United States Court of Appeals

For the Eighth Circuit

___________________________

No. 14-1053

___________________________

Larry Zavadil; Diane Zavadil,

lllllllllllllllllllllPetitioners - Appellants,

v.

Commissioner of Internal Revenue,

lllllllllllllllllllllRespondent - Appellee.

____________

Appeal from The United States Tax Court 

____________

 Submitted: October 8, 2014

 Filed: July 16, 2015

____________

Before LOKEN, COLLOTON, and SHEPHERD, Circuit Judges.

____________

COLLOTON, Circuit Judge.

Larry and Diane Zavadil and the InternalRevenueService dispute the propriety

of certain deductions that the Zavadils claimed on their personal tax returns in 2004

and 2005. The Service issued a notice of deficiency, and the dispute was aired in the

United States Tax Court. The tax court ruled for the Zavadils in part and for the
Service in part. The Zavadils appeal the adverse portion of the decision, and we

affirm.

I.

In 1981, Larry Zavadil organized American Business Forms, Inc.,which did

business as American Solutions for Business. American Solutions sold business

supplies and promotional products. Zavadil wasthe sole owner of the company until

2000, when he sold it to an employee stock ownership plan. In exchange for all

outstanding shares of American Solutions, the company provided Zavadil with a

$28,760,000 note, payable with interest in twenty annual installments. Zavadil

thereafter served without compensation asthe company’s chief executive officer and

as a member of the board of directors. 

In 2004 and 2005, Zavadil had a financial arrangement with American

Solutions under which the company paid Zavadil’s personal expenses and Zavadil

later reimbursed the company by personal check. American Solutions recorded

Zavadil’s personal expenses on a ledger. To generate a ledger entry, Zavadil charged

an item to his American Solutions credit card or instructed an employee to direct the

finance department to issue a check. As a condition of extending credit to American

Solutions, the company’s creditors required that all ledger accounts, including

Zavadil’s, must be paid off at the end of each month. To comply, Zavadil reimbursed

the company on a monthly basis by personal check.

At the end of certain months in 2004 and 2005, however, Zavadil’s personal

bank account had insufficient funds to reimburse American Solutions for the amount

recorded on the ledger. For those months, Zavadil and American Solutions employed

a system of advancesthat allowed the ledger to reflect a zero balance at the end of the

month. At the end of each month, Zavadil wrote a personal check to the company,

and the company brought the ledger balance to zero. At the beginning of the next

-2-
month, however, American Solutions advanced funds to Zavadil’s personal bank

account to cover some or all of the amount of the check, recorded the advance as an

expense on the ledger, and then cashed the personal check received at the end of the

previous month. 

The tax court found that the company’s advances were used to pay some or all

of Zavadil’s ledger balance in four months in 2004 and three months in the first half

of 2005, but that as of December 31, 2004, and June 30, 2005, Zavadil fully

reimbursed American Solutions for all expenses previously recorded on his ledger. 

The court also found that advances from American Solutions were used to pay some

or all of the ledger balance in each month from July through November 2005. The

ledger balance and advance for each month from July through November 2005 was

as follows:

Month Ledger balance and

amount of Zavadil’s

personal check

Amount American Solutions

advanced before cashing check

July $1,429,372 $587,000

August $1,428,517 $62,000

September $1,258,723 $1,371,000

October $1,579,358 $1,302,000

November $1,813,757 $1,800,000

For December 2005, the record did not show whether American Solutions advanced

funds in January 2006, but the court found that Zavadil’s bank account showed a

deposit of $1,610,000 on January 3, 2006, the same date on which the bank paid

Zavadil’s check for $1,508,316 to cover the December 2005 ledger balance. 

-3-
Zavadil used the ledger system in 2004 and 2005 to make three categories of

disbursements that were later disputed by the Internal Revenue Service. In their tax

returns, the Zavadils claimed charitable deductionsfor 2004 and 2005. They claimed

nonpassive losses for “unreimbursed expenses,” in the amounts of $150,000 in 2004

and $75,000 in 2005, paid to a company called National Business Development &

Finance, which we will call National Business. And they listed other “unreimbursed

expenses” of $35,800 in 2004 paid to Becky DePree, the widow of Zavadil’s former

colleague Dusty DePree. 

