Q:

Subject: Exchange Question

My wife’s mother wants to sell her bare land (non-adjacent) resulting in a large capital gain.  She wants to use the $ to pay off her current loan on her primary residence so she can quit her job and retire.  Can she do a tax free exchange from the bare land to pay off the property she already owes?

Sincerely,

 A:

The answer is a very big NO.

She would have to use the money to acquire new real estate.  Paying off loans on previously acquired property is not like kind and would not save her any tax on the land sale.

She should consult with her personal tax advisor about other options; such as selling the land on the installment basis, where she carries back a large portion of the sales price.  That way, the capital gains taxes would be spread out over the next several years, and she would be receiving monthly payments and earning a much higher interest rate than she would from bank account savings accounts.

There are plenty of other possible scenarios, depending on your mother-in-law's goals and circumstances.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/31/2005 05:21:00 PM Send this post:

Q:

Subject: country club

Kerry- I asked my accountant whether a Country Club membership and/or dues could be partially deductible if used for business purposes. He gave me a definite "no". I figured I better get a second opinion and since you are "The Guru" and seem to know your stuff, I though I might pose the same question to you. I figure a lot of politicians in Washington probably belong to clubs and they like to look out for their own. Thanks for a great site and you informative opinions.

A:

The dues for country clubs are specifically not allowed to be deducted. 

However, the direct costs of meals and green fees incurred at the country club while entertaining someone else can be deducted, as long as they meet the normal tests for deductibility.

Regarding politicians, it has been my experience that most of them allow their campaign contributors and lobbyists to pay for their country club dues and related expenses.  Some people would consider such payments to be forms of bribes; but that is how our rulers do business.

Those other parties then bury those costs among other expense categories on their books, so that they end up getting to deduct their full costs.

Kerry Kerstetter 

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/31/2005 04:36:00 PM Send this post:

Q:

Subject: s corporation

I have a big question. My husband and I have a business as S corporation. I have filed for divorced . How will this effect the corporation? My husband and I are the only shareholders. When I get my pay off any suggestions on what to do to save on Taxes?

A:

It sounds like you are in for a lot of negotiating. 

The corporation will technically go on the same regardless of your marital status. 

I'm assuming you are each 50% shareholders.  What you and he need to work out is if that will continue after the divorce or if one of you will buy out the other.  If one of you buys out the other before the end of the year, there will be even more negotiating as to how to divvy up the year's net income or loss between your K-1 and his.  There are all kinds of ways in which to do this allocation.

The other issue with a buy-out will involve whether or not the selling spouse will want to recognize any gain.  The tax law does allow the transfer of assets between spouses incident to a divorce to be a tax free event, with the acquiring spouse taking over the cost basis from the departing spouse.  What this generally means is that the spouse who keeps the assets is also accepting responsibility for all future capital gains taxes; while the departing spouse is released from that potential liability.  I have worked on several cases over the years where we calculate the avoided taxes for the departing spouse, and adjust the buy-out price downward accordingly.  But, that is also completely negotiable between the parties involved.

You and your husband will need to work with your own personal tax advisors to work on a mutually acceptable plan. 

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/31/2005 02:35:00 PM Send this post:

Q:

Subject: sale of personal residence

I bought a lot in 3/04. Sold my house in 8/04. built a new house and moved in 1/05. I now want to sell and move to a place with less mildew problems. Is there any exchange possibilities? If not when does the 2 years start/end.

Any help would be appreciated

A:

Since you have been using this property as a personal residence, it is not eligible for a 1031 exchange.

Your only possible way out of a taxable gain would be if you can get a doctor to verify in writing that the mildew problem is a health hazard for you.  In that case, you would be eligible for the prorated exclusion of  $342.47 per day that you lived there ($684.93 per day if married), starting from when you moved in.  Any gain above that would be subject to tax, which is why you also want to do a thorough job of accounting for your cost basis in the lot and home so that your gain is as small as possible.

You can see more on this on my main website.

Your own personal tax advisor should be able to provide more specific numbers for your unique situation.

Good luck.

Kerry Kerstetter

 

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/31/2005 02:29:00 PM Send this post:

Q:

Subject: Vacant Land Sale Question

Hi.  I am hoping you can answer my question.  We bought out house in June 04, it has two parcels...one the primary residence sits on, the other is an adjoining lot.  We are selling the lot for 150K.  Are the proceeds subject to taxation, if so, how much?  Any help would be appreciated.  Thank you!

A:

It depends on a couple of things. 

What was the lot used for?  If it was an extension of your living space, it could qualify for the tax free exclusion, as long as you sell the actual residence portion within two years of selling the lot.

I covered this on my website under the topic of  "Vacant Land."


If it wasn't used as part of your living space, it will not qualify for the primary residence tax free exclusion.  However, if you have been classifying the lot as "investment property" it could be disposed of under Section 1031, which would require you to follow all of its rules, as described at www.tfec.com.

Your personal tax advisor should be able to give you more specifics for your unique situation.

Good luck.

Kerry Kerstetter

 

Follow-Up Q:

I really appreciate your prompt response.  Nice to know someone cares out there!  Just to clarify, if I sell the lot (which is part of our primary living space), we would absolutely have to sell our main home within two years or face taxes retroactively on the vacant land sale?  Thanks again.

