A United States Tax Court recently issued a decision after trial that should serve as a reminder to management and controlling shareholders of family-owned businesses that salaries or other compensation paid to family-member employees may only be deductible if the salaries are “reasonable.” In Transupport, Incorporated v. Commissioner of Internal Revenue, the Tax Court conducted a trial on the company, Transupport’s appeal of an IRS notice of deficiency. In the notice, the IRS had determined that amounts the company attempted to deduct for compensation to four sons of the company’s founder and president were not reasonable. The IRS also had disallowed the deductions to the extent of the unreasonable compensation and assessed a penalty based on a “substantial understatement of income tax.”
In business purchase agreements, including agreements between family members, the seller often retains pre-sale liabilities, such as tax liabilities, while the buyer assumes post-closing liabilities related to the business’ ongoing operations. But what happens when the buyer induces the seller to retain such liabilities through fraud? In Bailey v. Bailey, a U.S. District Court in Texas recently gave its answer when faced with a claim that a son defrauded his parents in connection with his purchase of the assets of their family-owned business.
According to the Court’s post-trial decision, Roger and Shirley Bailey owned an electrical services company. Their son, Jeffrey, had worked in the company for many years. In 2007, Roger and Shirley decided they no longer wanted to manage the company and put Jeffrey in charge. Shirley’s sole remaining responsibility was to control the cash disbursements from a bank account that she controlled as the company’s treasurer. In doing so, Shirley relied solely on requests for funding by the company’s bookkeeper. Continue Reading Watch out for Fraud in Family-Business Purchase Agreements