Zavadil asserts that the payments to National Business were compensation for

consulting services that National Business provided to the Zavadils’ other whollyowned businesses. Zavadil contendsthe paymentsto DePree were a death benefit for

Dusty that American Solutions had agreed to pay, but which the company later

refused to fund.

In 2010, the Internal Revenue Service issued the Zavadils a notice of

deficiency for the 2004 and 2005 tax years, disallowing $358,472 of charitable

deductions claimed in 2004 and $333,672 of the charitable deductions claimed in

2005. The Service also disallowed the Zavadils’ claims for the payments to DePree

and National Business.

The Zavadils challenged the notice of deficiency in the tax court. As relevant

to this appeal, the tax court ruled in favor of the Zavadils on charitable contributions

made prior to July 2005, ruling that they were deductible because Zavadil reimbursed

American Solutions for those contributions and thus bore the economic burden. The

tax court, however, disallowed charitable deductions made from July 2005 through

December 2005, because the Zavadils did not demonstrate that they—not American

Solutions—bore the economic burden of those contributions. Because the record did

not establish that Zavadil bore the economic burden of paying the entire ledger

balance in any of those months, the court found that the Zavadils failed to prove

-4-
“what portion, if any, of the charitable contributions made after June 2005 Mr.

Zavadil effectively paid with his own funds and not funds advanced by [American

Solutions].” The court also found no evidence that the ledger account balance at the

end of 2005 represented bona fide indebtedness of Zavadil.

The tax court disallowed the Zavadils’ claimed unreimbursed expenses for

payments to National Business, finding they failed to introduce credible evidence

regarding the nature and purpose of the payments. The tax court also disallowed the

claimed deduction for the payments to DePree, concluding that Zavadil failed to

prove he made the payments to promote his business. The tax court then assessed

deficiencies against the Zavadils: $101,674 with a $20,334.80 penalty for tax year

2004, and $113,668 with a $22,733.60 penalty for tax year 2005.

II.

Generally, “an income tax deduction is a matter of legislative grace and . . . the

burden of clearly showing the right to the claimed deduction is on the taxpayer.” 

INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992) (internal quotation omitted). The

burden shifts to the Service in some circumstances, see 26 U.S.C. § 7491(a)(1);

Blodgett v. Comm’r, 394 F.3d 1030, 1035 (8th Cir. 2005), but the Zavadils do not

dispute the tax court’s determination that the burden in this case remains with them. 

This court reviews the tax court’s legal conclusions de novo and its factual

conclusions for clear error. DKD Enters. v. Comm’r, 685 F.3d 730, 734 (8th Cir.

2012).

A.

We consider first the charitable deductions. 26 U.S.C. § 170(a) provides a

deduction for “any charitable contribution . . . payment of which is made within the

-5-
taxable year.” To qualify for a deduction, the charitable contribution must be

“actually paid during the taxable year.” Treas. Reg. § 1.170A-1(a). 

The parties agree that a taxpayer may make a deductible contribution with

borrowed money, and that such a payment is deductible in the year the payment is

made, not when the loan is repaid. Rev. Rul. 78-38, 1978-1 C.B. 67, 68; see Crain

v. Comm’r, 75 F.2d 962, 964 (8th Cir. 1935); Granan v. Comm’r, 55 T.C. 753, 755

(1971). A contribution made by credit card, for example, is deductible by the

cardholder when charged, because the contribution “creates the cardholder’s own

debt to a third party.” Rev. Rul. 78-38, 1978-1 C.B. at 68. A charitable contribution

also may be effected through an agent acting on behalf of the donor. Weitz v.

Comm’r, 56 T.C.M. (CCH) 1422, 1426-27 (1989); Skripak v. Comm’r, 84 T.C. 285,

318 (1985); Rev. Rul. 80-335, 1980-2 C.B. 170. The economic substance of a

transaction, rather than its form, determines the proper characterization. See Weitz,

56 T.C.M. (CCH) at 1425; see also Estate of Sachs v. Comm’r, 856 F.2d 1158, 1164

(8th Cir. 1988). Under this framework, the tax court found that Zavadil properly

claimed charitable deductions for amounts that American Solutions contributed in

2004 and the first half of 2005, because Zavadil had fully reimbursed the company

as of December 31, 2004, and June 30, 2005.