 

 Regards,

A:

There's actually another twist to your situation as well, which is why you really need to be working one on one with a tax pro.

Assuming that you moved into the home in June 2004 and didn't just buy it then, you need to be concerned about the two year rule.  If you sell your home before the two year anniversary of occupying it, you will need to have a valid reason (health, employment, or other unforeseen event) in order to qualify for the pro-rated exclusion.  If you have no such reason, you will have to pay taxes on both portions of your sale, the lot and the home.

However, if you sell the home after June 2006 and before the two year anniversary of the lot sale, you should be okay.

One more warning. The issue of selling the lot before the two year anniversary of its purchase is in the infamous gray area of tax law.  Some people think that would automatically disqualify it from the tax free exclusion, unless it is due to the unforeseen circumstances; while others believe the date of the sale of the main home dictates the treatment of both portions of the sale. 

All of this discussion assumes that there will be a large profit on the sale of the lot to be concerned with.  Your original
question was unclear on how the lot was acquired.  If it was bought in a separate transaction from the home purchase, you will have to use that price as its cost basis.  However, if it was lumped in with the home purchase, you have some flexibility in allocating the purchase price between the two portions, as long as no such allocation was specified in your purchase contract. 

I have had several cases similar to this, where a client has spun off some land shortly after purchasing a large parcel.  Since the sales took place shortly after the purchases, I had no qualms about allocating the same amount as the sales prices as the cost bases of those particular parcels.  This gave them a break-even on the sale, or a loss after deducting selling costs.  That is something you may want to look into when you discuss your particular situation with your own personal tax advisor.

Good luck.

Kerry Kerstetter

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/31/2005 02:15:00 PM Send this post:

Q:

Subject: Question regarding C corp Taxation...

Hi Mr. Kerstetter,

I love your website and appreciate your frank opinion on all topics. I am a CSU Hayward grad as well, Year 2001. I wanted understand more about tax benefits on C corps, I am starting a business franchising Pizza from PapaJohn's in the east bay area. My family also owns a farming operation of Almonds. I have created 2 corporations and will be handling the books for both. Couple of questions that come to mind are:

- If I do not distribute any profits from any of the corporations, do I still have to pay taxes?
- Can I use the un-distributed income from a corporation towards buying more land and not pay any taxes on that income?
- If i show a loss on my corporation, is that perfectly ok and there is no limit to number of years I can do that for?
- Finally, I have read on 179 but still not very clear that what can I write off? Can you give me specific examples of types of writeoffs people do?
- If I buy a vehicle for pizza business and use that heavily what are my write-offs on that?

I hope you can answer these questions, I have been long searching for answers and validation on these but never found a straight answer.

Final question is about, if we had to hire you a s tax advisor and accountant for filling our taxes, what would that cost us?

Thanks

A:

You do really need to be working with a tax pro who can assist you with these kinds of things.  I wish we could help you; but we already have too many clients to take care of; so we are not accepting any new ones at this time. In fact, we are actually still cutting back on clients, trying to find the right balance of workload, so that I'm not so backlogged with projects.  I have no idea how long that will take.

Unfortunately, we don't have anyone else to whom we could refer you. If you haven't already done so, you should check out my tips on how to select the right tax preparer for you.

Your questions here are all extremely basic.  So, for the benefit of my readers, I will cover them briefly.

Distributing corp profits - With an S corp, there is no difference whether the profits are paid out to the shareholders or not.  With a C corp, if you don't bleed out the profits by making deductible payments, the tax rate can get pretty expensive at the corporate level.

Buying land won't do anything to reduce the corp's taxable income.

Corporate net operating losses can currently be carried forward up to 20 years.  This rule is changed occasionally by our rulers in DC.

I have a ton of info on Section 179 on my website.

How to handle vehicle expenses depends on who owns the vehicle (you personally or the corp), as well as the percentage of miles driven for business versus personal.  Any competent tax pro should be able to give you more specifics for your situation.  

Good luck.

Kerry Kerstetter

 

Labels: 179

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/31/2005 02:04:00 PM Send this post:

Saving The Farm From Death And Taxes, Part 2 – Gail Buckner discusses the use of Family Limited Partnerships, a popular estate planning tool. 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/30/2005 08:46:00 PM Send this post:

Stem Cell Study May Cure Tax-Dollar Addiction

…my addiction drives me to steal money from average Americans and spend it on my pet projects,"

This pretty well describes how our rulers see their purpose in office.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/29/2005 11:22:00 AM Send this post:

Uproar Over Roberts's Tax Returns Discounts Existing Disclosure Curbs

…no one -- not even the president of the United States -- is required to publicly divulge his or her tax information.

 

Bush to Senate Judiciary: Release Your Own Tax Records

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/28/2005 12:37:00 PM Send this post:

Aircraft Charter Business That Incurred Losses for 12 Straight Years Was For-Profit Activity – A common issue involves how long a taxpayer can show a loss from a business before IRS classifies it as a non-deductible hobby. Many people, including far too many tax professionals, misinterpret the IRS safe harbor rule.  What this rule says is that IRS is required to accept a venture as a deductible business if it shows net profits in three out of five years.  Many people construe that to mean any business not meeting that test is not producing deductible losses.  As this case cited by CCH proves, that has never been the case. 

