By Teela McCullar firstname.lastname@example.org
Now that business owners have had some time to digest the impacts of the 2017 Tax Act, some may be wondering if changing to a C corporation would give them a greater tax benefit with the reduced flat tax of 21%. Owners of an S corporation or partnership could potentially be taxed as high as an effective tax rate of 29.6% on their pass-through business income.
However, there are still some downsides to being a C corporation that should be considered.
One of the biggest downsides to a C Corp is double taxation. Though the impact is not as severe as it once was with the reduced tax rate, there is no getting around having the earnings of the corporation taxed twice: once within the corporation and again should the owner decided to take a dividend. Right now, for someone at the highest individual tax bracket, the maximum combined effective federal income tax they would pay on dividends received by their C Corporation would be 39.8%. Under the prior tax law this could have been as high as 50.47%.
Additionally, C Corps are not the best entity choice for a business that expects to incur losses. A C Corp cannot deduct losses and while they do carry forward, other entity types such as an S Corp or a partnership do allow owners to deduct losses in certain circumstances.
C Corps also are not a good entity type for any business that is holding assets that are likely to appreciate like real estate or intangibles (such as a patent or software). Again, this is due to double taxation. Should the corporation sell these appreciated assets, they will pay tax on the gain at the C Corp level and the owner will pay tax if they desire to pull out some of the proceeds.
Finally, though the C Corp tax rate reduction to 21% was considered “permanent”, there is already talk that the corporate tax rate will be on the chopping block should the office of the presidency switch parties in 2020. While a complete rollback of the 2018 tax law is unlikely, some of the Democratic presidential candidates have suggested increasing the corporate rate gradually to at least 28%. This rate would be even higher than it was prior to the tax law change where the minimum corporate tax rate started at 15% and went up from there.
All of these factors should be considered along with having your CPA running the numbers to see if a C Corporation makes sense for you.
Selling your home sale could impact your income taxes. You may or may not have to pay income taxes on the gain from the sale of your home.
The gain from the sale of your home may be excluded, either all or in part, from your income tax if you meet the eligibility test. The eligibility test consists of ownership and the use of the home rules. You must have owned and used it as your main home for at least two out of the five years before the date of the sale. Property acquired through a like-kind exchange (1031 exchange) during the 5-year period is not eligible for the exclusion.
The 24 months used as your main home can fall anywhere within the 5-year period and does not need to be consecutive 24 months. Short absences count as time lived at home. Only 12 months of residence will meet the requirement if you are physically or mentally unable to care for yourself. Time spent living in a licensed care facility also counts toward the residency requirement.
Partial exclusion is available if you moved because of work, health or an unforeseeable event. Work-related exception qualifies if your new job is at least 50 miles farther from home than your old work location. Health-related exception qualifies if you moved to obtain, provide, or facilitate diagnosis, cure, mitigation or treatment of disease, illness, or injury for yourself or a family member. Health-related exceptions also include a doctor’s recommendation of a change in residence due to health problems. Giving birth to two or more children from the same pregnancy is one of the situations qualifying as an unforeseeable related exception.
The maximum gain exclusion is $250,000 or ($500,000 if married filing jointly). The eligibility test must be met to qualify for the full or partial exclusion. Check for additional rules and any exceptions that may apply to you. One last note: You must report the sale to claim the exclusion and if you receive a form 1099-S, Proceeds from Real Estate Transactions, even if you have no gain from the sale.
In December of 2015, I wrote about many tax provisions benefiting taxpayers for 2015 and beyond that had expired. Most CPAs were anticipating these to be retroactively approved by Congress. After much anticipation, Congress ended up extending and in many cases making the provisions permanent. Below is a summary of the main legislation:
The Internal Revenue Service provides many different educational products, webinars and videos to help small businesses thrive.
Take child care services as an example. The IRS webinar “Tax-Related Guidance for Child Care Providers” provides information that would be beneficial for a provider just starting out in the business as well as anyone who is relatively new in the business.
Most small businesses employ CPAs to handle their financial needs, but having some knowledge of what is going on regarding the financial side of the business is important.
