However, the IRS may look twice at an operation if it includes multiple business entities — especially if recordkeeping and filing requirements aren't handled properly. One construction firm in Georgia

Under the tax code, a business is allowed to deduct all ordinary and necessary expenses. But the Tax Court noted: "As a general rule, payment by one taxpayer of the obligation of another taxpayer is not an ordinary and necessary expense" and is not deductible.

discovered that lesson the hard way when it took deductions that actually belonged to one of its corporate affiliates.

In the case, two married couples were shareholders of an S corporation. A.J. Concrete Services supplied concrete forming equipment and materials to various contractors. The shareholders transferred long-term construction contracts to four newly-formed C corporations affiliated with the original corporation.

The IRS disallowed more than $2 million in deductions because they were related to expenses incurred after the contracts were transferred. The fact that the balance due on the contracts was paid to the affiliates indicated that the transfers had occurred.

The reason for the transfer of the contracts: According to court documents, the S corporation wanted to get out of the concrete forming business and go into the business of providing management services to the C corporations in exchange for fees.

The Tax Court ruled the deductions benefited the C corps — rather than A.J. Concrete Services — so the shareholders could not write off expenses relating to the contracts that were paid after the transfer.

Furthermore, the Appeals Court ruled the corporation was not entitled to a deduction for Workers’ Compensation premiums since it had no workers in the construction business at the time the payments were made. (Bone, CA-11, 3/21/03).