When you are trying to close a deal or get a deduction before year-end, it can be tempting to get the family involved. Paying a deductible expense to a relative or, better yet, a controlled corporation can seem like a way to have your deduction and eat it too.
Be careful. The tax law has lots of rules to keep people from gaming the system through related parties. These rules can trip you up even when no trickery is involved or intended.
For example, Code Section 267 only allows a deduction to a related party “as of the day as of which such amount is includible in the gross income of the person to whom the payment is made.” That’s no problem if the “related party” is on the accrual method, because they will be accruing the income at the same time you accrue the expense. But if the related party is a cash-basis taxpayer, you have to pay this year to get a deduction this year.
Who is “related?” Most problems arise with closely-held accrual-method businesses and their cash basis owners. If you have a C corporation, only owners of more than 50% of the stock, and their families (siblings, spouses, ancestors and descendants) are related. Families are usually considered as a single owner for the 50% test. For pass-through entities — partnerships and S corporations — any owner is a related party, along with members of owners families and anybody related to the family members.
Accruing expenses isn’t the only way to run into problem with related parties, though, so if you are trying to make a tax move before year end involving relative or controlled entities, be sure to get your tax pro involved too.
Come back every day through December 31 for more 2013 year-end tax tips!