In the recent decision of Alioto v. Commissioner, T.C. Memo. 2025-125, the United States Tax Court addressed the consequences of a taxpayer failing to respect the separate existence of his closely held corporation. The Court ruled in favor of the Commissioner regarding deficiencies stemming from unreported wage income, constructive dividends, and capital gains, while simultaneously disallowing personal deductions for corporate business expenses. For tax professionals, this case serves as a stark reminder of the rigorous substantiation requirements for accountable plans and the application of the "duty of consistency" in preventing taxpayers from taking contrary positions to those of their controlled entities.

Factual Background

The petitioner, David S. Alioto, incorporated Probity Enterprises, Inc. (Probity) in 2011 to provide logistics services. While initially the sole shareholder holding 1,000 shares at a par value of $0.01, Alioto engaged in several stock transfers with his wife in 2014, eventually retaining 499 shares while his wife held 501. In June 2014, Probity entered a contract with Transplace Texas, LP, which paid Probity a $105,000 "program fee" and monthly commissions.

Contemporaneously, Alioto entered into an employment agreement with Probity for $550,000 in deferred compensation payable in January 2018. Subsequently, in February 2015, Alioto executed a promissory note to purchase 125 "treasury" shares from Probity for $500,000. The note’s maturity date aligned closely with the deferred compensation payout date, and Alioto made no payments on the note, claiming an offset against the unpaid compensation.

During the years at issue (2014 and 2015), Probity transferred funds to Alioto’s personal accounts—$89,900 in 2014 and $6,044 in 2015. Additionally, Probity paid various personal living expenses for Alioto, including food and fuel. On his personal return, Alioto reported negative income, claiming substantial Schedule C business expense deductions that effectively zeroed out his tax liability. He also sold shares of Probity stock to family and associates in 2015.

Taxpayer’s Request for Relief and Arguments

Alioto contested the IRS deficiency determinations on several grounds. Regarding the cash transfers, he argued the 2014 payments were non-taxable advance expense reimbursements under an accountable plan, and the 2015 payments were a return of capital used to test a payment portal. Regarding the payments of personal expenses, he asserted they were business-related.

Concerning the stock sales, Alioto argued he incurred a capital loss rather than a gain. He contended that the shares sold were the high-basis treasury stock (purchased via the $500,000 promissory note) with a basis of $4,000 per share, rather than the original penny stock. Finally, he argued entitlement to deduct Probity’s operating expenses on his personal Schedule C, suggesting the expenses stemmed from his strategic consulting business.

Court’s Analysis of the Law

Burden of Proof and Recordkeeping

The Court reiterated that while the IRS generally bears the presumption of correctness, the burden shifts to the Commissioner for "new matters" or increases in deficiency raised in the amended answer. Because the IRS increased the asserted deficiency based on an audit of Probity performed during the litigation, the Commissioner bore the burden of proving the constructive dividends and the specific capital gain amounts.

Unreported Wage Income and the Duty of Consistency

The Court rejected Alioto’s claim that the 2014 transfers were accountable plan reimbursements. To exclude such payments from gross income under Treasury Regulation § 1.62-2(c)(4), an arrangement must satisfy business connection, substantiation, and return of excess requirements. Alioto failed to introduce a plan into evidence or demonstrate compliance with these regulations.

Crucially, the Court applied the "duty of consistency" to classify the payments as wages. This quasi-estoppel doctrine prevents a taxpayer from benefiting in a later year from an error in an earlier year, or from taking a position contrary to one acquiesced to in a prior representation. The Court found that Alioto, as the "animating force" and president of Probity, had a sufficiently close relationship with the corporation to be estopped by its tax reporting. Since Probity—with Alioto’s participation—accepted a deduction for officer compensation during its own examination, Alioto was precluded from recharacterizing those same amounts as non-taxable reimbursements on his personal return.

Constructive Dividends

The Court applied the standard that an economic benefit conferred on a shareholder without expectation of repayment constitutes a constructive dividend. The IRS established that Probity paid $13,282 (2014) and $1,377 (2015) for Alioto’s personal expenses. As Alioto provided no evidence to substantiate the business nature of these expenses beyond self-serving testimony, the Court sustained the constructive dividend treatment.

Capital Gains and Basis in Promissory Notes

The Court’s analysis of the capital gains issue focused on the basis of the stock sold. Alioto failed to substantiate which block of stock was sold (the penny stock or the alleged $4,000/share stock). More importantly, the Court analyzed the basis of the shares acquired via the $500,000 promissory note.

Under Section 358(a)(1), the basis of property received in a Section 351 exchange is the same as the property exchanged. Citing Alderman v. Commissioner, the Court held that a taxpayer incurs no cost in making their own note; thus, the basis in the note—and the resulting stock—is zero. The Court distinguished Peracchi v. Commissioner (which allowed basis for a note in a bankruptcy-risk scenario), noting that Alioto held the unilateral right to offset the note against his employment agreement, rendering the debt illusory. The Court concluded the parties lacked a bona fide intent to create a debtor-creditor relationship, resulting in zero basis for the shares and confirming the capital gain.

Schedule C Deductions for Corporate Expenses

The Court firmly rejected Alioto’s attempt to deduct Probity’s expenses on his personal Schedule C. Citing Moline Properties, Inc. v. Commissioner, the Court emphasized that a corporation is a separate taxable entity. Shareholders cannot deduct corporate expenses, even if they pay them personally; such payments are treated as capital contributions or loans. Furthermore, the Court noted that Alioto failed to meet the strict substantiation requirements of Section 274(d) for the car, truck, and travel expenses claimed.

Conclusion

The Tax Court decided in favor of the Commissioner on all substantive issues. The Court held that the payments from the corporation were taxable wages, supported by the duty of consistency. The personal expenses paid by the corporation were taxable constructive dividends. The stock sales resulted in capital gains because the shares purportedly purchased with a circular promissory note had a basis of zero. Finally, the petitioner was denied all Schedule C deductions for corporate expenses due to the separate entity doctrine and lack of substantiation. The Court also upheld additions to tax for failure to file and failure to pay estimated taxes, as the petitioner abandoned these challenges on brief.

Prepared with assistance from NotebookLM.