The child care webinar is broken down into four main topics:
1. Child Care Income – This section covers various types of income that must be reported. Some examples are:
➜ Income from contracts specifying charges, terms and responsibilities
➜ Late pick-up or early drop-off fees
➜ Registration fees
2. Child Care Expenses – This section focuses on what criteria must be met for an expense to be deductible. Some examples of topics covered in this section are:
➜ The business must be a for-profit activity. Remember, hobby losses are not deductible.
➜ The expense must be ordinary and necessary.
➜ An allocation must be made for business/personal expenses. Only the business portion is deductible.
➜ Personal expenses are never deductible.
3. Special Rules – A hot button for child care providers is the business use of the home. The webinar covers the special method used to compute the business use percentage of a home available only for daycare service providers.
4. Other Expenses – There are some expenses common to the daycare industry. The webinar discusses how to deal with these expenses:
➜ Food consumed by daycare recipients, including the USDA food reimbursement program
➜ Supplies such as games, books, child-proofing devices, toys and diapers
➜ Depreciation expenses
Child care is only one of several businesses that can benefit from the targeted IRS educational products. Check out the various webinars and videos at www.irsvideos.gov. ■
A New York couple who had received an enterprise zone credit for property taxes were required to pay taxes on the amount because of the tax benefit rule.
Yigal and Bonnie Elbaz were required to include in income $54,507 received in 2008 from a refund of New York state income taxes as a result of the tax benefit rule. The entities receiving the benefits were actually flow-through entities.
The Elbazes owned three different companies organized as flow-through entities – in which income passes on to the owners or investors.
They had a 50 percent interest in all three of the entities. Superflex Management, LLC, was treated as a partnership for federal income tax purposes. Superflex Realty, LLC, was treated as an LLC for federal income tax purposes.
The state of New York provides tax benefits to businesses that invest in certain designated areas of the state. One of these benefits is the Qualified Empire Zone Enterprise credit for real property taxes.
In calculating this credit, the amount of property taxes paid or incurred by a business is a major factor. All three of the businesses owned by the Elbazes qualified for this credit.
The Elbazes’ three businesses deducted the share of property taxes that they had paid or incurred during 2007. These expenses decreased the amount of income allocated to them on their respective K-1 schedules. This is where the tax benefit comes in.
The taxpayers report less income on their 1040 return as a result of the businesses having deducted the property taxes paid or incurred.
The $54,507 refund received in 2008 by the taxpayers was a direct result of the Qualified Empire Zone Enterprise credit. The credit was calculated using the property taxes paid or incurred by the three flow-through entities owned by the taxpayers.
Therefore, the $54,507 was the receipt of a refund of a previously deducted tax and was fundamentally inconsistent with the previous treatment to the extent that the Elbazes benefited from the decreased pass-through income. Thus, the $54,507 is considered to be taxable income (Yigal Elbaz and Bonnie Elbaz v. Commissioner, U.S. Tax Court, T.C. Memo 2015-49, March 17, 2015). ■
A Florida woman was denied a first-time homebuyer credit of $7,500 because the U.S. Tax Court determined that she had never actually purchased the home.
On Jan. 22, 2007, Ada Mae Pittman entered into a lease contract with an option to buy with James Piotrowski Jr. Pittman was required to meet certain conditions to exercise the option to purchase the house. She was required to:
➜ Close on the purchase of the home by Jan. 31, 2008
➜ Pay a $1,250 option fee
➜ Pay an additional $150 per month, which would be applied against the purchase price of the home if the option were exercised
Pittman paid the $1,250 option fee and made the $150 per month payments.
However, she did not exercise the right to purchase the house by Jan. 31, 2008, because she was unable to obtain the financing needed to close the purchase.
No sales documents were ever prepared.
When Pittman timely filed her 2008 federal income tax return, she claimed the $7,500 first-time homebuyer credit. The IRS subsequently sent her a letter of deficiency disallowing the credit.
Generally, under Internal Revenue Code Section 36, a transfer is complete upon the earlier of the transfer of title or the shift of the benefits and burdens of ownership.
An option to purchase a home in Florida does not give the person with the option an equitable interest in realty until the option is exercised.
