressed an interest in the course, and the Wards offered to pay the tuition if he was admitted. Before taking the course, he worked in the construction industry and had no previous coding experience. After completing the course in 2017, Kocemba used the skills that he had learned to update Sherwin's website over the course of several months and spent a considerable amount of time working on the website. Sherwin did not pay him for his work. Kocemba later married the Wards' daughter. He has performed additional computer-related work for Sherwin without compensation.

Sherwin also claimed business expense deductions in 2016 for office equipment, office supplies, gas, entertainment, and promotional materials. The office equipment expenses related primarily to the purchase of iPads, iPhones, and accessories, which the Wards said were used by Sherwin's employees in the performance of their jobs.

In a notice of deficiency to Sherwin, the IRS disallowed Sherwin's business expense deductions based on its determination that the expenses did not have a business purpose and thus were not ordinary and necessary business expenses under Code Sec. 162(a). In a notice of deficiency to the Wards, the IRS recharacterized a shareholder loan of $38,199 as a constructive dividend from Sherwin to Swanette. A constructive dividend arises when a corporation confers an economic benefit on a shareholder without an expectation of repayment and is includible in the shareholder's gross income under Code Sec. 61(a)(7). Sherwin's tax return reported that the loan was in fact made from Swanette to Sherwin. Nevertheless, the IRS refused to concede its error and argued before the Tax Court that Sherwin's disallowed business expense deductions should be treated as constructive dividends to Swanette.

Analysis

The Tax Court held that Sherwin was not entitled to deduct the tuition expense for Kocemba's coding classes. The court said that Kocemba provided services to Sherwin free of charge that would have likely cost Sherwin more than the amount of the tuition. However, the court noted that Kocemba was not an employee of Sherwin. The court also noted that the Wards did not have an agreement with Kocemba that he would provide any services in exchange for the tuition payment. In the court's view, Sherwin paid the tuition without any expectation of a return and thus did not have a business purpose for the payment. The court concluded that the tuition was a personal expense and Sherwin was not entitled to deduct it.

Regarding Sherwin's expenses for office equipment, supplies and promotional materials, the court held that these expenses were deductible under Code Sec. 162(a). The court accepted the Wards' assertion as to the business purpose of the iPads and iPhones and found that Sherwin substantiated the amount and business purpose of each expense. The court also accepted the Wards' proffered business purpose of the office supplies and promotional items and concluded that they were allowed to deduct those expenses.

Finally, the court rejected the IRS's position that the disallowed business expense deductions should be treated as constructive dividends to Swanette. The court said that there was no relationship between the disallowed expenses and the amount of the purported constructive dividends. Sherwin's failure to substantiate the business purpose of the disallowed deductions, the court reasoned, did not render the amount a constructive dividend. The court found that there was no indication that the Wards received an economic benefit from the amount of disallowed expenses. Accordingly, the court held that the Wards did not receive any unreported dividends from Sherwin.

For a discussion of the deduction for ordinary and necessary business expenses, see Parker Tax ¶90,100.

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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