Remember those television commercials around Christmas season that showcased a new Lexus with red holiday bow as a present? Those commercials must have been generated by a producer whose earlier career involved the practice of tax law, as exemplified by the following Tax Court case.
Mr. Wright was the sole shareholder and president of HJ Builders, a corporation engaged in residential construction and real estate development. On July 10, 2001, HJ Builders made a payment of $12,155 to "Lexus." The Lexus was driven exclusively by Mrs. Wright, who was not a salaried employee of HJ Builders and was listed as a "housewife" on the Wrights' 2001 income tax return. No mileage logs were kept by Mrs. Wright or HJ Builders with respect to the Lexus.
Upon audit, the IRS issued notices of delinquency to the Wrights on the basis that the $12,155 payment to Lexus by HJ Builders was for a personal vehicle and the payment was taxable as constructive dividend income to Mr. Wright. The notices also asserted negligence penalties under Internal Revenue Code Section 6662 with respect to the Wrights and HJ Builders.
Neither the Wrights nor HJ Builders presented any reliable evidence that the Lexus was a business asset. Although Mr. Wright testified that his wife used the Lexus exclusively for business, she did not appear at trial. Deductions related to passenger vehicles are not allowable unless the taxpayer substantiates by adequate records, or by sufficient evidence corroborating the taxpayer's own statement, the time, place, and business purpose of the vehicle's use.
HJ Builders and the Wrights claimed the payment to Lexus was not income to the Wrights because the Lexus vehicle was a business asset. No record of use of the Lexus was provided by either the Wrights or HJ Builders. The Tax Court thus concluded the $12,155 payment to Lexus was a personal expense of the Wrights paid by HJ builders and thus a constructive dividend by HJ Builders to Mr. Wright, its sole shareholder.
When a corporation pays the personal expenses of a shareholder without expectation of repayment, it may have made a constructive dividend distribution which is taxable to the shareholder. Whether a constructive dividend exists turns on whether the distribution was primarily for the benefit of the shareholder.
Section 6662 imposes a 20-percent accuracy-related penalty on any underpayment of Federal income tax attributable to a taxpayer's substantial understatement of income tax or negligence or disregard of rules or regulations. Negligence includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code. The evidence in this case was quite clear that neither HJ Builders nor the Wrights maintained adequate records to substantiate deductions, and that they acted carelessly, recklessly, or with intentional disregard of Internal Revenue Service rules or regulations.
If the Lexus was a Christmas gift from Mr. Wright to Mrs. Wright, it was a very, very expensive gift.