IRC Section 36 is quite clear. A taxpayer must actually acquire a property to claim the first-time homebuyer credit.
Pittman did not provide any documentation substantiating her purchase of the residence.
In addition, she never exercised the option to purchase. Therefore, Pittman is not entitled to the claimed first-time homebuyer credit (Ada Mae Pittman v. Commissioner, T.C. Memo 2015-44, March 16, 2015).
©2015 CPAmerica International
If you’ve started your own business since 1993, and funded it with your own money as a C Corporation there could be some valuable tax savings if you’re planning on selling the company. This comes in the form of the section 1202 exclusion.
The Section 1202 exclusion allows a person to exclude up to 100% of the gain on the sale of qualified small business stock (QSBS) that has been held more than five years.
The amount available to be excluded varies depending on when the business was started and funded. If the corporation was started between Aug 10, 1993 and Feb 17, 2009, 50% is excludable; if between Feb. 17, 2009 and Sept 27, 2010, 75%; and if you were lucky enough to start the corporation between Sept 27, 2010 and before Jan 1, 2014 100% of the gain is excluded.
So what are the catches? The taxable portion of the gain is taxed at 28% (excluding the possible Medicare investment tax of 2.8%) as opposed to the regular long term capital gain rate of 20%. The maximum amount of gain that can be excluded is the greater of $10 million of 10 times the taxpayer’s basis in the stock. Further, QSBS is defined as a C Corporation that the taxpayer funded directly with no more than $50 million of gross assets, 80% of its assets must be in an active trade or business, the corporation cannot own real property or stock/securities exceeding 10% of its total assets, and stock/securities cannot exceed 10% of its total assets in excess of its liabilities.
As you have read the 1202 exclusion can save a lot of money, but there are many complexities not outlined above including possible alternative minimum taxes. All the more reason to contact a CPA!
The U.S. Tax Court recently determined that a cash method taxpayer is entitled to claim an American Opportunity Credit only in the tax year when the payment was actually made – not for the academic year when the tuition payment was paid.
John and Brenda Ferm paid their daughter’s tuition at the local community college for the 2011 winter semester, which ran January through April 2011. They made the tuition payments in three installments with the majority of the tuition paid on Dec. 28, 2010.
The taxpayers timely filed their 2011 income tax return, but they did not claim the American Opportunity Credit, a tuition credit available to parents of dependent children who are undergraduate students.
On April 1, 2013, the taxpayers filed an amended return. On the amended return, the taxpayers claimed an American Opportunity Credit of $2,107.
On June 13, 2013, the IRS sent the taxpayers a notice of deficiency disallowing the American Opportunity Credit for lack of payment verification.
The taxpayers filed a petition in court contesting the IRS in its disallowance of the credit.The taxpayers provided the court with the appropriate evidence that the tuition had been paid. The court disallowed all but $157 of the credit because $2,151 of the qualified educational expenses was paid in 2010, not in 2011.
The portion of the tuition paid in 2010 cannot be used to claim a credit in 2011. Only $157 of qualified tuition and related expense was actually paid in 2011.
The American Opportunity Credit is allowed only when payment is made in the same year that the academic period begins.
When a taxpayer prepays qualified tuition and related expense during one taxable year for an academic period that begins during the first three months of the following taxable year, the academic period is treated as beginning during the taxable year in which payment was made.
In this case (John Mark Ferm and Brenda Kay Ferm vs. Commissioner, T.C. Summary Opinion 2014-115, Dec. 30, 2014), the academic year and the majority of the tuition payments were considered 2010 transactions, not 2011, explaining the court’s disallowance of most of the credit.
The Tax Court’s opinion in this case may not be used as precedent for any other case.
©2015 CPAmerica International
There are 55 tax provisions, also know as “extenders” that expired at the end of 2013. In a letter from the Internal Revenue Commissioner sent to the United States Congress, members of the tax writing committees stated that if Congress waits until 2015 to enact tax law changes affecting the tax year 2014, there may be a delay in the opening of tax filing season.
