Corporate Concealment

Not all corporations are large publicly traded entities.  Many small business owners form corporations to limit liability, bring in investors and establish a governing structure for their business.  While corporations must pay taxes, they can still be used to evade income taxes.  By using a corporation to improperly conceal income or pay for personal expenses, taxpayers may not only be liable to shareholders but will also invite scrutiny from the Internal Revenue Service.

As with any small business, expenses can be deducted from a corporation’s income.  So when a corporation expends money on salary, supplies or inventory, those expenses get reduced from the corporation’s income.  But if corporate funds are diverted to personal expenses or into the accounts of shareholders, this can allow owners of the corporation to improperly conceal income.  The corporation deducts the expenditure as a legitimate expense while the taxpayer fails to report the income.

A taxpayer however must pay income tax on any income received from the corporation.  One way that some individuals have attempted to take advantage of the corporate structure to conceal income is to have the corporation pay personal expenses and deduct these as business expenses.  The taxpayer then fails to claim the expenditures on his tax return as income.  While there is nothing wrong with a corporation paying the expenses of employees, the IRS will prosecute those who use corporate funds to pay for personal expenses while not claiming any income.  The IRS is also likely to target a taxpayer who allocates his income from the corporation to a family member in order to avoid a higher tax bracket.

If a taxpayer is charged with using corporate funds as personal income in order to evade taxes, one possible defense available is the claim that the corporation lacked sufficient earnings and profits.  If a corporation did not have sufficient earnings and profits to actually pay for the diverted funds, some taxpayers have been successful in arguing that the expenditures are merely a non-taxable return of capital contributions.  The government must prove that the corporation actually had earnings and profits in order to substantiate a case of tax evasion.

And like all concealment schemes, there is nothing wrong with creating a corporation, even if part of the reason is to minimize tax liability.  In fact, limiting personal liability is the entire purpose of a corporation.  But when a taxpayer attempts to conceal income from the IRS through corporate expenses and deductions, the IRS may seek criminal penalties.

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