If business owners are overly aggressive, the IRS may challenge deductions claimed for business activities. Depending on the nature of the expenses, the IRS may even say that the payments are “constructive dividends” resulting in tax liability for the owner. In a new case, Alioto, TC Memo 2025-125, 12/4/25, a C corporation paid the personal expenses of its main shareholder, with adverse tax consequences.
Background: Typically, a C corporation pays out dividends to its shareholders, based on earnings for the year. The exact amount of dividends a shareholder receives is based on their proportionate interest in the company. These dividends are declared by the company on a specific date and then paid out or reinvested.
However, a company may make other payments to several shareholders, or even just one, such as a sole business owner. If the company doesn’t report the payment to the IRS as a dividend, the IRS may deem it to be a constructive dividend to the extent the corporation has earnings and profits.
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This often happens when owners of a successful closely-held business uses corporate funds to pay personal expenses like rent or a mortgage, but it can also occur with larger companies. The key takeaway is that you can’t do what you want simply because “it’s your company.”
At least, qualified dividends are taxed at the same favorable tax rates as long-term capital gains. Currently, the maximum tax rate for qualified dividends is 15% (20% for high-income taxpayers). On the downside, dividends can’t be deducted by the company. Conversely, wages paid to employees are taxable at ordinary income rate reaching as high as 37%, but those amounts are deductible by the company.
Facts of the new case: The taxpayer, a resident of Ohio, had many years of experience in the freight transportation industry. His career began in 1986 and included stints as the chief executive officer of two transportation logistics companies, including one that he started himself. Her later transitioned into strategic consulting.
Eventually, the taxpayer started another company as the sole shareholder, formed as a C corporation. He subsequently sold some shares but retained a controlling interest and continued to act as the CEO. He was paid an annual salary for these services.
During the two tax years in question—2014 and 2015—the C corporation paid some personal expenses of the taxpayer, primarily food and fuel. The total for the two years came to approximately $15,000. Although the taxpayer claimed that these expenses were related to the business, he offered no evidence to refute the IRS’ conclusion that these were his personal expenses.
Bottom line: The Tax Court treated the payment of personal expenses as constructive dividends. Accordingly, the taxpayer owed back taxes on the dividend income.
Advise clients who are business owners of this potential danger. Make sure that payments are properly characterized on their corporate and personal tax returns.
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Tags: c corporations, deductions, dividends, Income Taxes, liability, shareholders, tax court, Taxes
