The Tax Court held that a corporate taxpayer could not deduct its payment of an expense of another entity. According to the court, the taxpayer's payment did not primarily benefit its own business, and the payment was not an ordinary and necessary expense of the taxpayer.
Facts: In 2010, Plano Molding Co. (Plano), an Illinois-based manufacturer of plastic storage cases and containers for outdoor sporting goods, retained Robert W. Baird & Co. as its financial adviser for purposes of a sale of the company. In 2012, Baird suggested to the Ontario Teachers' Pension Plan Board (OTPP), a large, not-for-profit institutional investor, that it should buy Plano. The OTPP decided to acquire Plano through a merger transaction and organized Plano Holding LLC (Holding) and Plano Acquisition LLC as its wholly owned subsidiaries to effect the merger.
The merger of Plano and OTPP was closed in 2012. OTPP also agreed (in a separate agreement) to pay Baird $1.5 million for suggesting Plano to OTPP; however, Plano paid Baird that amount.
On their 2012 consolidated federal income tax return, Holding and Plano deducted $1.05 million of the $1.5 million fee and capitalized the remaining amount. The IRS disallowed the deduction, claiming that Plano had not incurred or paid the amount for ordinary and necessary business purposes and issued Holding a deficiency notice of $90,385 plus an accuracy-related penalty of $18,077. Holding petitioned the Tax Court for relief.
Issues: Sec. 162(a) allows a deduction for expenses directly connected to a taxpayer's business that are ordinary (common for that business in the industry in which it operates) and necessary (helpful and appropriate for that business). Generally, a taxpayer cannot deduct the payment of another's expenses. However, in Lohrke, 48 T.C. 679 (1967), the Tax Court allowed a deduction for payments of another's obligation when (1) the primary motive for the payment is to benefit the taxpayer's own business by protecting or promoting it, and any benefit received by the other party is incidental; and (2) the payment is of an ordinary and necessary expense of the taxpayer's business.
To show that a payment primarily benefits a taxpayer's own business, the taxpayer must show a direct connection between the payment's purpose and the taxpayer's business. This can be accomplished by showing that failure to make the payment would have direct and proximate adverse consequences on the taxpayer's business. The IRS argued that Holding satisfied neither of the two conditions outlined in Lohrke.
Holding argued that the payment facilitated its acquisition by OTPP, enabling Plano to expand its business.
Holding: The Tax Court held that the payment satisfied neither prong of the Lohrke test and disallowed the deduction. The court held that Plano did not benefit from its payment to Baird, but, rather, OTPP received the primary benefit, as the payment might motivate Baird to bring potential acquisitions to OTPP's attention in the future. Also, according to the court, Holding did not demonstrate that Plano would have suffered any negative consequences had it not made the payment, because there was no evidence that OTPP would have reduced its financial backing of Plano.
While Holding's failure to satisfy the first test of Lohrke was enough to disallow the deduction, the court also held that the second test of Lohrke, that the expense must be an ordinary and necessary expense, was not met as well. The court held that the amount Plano paid to Baird was for Baird's work for OTPP identifying Plano as a potential acquisition, and while the fee could be considered an ordinary and necessary expense of OTPP, an institutional investor, Plano's payment of the fee was not connected to Plano's business of manufacturing plastic goods.
Holding also argued that its situation was similar to that of the plaintiff in Square D Co., 121 T.C. 168 (2003). In Square D, the court allowed a corporate taxpayer's deduction when its corporate parent had negotiated a loan commitment and agreed to pay the related fees on the taxpayer's behalf before it was organized as the parent's subsidiary. The subsidiary later received the loan proceeds, paid the loan fees, and took a tax deduction. The court distinguished Square D from this case, stating that the taxpayer making the payment in Square D also received the benefit (the loan proceeds) from the payment. However, in this case, OTPP had acted on its own behalf, not Plano's, when it had agreed to pay Baird the $1.5 million.
The court also upheld the IRS's assessment of the accuracy-related penalty.
- Plano Holding LLC, T.C. Memo. 2019-140
— By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota—Duluth.