Sibling Rivalry

[fjd_98]

Dick and Jane own a small business (S Corp) together. Both work for the business. Jane does some light bookkeeping and Dick does everything else. Jane stops working at the business and demands to be bought out for $250K. Dick refuses as the corporation has a net value approaching $0, given the debt it carries. Jane sues Dick and the corporation. Dick prevails and a buy out of $50K is agreed to. The buyout is executed at the end of January 2013. Dick paid $30K in legal fees in 2012 to get to that point.

I belive that Dick could claim that the $30K he paid the lawyer was actually an expense of the corporation. However, he does not want Jane to get part of the benefit of the write-off on her K-1. What are his options?

Are these legal fees deductible on Schedule A?
Would they be subject to the 2% floor?
Is there a way that these costs could be capitalized as reorganization expenses and deducted over a period of years?

 

[Samir]

I'd just defer taking any benefits of the legal costs to the next tax year.

 

[fjd_98]

I didn't think a cash basis taxpayer could do that.

 

[Samir]

I think he can if he's paid for the expense personally. Then the corp is unaware of the expense until it is presented to the corp for reimbursement. The caveat to this is that he can't claim the expense on his personal taxes either until it is expensed by the corp.

 

[fjd_98]

That sounds reasonable... I think. Can anyone else confirm this?

 

[Samir]

Yes, please confirm! I'm no tax expert for sure!

I look at it this way--in an audit, the IRS would find that you overpaid taxes in year x because you had this deduction. So then they have to give a refund+interest. Then, they'll show that you underpaid tax in year x+1 since the expense was not allowed there, and will charge penalty and interest. Typically, the interest rates are the same for the IRS whether it is giving or receiving money. So what does the IRS really have in a net gain? The penalty? And the penalty alone probably wouldn't justify the time for such an audit. They've got much bigger fish to fry...