Losses from a sole proprietorship will usually offset an individual's other income. But if the business is housed in a C corporation, its losses are stuck in the corporation. Deciding whether the business is a sole proprietorship or a C corporation is easy - right? Not for the parents of a meddling son in Manjity Rochlani et al v. Commissioner, T.C. Memo 2015-174 (9/8/15).
In that case, the parents ran a ticket purchasing and resale business as a sole proprietorship, reporting net losses on Schedule C of their 1040. But their son - still a minor - decided on his own and without his parent's consent to incorporate the business using an online legal service. No assets were transferred to the new corporation. No corporate bank accounts were opened. All business receipts were deposited in the parent's personal bank accounts, and they used their own personal credit cards to pay expenses.
The father asked the son if he had incorporated the business. The decision doesn't say what the son's answer was. But the father "did nothing to stop or unwind the incorporation process." And, the father filed corporate annual reports with the state department of energy, labor and economic growth.
The court found that even though the son's incorporation wasn't authorized, the father's filing of state annual corporate reports "recognized and ratified the corporate form." The corporation was at best a mere shell - it had no assets, no bank accounts, no payroll, nothing. Except for the annual state corporate filing, it appears the parents acted the entire time as though the business was a sole proprietorship.
But that wasn't enough for the Tax Court. The court disallowed the parent's deduction of business losses on their personal return because it decided the business was housed in a C corporation. It observed that the ratification of the corporate form "requires the acceptance of its tax disadvantages."
Hopefully, the parents docked the son's allowance.