This post was originally published on Forbes Jul 21, 2015
Larry Zavadil, founder and CEO of American Solutions For Business, may have gotten a raw deal from the IRS and the Tax Court on his 2005 charitable contributions and the Eighth Circuit is not cutting him any slack in its decision last week. There is a useful lesson to accountants in the decision. The lesson is that life is easier if you have everybody pay their own bills. It is really a variation of Reilly's Fourth Law of Tax Planning - "Execution isn't everything but it's a lot".
At the end of certain months in 2004 and 2005, however, Zavadil's personal bank account had insufficient funds to reimburse American Solutions for the amount recorded on the ledger. For those months, Zavadil and American Solutions employed a system of advances that allowed the ledger to reflect a zero balance at the end of the month. At the end of each month, Zavadil wrote a personal check to the company, and the company brought the ledger balance to zero. At the beginning of the next month, however, American Solutions advanced funds to Zavadil's personal bank account to cover some or all of the amount of the check, recorded the advance as an expense on the ledger, and then cashed the personal check received at the end of the previous month.
As relevant to this appeal, the tax court ruled in favor of the Zavadils on charitable contributions made prior to July 2005, ruling that they were deductible because Zavadil reimbursed American Solutions for those contributions and thus bore the economic burden. The tax court, however, disallowed charitable deductions made from July 2005 through December 2005, because the Zavadils did not demonstrate that they—not American Solutions—bore the economic burden of those contributions. Because the record did not establish that Zavadil bore the economic burden of paying the entire ledger balance in any of those months, the court found that the Zavadils failed to prove “what portion, if any, of the charitable contributions made after June 2005 Mr. Zavadil effectively paid with his own funds and not funds advanced by [American Solutions].” The court also found no evidence that the ledger account balance at the end of 2005 represented bona fide indebtedness of Zavadil.
That Zavadil repaid all funds in the first half of 2005 did not necessarily show that he was obliged to do so, especially when there was no evidence that he did so in the second half. The court permissibly declined to accept accountant Carlson's testimony, given that the system of advances undermined the claim that Zavadil actually repaid the company in full at the end of every month. The requirement imposed by creditors that the company show a zero ledger balance at the end of each month did not exclude the possibility that American Solutions nonetheless bore the economic burden by reimbursing Zavadil for some or all of his end-of-month payments through advances at the beginning of the next month. And the company's obligation to make installment payments to Zavadil in exchange for his sale of the company does not establish that Zavadil was required to repay the advances. Zavadil points to no evidence that the company deducted the advances from its installment payments on the note, or that the note was designated as collateral for the advances. It was not clear error for the tax court to find Zavadil's evidence wanting.