When I left off yesterday, my client Fritz, sole owner of On the Fritz Auto Repair, Inc. was convinced that I was an unsympathetic nit-picking bookkeeper type, willing to see him risk the loss of marital bliss for no better reason than a sense of accountancy aesthetics. JR had found out the hard way that the consequences of having a corporation pay for your personal expenses can run deeper than getting your CPA all riled up. JR lost his home mortgage interest and tax deductions, because his wife´s corporation paid them for him.
What could JR have done to preserve his itemized deductions? There are at least two alternatives:
1. If he intended to pay back his wife´s corporation, he could have signed a promissory note to document the fact that the corporation has loaned him money and that he was obligated to repay it. JR´s wife could then have made out a corporate check to JR for the amount of the house payments, including taxes and interest, and JR could have used the money to make the house payments himself; or
2. If JR did not intend to repay the corporation, the corporation could have distributed a dividend to JR´s wife (it was an S corporation, so dividend distributions would probably not have been taxable), then JR´s wife could have given JR a gift in the amount needed to make the house payments, and JR could have made the house payments himself.
Either way, JR has paid the mortgage interest and taxes himself, so he will qualify for the deductions.
Since Fritz was not using the corporate credit card to pay for deductible expenses, he won´t be at risk for losing itemized deductions, as JR was. But there are other potential problems. For example, since On the Fritz is a "C" corporation, dividends paid to the shareholder are taxable, so even if Fritz later puts money back into the corporation, IRS could take the position that Fritz has received a taxable dividend and then made a non-deductible capital contribution to the corporation. To avoid unexpected problems, Fritz could have signed a promissory note to the corporation, or documented the credit card charge as an advance against his salary or repayment of money the corporation owes him.
"But this is unrealistic!" Fritz says. "I didn´t have time to do any of those things. I was there at the jewelry store, and all I had was the company credit card. I didn´t have time to go back to the office and make out a corporate check and deposit it into my personal account, much less do all that paperwork for notes or advances or whatever. Anyway, what´s done is done."
It´s better to plan ahead, but all is not lost. Fritz can document the loan or advance or repayment the next day, or the following week, or when I do the quarterly review for the corporation. But please, Fritz, don´t wait until you get the notice from IRS that your return is being audited! Take care of documenting transfers between you and your business entity on a day-by-day or at least week-by-week basis.