It might be advantageous from a tax standpoint to run a business through multiple entities. For example, a construction company might form a separate company to own and lease its trucks and equipment back to its related entities. Or a corporation might transfer appreciated property to an affiliated corporation in order to limit risk in case it is sued.
However, the IRS may look twice at an operation if it includes multiple business entities — especially if recordkeeping and filing requirements aren’t handled properly. One construction firm in Georgia discovered that lesson the hard way when it took deductions that actually belonged to one of its corporate affiliates.
In the case, two married couples were shareholders of an S corporation. A.J. Concrete Services supplied concrete forming equipment and materials to various contractors. The shareholders transferred long-term construction contracts to four newly-formed C corporations affiliated with the original corporation.
The IRS disallowed more than $2 million in deductions because they were related to expenses incurred after the contracts were transferred. The fact that the balance due on the contracts was paid to the affiliates indicated that the transfers had occurred.
The reason for the transfer of the contracts: According to court documents, the S corporation wanted to get out of the concrete forming business and go into the business of providing management services to the C corporations in exchange for fees.
The Tax Court ruled the deductions benefited the C corps – rather than A.J. Concrete Services – so the shareholders could not write off expenses relating to the contracts that were paid after the transfer.
Furthermore, the Court of Appeals ruled the corporation was not entitled to a deduction for Workers’ Compensation premiums since it had no workers in the construction business at the time the payments were made. (Bone, CA-11, 3/21/03).
Splitting an operation into more than one entity is not right for everyone and the transaction must be handled with utmost care. Your accountant can help determine the best structure for your business (such as an S corp, C corp or LLC) and whether you should change your entity based on current conditions.
For more information, please contact Tom Bailey via our online contact form.
Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.