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Tax Court rules employee received advance payment instead of loan

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Tax Hot Topics - Tax Court rules employee received advance payment instead of loanThe Tax Court issued a decision in Starke v. Commissioner (T.C. Summary Opinion 2015-40) addressing whether an employee received an advance payment, which can be included in income when the advance is made, or whether the employee received a loan, which can be included in income if and when the loan is forgiven.  

The case was brought by George Starke, who established a school that taught people in the community to become automotive service technicians. During Starke’s employment, he had access to a business credit card that he used for both business and personal expenses. For personal expenses, the organization treated the expense as an advance to Starke by recording it as an advance on the organization’s books. All of Starke’s advances occurred between 2003 and 2006.  Between 2007 and 2010, the organization withheld amounts from Starke’s pay to offset the previous advances. Starke’s employment with the organization terminated in 2010, and the organization issued Starke a Form 1099-MISC reporting the balance of the advances as income to him. Starke didn’t include the amount in income.  

The IRS argued that the advances made to Starke were a loan by the organization to Starke. As a result, Starke should have recognized compensation income in 2010 equal to the amount of the loan forgiven by the organization (i.e., the amount of the advances not repaid by Starke). Conversely, Starke argued that the payments were advances and could be included in income when the advances were made in 2003 through 2006.

The Tax Court considered whether a debtor-creditor relationship was established at the time the funds (i.e., the advances) were distributed. The court found no evidence that Starke intended to repay the organization at the time the payments were made. In addition, there was no evidence of loan documents or any other documents memorializing a loan agreement. In fact, a letter from the organization’s accountants made it clear that the organization did not consider the payments to be loans.  

The court ruled that no loan existed between the organization and Starke. Thus, he wasn’t required to recognize income in 2010 related to loan forgiveness. Instead, these payments were advances that could be included in income when the advances were made. The advances were made in years closed under the statute of limitations, so Starke wasn’t required to include any amount in income related to the advances.

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Eddie Adkins
+1 202 521 1565
eddie.adkins@us.gt.com

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