Expense does not qualify as compensation but does qualify as theft loss.

• Author: Beavers, James A.

The Tax Court held that amounts that an abusive man took from his live-in girlfriend's business did not qualify as deductible compensation expenses but did qualify as deductible theft losses.

Background

In 1991, Mona Lisa Herrington began a relationship with a man who eventually moved in with her. Her boyfriend, she later learned, had an extensive criminal record and a violent temper. The boyfriend subjected Herrington to frequent intimidation and physical abuse. Despite his ill treatment of her, Herrington was afraid to leave him because of his threats of violence to her and her children if she did.

[ILLUSTRATION OMITTED]

In 1996, Herrington acquired two Louisiana video poker licenses in her own name. In order to comply with the terms of the licenses, she opened two sandwich shops next door to each other in Farmerville, Louisiana, each with a video poker machine. The boyfriend took charge of the finances and the books and had check-signing authority on the business bank accounts. Virtually all the shops' income resulted from video poker revenue.

Herrington and her boyfriend had no agreement regarding his compensation, and Herrington testified that the boyfriend set his own compensation by writing checks to himself or to cash, signing either his name or the petitioner's name. He withdrew $114,000 during 1997 and $96,000 during 1998 horn the businesses' bank accounts. He used these funds to pay his personal expenses, including his child support obligations.

Herrington knew her boyfriend was writing checks and taking money out of the business accounts, but she did not know beforehand when he might write checks or for how much. Consequently, she was constantly uncertain about the balances in the accounts. Therefore, she worked out an arrangement with a friend at her bank to ensure that she knew when she needed to deposit money in the accounts to avoid overdrafts.

As a condition for maintaining her video poker licenses, Herrington had been required to submit copies of her federal income tax returns annually to the Louisiana state police. Her boyfriend had prepared her 1997 federal income tax return, and she had signed it. According to Herrington, her boyfriend told her that he would file the return, but he never did. She attached a copy of the return to her state video poker application and signed a release allowing the police to verify that she had filed the return with the IRS.

This led to the revelation that Herrington's 1997 and 1998...