spouse working for no compensation

Why? Many people work for companies without pay (e.g. interns).

Do they file a joint return?

Seth

The expenses are allowable to the business only if the business is paying them. You appear to describe a situation in which the wife of the owner is paying the expenses out of pocket without reimbursement from his employer (the S-corp). If so, he will deduct those unreimbursed job related costs on Form 2106 and Schedule A.

I'm sure you've noticed I refer to he husband as an employee. That's because you described an employer-employee relationship.

an S-Corp (she owns 100% of the stock); her

For clarity, the wife is the owner of the company. The husband is generating almost 100% of the expenses, most of which involve travel. So, come audit time, his name is going to be on all the airline tickets, hotel bills, etc., yet he is not an owner nor is he receiving compensation (as an employee or independent contractor). Right now, no one is receiving any compensation, including the owner (but they have yet to show a profit).

But then is there a true employer-employee relationship? If he is a wage worker, then I'm pretty sure there would be some minimum wage laws being violated. If he is "salaried" (exempt), I would still think there needs to be some evidence of an employer-employee relationship (meeting the 20 common-law rules, and so on).

He can't deduct unreimbursed employee expenses if he is not an employee.

By far the simplest thing would be for the company to reimburse him under an accountable plan.

Brew1, if you do prepare the return, perhaps you should include a Form

8275 disclosure. The absence of a W-2 coupled with a claim of unreimbursed employee expenses is definitely an unusual situation, to say the least.

-Mark Bole

First (should have been obvious) question: are they in a community property state? If so, they are the same "person" for tax purposes.

The issue is who _paid_ the expenses. From which account were those bills paid? Who owned that account?

Seth

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At least for income tax. The FICA taxes is a little more complicated.

Are you saying community property laws apply to corporations? I don't understand how this affects the situation as stated... what would be different solely due to community/separate property rules?

-Mark Bole

,

If it's community property, they each own 50% of the corporation, and any money the husband pays for expenses is half his wife's, so deductibility applies. (Yes, I know that's simplifying; if he pays from segregated assets he owned before the marriage, _and_ she owned the corporation before the marriage and kept it as a segregated asset, then lawyers could make the whole issue more interesting than anybody else wants it to be.)

Seth

This is not in a community property state.

I appreciate all the input and now have a grip on how I'll handle this situation next year--hopefully they have made the changes I recommended last year, otherwise I will decline to do either the corporate or personal return.

I'm still not sure about this. For example, an S-corp accounts for wages paid to shareholders differently than wages paid to other employees. AFAIK, the corporation still has only one shareholder (the wife), and the question still remains, is the husband a non-shareholder employee, or a non-paid volunteer? I don't see how the corporation can consider the husband to be a shareholder. If the corporation has legitimate business expenses paid either directly or by reimbursement, then they are deductible at the corporate level.

Now, we cross the boundary in the realm of individual taxes. Community property rules *only* come into play when a married couple files separately. But even then, I don't think a non-employee spouse can claim unreimbursed employee business expenses for items paid by the employee spouse (but that is an interesting question... maybe time for a tax research expedition...).

It sounds to me like you are saying that community property rules flow upstream into the corporate entity, that doesn't sound right to me. If it were a sole proprietorship, then it's a different matter.

Even under community property rules, each spouse can still own property in their own name, such as shares of stock. The *income* from such property belongs to the community, and if the community *ends* (divorce or separation), then perhaps the property is subject to being split (transfer ownership of half of the shares), but this last item is a legal issue, not a tax issue.

-Mark Bole

You've gotten a lot of responses to this, but there seems to be one thing that is either missing or wasn't elaborated on sufficiently (to suit me).

The expenses can only be deducted if they are paid by the corporation OR if the corporation requires the employee to pay certain employee business expenses out of pocket. Since your client's spouse is NOT an employee (he gets no wage) any money he spends out of pocket is essentially lost. I think the best case on this is Kliethermes vs.. United States, KTC 1992-129 (Ct. Cls. 1992).

Briefly, Kliethermes paid certain corporate expenses out of his pocket and claimed them as employee business expenses on his personal return. The IRS said NO - you are not personally responsible for paying corporate expenses, no deduction is allowed. Also, he was not allowed a deduction on the corporate return because the corporation did NOT pay the expenses. Essentially the money was wasted, no deduction was allowed on either return.

This could have been avoided in one of several ways -

A - the corporation could have reimbursed him under an Accountable Reimbursement Plan;

B - the corporation could have paid the expenses directly;

C - the corporation and he could have entered in an agreement that required him to pay certain expenses

OR my personal favorite -

As a stockholder of the corporation there could have a been a simple book entry to record the expenses with offsetting entry to additional paid in capital. This would get the expense on the corporate books where it belongs AND give him basis in his investment in the corporation for the money he disbursed.

In this particular situation, you have a spouse working for a company for which they are neither an employee nor a stockholder - I understand why he's not an employee, there's no money to pay him (presumably - but then the question is where is the money coming from for him to pay the expenses?). BUT why isn't he a stockholder?

Were this my client, I'd book the money spent and offset it to APIC - the corporation gets the deduction, the stockholder gets basis, the books properly reflect the substance of the transaction and everyone is happy.

Gene E. Utterback, EA, RFC, ABA

Your post is very thorough, which is much appreciated. I have seen reference before to "Accountable Reimbursement Plan". What is this? Does it need to be in writing? How formal? Any sample language out there?

Wallace wrote: [snip]

This explains it quite thoroughly:

Here's a sample plan (MS Word Doc):

Wallace wrote: [snip]

Note: This may be a duplicate as I never got a sent confirmation on the first try.

This explains it quite thoroughly:

Here's a sample plan (MS Word Doc):

Your post is very thorough, which is much appreciated. I have seen

It is a written plan adopted by the company that provides for reimbursement for certain allowed employee expenses, if submitted timely and contains documentation of that expense.

See IRS Pub 535 page 8 for example. Or Pub 463.

If reimbursed via an accountable plan, the employee does not declare the income.

See

4471,00.html

Here is what some kind soul posted as a sample accountable plan -- no guarantees that it is sufficient or correct but looks good after a surface scan.

I do see a lot of statutory language for California that says things like "a judge can order transfer of ownership of half of community property", but except in a divorce I've never heard of a court getting involved in spousal ownership-and-control-of-property issues. IANAL.

-Mark Bole