Zavadil contends that he also is entitled to deduct the charitable contributions

that he caused American Solutions to make from July 2005 through December 2005. 

The record does not establish that Zavadil fully reimbursed the company for these

contributions, but Zavadil argues that he is entitled to deductions, because he was

required to reimburse the company for those contributions. The tax court rejected

Zavadil’s plea, finding that he presented “no credible evidence” that the payments

from July through December 2005 represented “bona fide indebtedness” for which

the Zavadils were required to repay American Solutions. The court found that the

company’s practice of advancing Zavadil the funds he used to pay off his monthly

ledger balance was a “circular flow of funds [that] resulted in [the company’s]

-6-
assumption of most, if not all, of the economic burden of the charitable contributions

. . . after June 2005.”

Zavadil submits that the finding was clear error and relies principally on three

pieces of evidence: (1) his repayment of advances made by American Solutions

before July 2005; (2) his testimony that he was required to repay the company, and

that the company’s third-party lenders required that his “ledger would be at zero at

the end of every fiscal month”; and (3) testimony of Colette Carlson, Zavadil’s

accountant, that Zavadil would “bear the economic cost” of the expenses reflected in

the ledger by paying the balance at the end of each month. Zavadil also argues

American Solutions’ awareness that Zavadil had the means to repay the

advances—based on the company’s obligation to make annual payments to Zavadil

on the $28,760,000 note—is evidence of an agreement between Zavadil and the

company that Zavadil would repay the advances. 

The court’s finding that Zavadil did not incur bona fide indebtedness to

American Solutions for ledger balances between July and December 2005 was not

clearly erroneous. There was no written agreement between American Solutions and

Zavadil that required repayment, no evidence that interest was charged, no sign of

collateral to secure payment, and no record of a due date. See Rolwing-Moxley Co.

v. United States, 589 F.2d 353, 355 (8thCir. 1978) (per curiam); Caligiuri v. Comm’r,

549 F.2d 1155, 1157 (8th Cir. 1977); Rife v. Comm’r, 356 F.2d 883, 888 (5th Cir.

1966). The tax court was not required to credit Zavadil’s say-so in the face of

conflicting circumstantial evidence. See Blodgett v. Comm’r, 394 F.3d at 1036;

Banks v. Comm’r, 322 F.2d 530, 537 (8th Cir. 1963). 

That Zavadil repaid all funds in the first half of 2005 did not necessarily show

that he was obliged to do so, especially when there was no evidence that he did so in

the second half. The court permissibly declined to accept accountant Carlson’s

testimony, given that the system of advances undermined the claim that Zavadil

-7-
actually repaid the company in full at the end of every month. The requirement

imposed by creditors that the company show a zero ledger balance at the end of each

month did not exclude the possibility that American Solutions nonetheless bore the

economic burden by reimbursing Zavadil for some or all of his end-of-month

payments through advances at the beginning of the next month. And the company’s

obligation to make installment payments to Zavadil in exchange for his sale of the

company does not establish that Zavadil wasrequired to repay the advances. Zavadil

points to no evidence that the company deducted the advances from its installment

payments on the note, or that the note was designated as collateral for the advances. 

It was not clear error for the tax court to find Zavadil’s evidence wanting. 

B.

Zavadil next asserts the tax court erred in denying his deduction for the

$35,800 he paid to Becky DePree in 2004. Zavadil claimed this amount as a business

expense under 26 U.S.C. § 162(a). He says the payments were made to DePree as a

death benefit for her late husband, Dusty, who was Zavadil’s former colleague at

American Solutions. 

To qualify for a deduction under § 162(a), a taxpayer must show that the

expense was (1) “paid or incurred during the taxable year,” (2) for “carrying on any

trade or business,” and (3) an “ordinary” and “necessary” expense. Comm’r v.

Lincoln Sav. & Loan Ass’n, 403 U.S. 345, 352 (1971) (internal quotation omitted). 

Generally, a taxpayer is not entitled to deduct his payment of another party’s business

expense, even when the payments are made for the development of the taxpayer’s

reputation and goodwill. Welch v. Helvering, 290 U.S. 111, 114 (1933). 

