Taxpayer May Not Disregard the Corporate Form by Taking Personal Deductions for Paying Corporate Obligations

Schulmann v. Director, New Jersey Div. of Taxation, 423 N.J. Super. 333  (App. Div. 2011).  Daniel Schulmann used personal funds to pay certain commissions that two “S corporations” were contractually obligated to pay to instructors at Tiger Schulmann karate schools.  The corporations did not report those commissions as expenses on their corporate business tax returns.  Instead, Schulmann and his wife deducted the commissions from their S corporation income on their personal tax returns.  The Division of Taxation disallowed that deduction.  The Schulmanns appealed to the Tax Court, which upheld the Division’s ruling.  On further appeal to the Appellate Division, the Schulmanns lost again.  Judge Reisner wrote for the panel, which affirmed on the Tax Court’s opinion.

Judge Reisner added some important notes.  First, New Jersey’s Gross Income Tax Act was not based on the federal Internal Revenue Code.  Thus, some deductions permitted under the federal regime are not allowed under New Jersey’s scheme.  Schulmann’s attempt to “cross-net” the S corporations’ commissions against his own income from those corporations was one of the disallowed deductions.

Second, Judge Reisner emphasized that “regardless of Schulmann’s reasons for paying the commissions from his own funds, he may not disregard the corporate form by taking personal deductions for paying corporate obligations….  [W]hile a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not …, and may not enjoy the benefit of some other route he might have chosen to follow but did not.”

This principle has an important parallel in the civil arena, where our Supreme Court has made clear that “one who accepts the benefits of incorporation must also accept the burdens that flow from the use of a corporate structure.”  Lyon v. Barrett, 89 N.J. 294, 300 (1982).  While there are societal values that support the allowance of the corporate form, parties cannot be permitted to use that form when it suits them and abandon that form when it does not.  Judge Reisner’s decision, and that of the Tax Court judge whom the Appellate Division affirmed, wisely implement that larger principle.