PARENT MAY NOT DEDUCT CASH BONUSES PAID TO EMPLOYEES OF SUBSIDIARY BUT SUBSIDIARY MAY

Rev. Rul. 84-68

ISSUE

May a parent corporation deduct as a business expense under section 162 of the Internal Revenue Code cash bonuses it pays to employees of its wholly owned subsidiary or may the bonuses be deducted by the subsidiary?

FACTS

In 1980 a domestic corporation, P, established a bonus program for the employees of its wholly owned domestic subsidiary, S. Under the program, P pays cash bonuses in December of each year S's employees for their past services performed for S during the calendar year. The total compensation paid to these employees, including the cash bonuses, is reasonable remuneration for the services rendered. None of these employees perform any services for P. The employees who receive the bonuses include them in income in the year received.

LAW AND ANALYSIS

Section 162(a) of the Code allows as a deduction all the ordinary and necessary business expenses paid or incurred during the tax year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered.

Section 1.162-9 of the Income Tax Regulations specifies that bonuses to employees will constitute allowable deductions when such payments are made in good faith and as additional compensation for the services actually rendered by the employees, provided such payments, when added to the stipulated salaries, do not exceed reasonable compensation for the service performed.

Section 118 of the Code provides that in the case of a corporation, gross income does not include any contribution to the capital of the taxpayer.

Section 83 of the Code prescribes the income tax treatment of property transferred to another in connection with the performance of services. Because section 83 does not apply to compensation paid in cash, this section of the Code has no application to the issues under consideration in the present situation.

It is implicit in section 162 that a taxpayer may not deduct the expenses of another, even though those expenses would otherwise be ordinary and necessary trade or business expenses. See Interstate Transit Lines v. Commissioner, 319 U.S. 590 (1943), 1943 C.B. 1016; Deputy v. Dupont, 308 U.S. 488 (1940), 1940), 1940-1 C.B. 118. A parent corporation may not therefore deduct compensation paid by it to the employees of its wholly owned subsidiary, even though the indirect benefit of their services inures to the parent corporation as sole shareholder of the employer. Columbian Rope Co. v. Commissioner, 42 T.C. 800 (1964), acq. on other issues, 1965-1 C.B. 4.

A cash payment by a shareholder for the benefit of a corporation in which the shareholder owns stock is recognized for federal income tax purposes as a contribution of capital to the corporation. Estate of A.P. Steckel v. Commissioner, 26 T.C. 600 (1956), aff'd per curiam, 253 F.2d 267 (6th Cir. 1958); South American Gold & Platinum Co. v. Commissioner, 8 T.C. 1297 (1947), aff'd per curiam, 168 F.2d 71 (2d Cir. 1948).

In the present situation because the cash bonuses paid by P to employees of S is deemed to be a capital contribution by P to S, the bonuses paid to S's employees is therefore deemed to be paid from S's own funds. See Anderson v. Commissioner, 67 T.C. 522 (1976), aff'd per curiam, 583 F. 2d 953 (7th Cir. 1978).

HOLDINGS

The parent corporation may not deduct as a business expense under section 162 of the Code the cash bonuses that it pays to employees of its wholly owned subsidiary. Because the parent's payment of cash bonuses to its subsidiary's employees is treated as a contribution to the subsidiary's capital accompanied by a constructive payment by the subsidiary of the cash bonuses to its employees, the cash bonuses may be deducted by the subsidiary under section 162 the Code, provided that each employee's total compensation is reasonable for the services performed.