The tax court has recognized an exception to the general rule. A taxpayer’s

payment of another’s business expense is deductible, if (1) the taxpayer’s primary

motive was to “protect or promote” his own business, and (2) the expense was an

-8-
ordinary and necessary expense of the taxpayer’s trade or business. Lohrke v.

Comm’r, 48 T.C. 679, 688 (1967); see Bone v. Comm’r, 324 F.3d 1289, 1295 (11th

Cir. 2003); Capital Video Corp. v. Comm’r, 311 F.3d 458, 464 (1st Cir. 2002). The

tax court has ruled that, in certain circumstances, a taxpayer may satisfy the first

element of this exception—motive to “protect or promote” his own business—by

showing that his purpose was to protect his own pre-existing “standing and

reputation” in his business community. See Conley v. Comm’r, 36 T.C.M. (CCH)

1644, 1648 (1977); see also Allen v. Comm’r, 283 F.2d 785, 790-91 (7th Cir. 1960). 

The burden is on the taxpayer to show “a direct nexus between the purpose of the

payment and the taxpayer’s business or income producing activities.” Dietrick v.

Comm’r, 881 F.2d 336, 339 (6th Cir. 1989) (internal quotation omitted); see Bone,

324 F.3d at 1296. 

Zavadil argues that he made the payments to DePree for the purpose of

protecting his and Mrs. Zavadil’s business reputations. The tax court found to the

contrary. The court reasoned that Zavadil promised to pay the death benefit to

DePree as additional compensation for Dusty’s work at American Solutions. After

the employee stock ownership plan acquired the company, the company declined to

continue making payments to DePree. The board of directors concluded that the

death benefit was Zavadil’s personal obligation, and that the new owner should not

be burdened with the payments on top of its other debt. The tax court also observed

that Zavadil never claimed in testimony that his motive for the continued payments

was to protect his business reputation. The court thus concluded that the Zavadils

failed to establish that the payments were deductible business expenses.

Zavadil responds that he paid the death benefit in order to fulfill an obligation

to “the family of one of [American Solutions’] most well-loved, well-known, and

longest-serving employees,” and that he thereby acted to protect the Zavadils’

business reputations. In support, he points to testimony that he was the

uncompensated CEO of American Solutions, that Mrs. Zavadil owned a company

-9-
engaged in the same business as American Solutions, and that Dusty had been a

valuable salesperson and vice president at American Solutions. Zavadil also asserts

that some of Dusty’s work had been uncompensated, and that he initially pledged to

pay the death benefit “to do something for Dusty for all of his work and all of his

effort.”

Zavadil never testified, however, that he continued to pay DePree because he

was concerned about his business reputation. Zavadil did not testify about his

reasons for continuing to pay DePree after American Solutions decided to cease the

payments, how the payments affected his business reputation, or how non-payment

might damage the Zavadils’ reputation. Zavadil’s testimony about motive speaks

only to his intention to compensate Dusty for his previous work. It does not address

whether Zavadil was motivated by a desire to protect his business reputation when

he paid DePree. In light of the record as a whole, the tax court did not clearly err in

finding that Zavadil failed to prove that his payments to DePree were deductible. 

C.

Zavadil’s final contention isthat the tax court erred by disallowing his claimed

deduction for $225,000 in payments to National Business. The tax court found that

the Zavadils introduced no credible evidence regarding the nature and purpose of the

payments, and thus denied the claim that they were ordinary and necessary business

expenses. 

Zavadil concedes that the only evidence to support the deduction was his

testimony about the nature of the payments. Zavadil testified that Curt Briggs,

National Business’s owner, provided consulting services to Zavadil at unspecified

times in the past. He asserted that the payments to National Business in 2004 and

2005 were in exchange for “a lot of personal things for [Zavadil], on [his] personal

side, and personal investments,” including consulting servicesfor the Zavadils’ other

-10-
businesses. But Zavadil provided only vague testimony that the payments were for

consulting services. Briggs did not testify, and no documents were introduced about

consulting services. 

The tax court reasonably found that Zavadil did not explain the nature of the

consulting servicesin sufficient detail to establish that the payments were for carrying

on Zavadil’s trade or business or that the amounts were ordinary and necessary

business expenditures. Given the paucity of evidence, it was not clearly erroneous

for the tax court to find that the Zavadils failed to satisfy their burden on this point.

* * *

The judgment of the tax court is affirmed.

______________________________

-11-