S corporation denied deduction for owner's child-care expenses.

A started a window-washing business through wholly owned S corporations. A's wife (B) began working in that business two years later. During the relevant years, approximately 24 and 31 individuals worked in the business.

B was employed by the S corporations to wash windows one or two days a week and to provide clerical services for approximately 10 to 15 hours per week. Although the S corporations did not formally pay her any wages during either year, she actually received $4,480 and $5,000 during the respective years. A was employed by the S corporations essentially as their general and operations manager, but also washed windows. The S corporations formally paid A no wages during 2001, but paid him $6,800 in wages during 2002.

When B was working, A and B left their children with either a day-care service or a neighbor. They paid their neighbor in cash and the day-care service with a check drawn on one of the S corporation bank accounts. The S corporations claimed deductions for the children's day-care expenses.

Analysis

The taxpayers assert that the S corporations are entitled to deduct the daycare expenses under Rev. Rul. 73-348, 1973-2 CB 31, which allows a Sec. 162 deduction for the corporation's day-care payments for an employee's preschool children while at work, because B could not have worked unless day care was provided to her preschool children.

We are unpersuaded by this argument. While Sec. 162 allows a corporate taxpayer to deduct the ordinary and necessary expenses of its business, the mere fact that B might not have been able to work for the S corporations unless day care was provided to her children does not necessarily mean that the payment of A and B's day-care expenses is an ordinary and necessary expense of the S corporations. While the Service ruled in Rev. Rul. 73-348 that a taxpayer could deduct the daycare expenses related to the children of its employees, the ruling notes that the expenses were "directly related" to the taxpayer's business.

On the basis of the record at hand, we cannot find that A and B's day-care expenses were directly related to the S corporations' business or, in other words, that those expenses were an ordinary and necessary expense of the S corporations. Indeed, the only individuals whose children's day-care expenses were paid by the S corporations were the sole owner of the S corporations and his wife. Thus, we hold for the Service.

FRANK SETTIMO, TC Memo 2006-261