Father Denied Business Deduction for Payments to Son Who Lacked General Contractor License

Sometimes individuals want to take shortcuts to get around certain non-tax rules and regulations.  In the case of Gaunt v. Commissioner, TC Memo 2018-78, the couple ran into tax issues when attempting to assist their son who lacked a general contractor’s license.

The exact situation was described as follows by the Tax Court:

During the years in issue James Gaunt (petitioner) was the sole proprietor of All American Pool and Spa (AAPS). AAPS built in-ground pools (and to a lesser extent, spas). Most of its clients were homeowners in Los Angeles. Petitioner’s role at AAPS was that of a general contractor: He would negotiate a fee for a project, then hire and supervise subcontractors to perform whatever tasks were required. These subcontractors included excavators, steelworkers, electricians, cement masons, tilers, and landscapers. In most instances AAPS paid the subcontractors by check.

Petitioner’s son, David, owned a plumbing company called David Gaunt Pool Services (DGPS). DGPS designed plumbing systems for pools and often worked on the same projects as AAPS. DGPS was not a subcontractor to AAPS and negotiated its fee directly with customers. But this arrangement was complicated by the fact that David lacked a general contractor’s license. Petitioner, who had the required license, sometimes agreed to accept payments on his son’s behalf. He deposited each payment into an AAPS bank account and then remitted it, either in cash or by check, to David. He remitted at least $20,745 to David or DGPS during 2008.

Presumably, Dad did this to cover the fact that his son was doing work that required a general contractor’s license. Dad picked up the income and then claimed an offsetting deduction for the payment to his son.

But the IRS questioned whether, given that David was not a subcontractor, whether the payment represented an ordinary and necessary business expense.

The Tax Court agreed, holding:

…because DGPS was not a subcontractor to AAPS, checks issued to it (or to David on its behalf) were not “ordinary and necessary” expenses of AAPS' business and hence were not deductible. We therefore find that petitioners are entitled to a deduction for contract labor of only $55,700 ($80,845 - [$4,400 + $20,745]).