The 2014 filing season opened on January 31, 2014, instead of January 21, due to the 16-day federal government closure in October of 2013. A delay is very possible in 2015 if the decision whether to extend the expired tax provisions is not made before the end of this year.
Several tax extenders that may affect individuals in particular are:
This deduction benefited individuals who lived in states without state income tax, such as Nevada. Sales taxes are deducted in lieu of state and local income taxes on Schedule A, Itemized Deductions.
Taxpayers who are 70 ½ or older are able to exclude from income up to $100,000 per year when distributions are made directly to certain qualified charities. Seniors who can no longer itemize deductions benefit from this extender.
Qualifying individuals could deduct qualifying higher education tuition or expenses above-the-line.
The Mortgage Debt Relief Act provided the exclusion from income of up to $2 million of qualified cancellation of mortgage debt on a principal residence.
This extender provides for the 50 percent bonus depreciation on qualified property purchased and placed in service in a business.
A taxpayer may immediately expense up to $25,000 of Section 179 property, with a dollar for dollar phase-out of the maximum deductible amount for purchases in excess of $200,000 for tax years 2014 and thereafter. The proposal would increase the maximum amount and phase-out threshold to $500,000 and $2 million, respectively.
If Congress does not act on these and other tax extender issues before the end of 2014, and instead reinstates them retroactively sometime in 2015, millions of Americans would be forced to file amended returns to claim these deductions.
A recent case demonstrates the difficulties involved in securing a tax deduction from transactions between related parties.
In 1990, Robert Alpert established two irrevocable trusts to fund his two sons’ educations. In 1996, he established a third trust for the benefit of his sons.
Between 1990 and 1996, Alpert transferred $1.1 million to the trusts. In January 1996, the trustee of each of the trusts signed a promissory note to Alpert. No funds were actually transferred in connection with the promissory notes.
Rather, the amounts stated as owed approximated the net funds Alpert had previously advanced to each trust. Subsequently, Alpert continued to transfer moneys to the trusts, but no additional promissory notes were executed.
In 2006, Alpert reported a $1.9 million nonbusiness bad debt deduction on account of worthless debts owed him by the 1990 trusts.
The IRS argued that Alpert was not entitled to the bad debt deduction because he did not establish that:
➜ The transfers to the trusts were bona fide debts;
➜ He was the debt holder in 2006; and
➜ The debts became worthless in 2006.
In concluding that the transfers were not bona fide debts, the court noted that:
➜ The beneficiaries of the trusts were Alpert’s sons.
➜ There was no written agreement with respect to the majority of the transfers.
➜ There was no evident plan of repayment.
The court then said that, even if the transfers represented bona fide indebtedness, Alpert failed to establish that he was the creditor in 2006. Finally, the court found that Alpert failed to show that the debts became wholly worthless in 2006, particularly since the trusts were not insolvent.
Alpert was the founder of Aviation Sales Co. (AVS), a publicly traded company. He also had trading authority over his mother’s brokerage accounts.
Acting without his mother’s knowledge, Alpert purchased AVS shares for her at a cost of $2 million. The share price of AVS declined precipitously, and when Mrs. Alpert learned of the purchases, she threatened to sue.
Alpert orally promised his mother that he would cover any losses she incurred if she sold the AVS shares at a loss. In exchange, she agreed that he would share in half of any profits if the shares were sold at a gain. Those promises were later memorialized in a letter.
In 2006, Alpert reported a loss, which he identified as “Indemnification Payment to G. Alpert.” Alpert contended that he was entitled to a loss for his indemnification payments because:
➜ His trade or business involved acquiring majority ownership positions in distressed companies, improving their operations and profitability, and taking them public;
➜ In so doing, he sought out and enlisted other investors for the purpose of acquiring these companies; and
➜ The indemnification agreement with his mother was part of that business process.
In rejecting Alpert’s argument, the court said that the indemnification agreement and the losses stemming from it were not incurred in his business activities. The court said that it was clear from the letter agreement between Alpert and his mother that he was trying to protect himself from liability for mismanagement of his mother’s assets, not from his business activities. (Robert Alpert v. Commissioner, TC Memo 2014-70, April 17, 2014) .
©2014 CPAmerica International