As with any tax matter, the burden of proving you are entitled to claim a business loss lies with you.  You must be able to prove to IRS or the Court that you have been conducting the business according to professional standards that could eventually result in net profits and it is not just being done for fun.  In fact, I have always advised anyone who is interfacing with IRS to banish the word FUN from their vocabulary in regard to their businesses.  Once that word pops up, IRS auditors scrutinize everything more closely in their search for expenses to disallow.  The fact is that most IRS auditors hate their government civil service jobs and cannot fathom the fact that many of us self employed people actually enjoy what we are doing.

 You can download the full record of this case from the Tax Court website.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/28/2005 12:11:00 PM Send this post:

For several years, I have been trying to explain that there are several pitfalls to choosing to use the supposedly sexy S corp format instead of a plan Jane C corp.  Several months ago, an IRS auditor told me that his upcoming projects would involve in-depth reviews of pass-through entities, such as partnerships and S corps.  This project would include following every single pass-through item from the K-1s into the owners’ 1040s.

IRS has now officially announced the upcoming commencement of an in depth study of 5,000 randomly selected S corp tax returns for the years 2003 and 2004.  Their reason is the tremendous growth in the use of this format, which as I have pointed out on several occasions, is due to widespread ignorance on the part of small business owners who jumped into this without having the foggiest idea of what the repercussions were, just because they heard from someone that S corps are the best way to operate. 

 Joe Kristan appropriately compares this to the more well known 1040 audits from Hell, where IRS analyzes every single item on the victims’ tax returns in order to fine tune their audit selection criteria.  Every S corp shareholder should have their fingers crossed that their corp isn’t one of the unlucky 5,000 to be chosen by IRS. You need to remember that, if your corp is selected, your 1040 will also be part of the IRS examiner’s audit; so it could very easily open an extremely messy can of worms.    

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/26/2005 12:00:00 PM Send this post:

Q:

Hello Kerry,

We just bought a some what expensive boat out of our corporation.  We will use the boat both for personal and client entertainment.  Would it be an OK idea to depreciate this asset on our corporate return?

Thanks for your input.

A:

It would be the same as with a car or any other vehicle.

There are a couple of main ways in which it can be handled.

You can just depreciate the business usage percent of the boat's cost.

or

You can depreciate it as 100% business usage and then you either:
  reimburse the corp for the personal usage

or

include the value of the personal usage in your W-2 wages. 

Kerry

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/24/2005 07:33:00 PM Send this post:

Q:

Question:

Selling  a home that is used for rental and exchanging to another home for rental, using the 1031.

In this case, husband owns the property and resides in another residence in another town. Wife lives and works in the town where new rental is

acquired.

Is it possible to rent out the newly acquired property to the wife who has no financial interest in it and files separate federal and state income tax returns? Would this meet the requirement of being a rental?

A:

That could work.  You will need to be sure to charge a fair market rent, which you will report on Schedule E of your 1040.   Your wife will also need to book her payments as rent and not as something else, such as mortgage interest.

You also need to know that the home will not qualify for the tax free residence sale while it is considered a rental, by either you or your wife.

Your personal tax advisor should be able to give you more guidance.

Good luck.

Kerry Kerstetter

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/24/2005 07:13:00 PM Send this post:

Q:

Dear Kerry,

I am now using Quicken for the first time. Is there a way that Quicken can be used to automatically track tax deductible expenses as they are made from my bank account? i.e. can you assign a payee to a ‘category’ (like capital improvements) and then program Quicken to automatically assign all the entries for the designated  ‘payee’ in your check register to the previously designated  ‘category’?  If this is a possibility, and you have any helpful information that can be used to program the system I will be glad to reimburse you for any time you spend discussing the matter with me.

Sincerely,

 A:

I don't think you can have the program automatically categorize entries that have already been input into the file.  However, with new entries, these will be automatically assigned the proper categories if you have the box checked under "Register Options" that says "Complete Fields Using Previous Entries."  After you manually make one entry to a payee and assign the appropriate category, all future entries to that same payee will go to the same category.

I hope this helps.

Good luck.

Kerry Kerstetter

Follow-Up

 Kerry -

 Thank you so much. This is extremely helpful.

 I have had almost no success getting useful answers about obvious questions from any of the Quicken support staff.

Take care. 

 

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/24/2005 07:05:00 PM Send this post:

Gail Delivers the Skinny on 'SCINS' – Good look at estate taxes by Gal Buckner, including the tactic of parents selling appreciated property to their kids with self cancelling installment notes, a strategy I have advised for a very long time.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/23/2005 11:57:00 AM Send this post:

Panel suggests repealing alternative minimum tax 

What is more telling about the mentality of our rulers is this sub-head:

Still at issue: How to recoup lost revenue

As I’ve long explained, the words fairness and taxes cannot be in the same sentence with any credibility.  When it comes to money for our rulers to confiscate from the people, fairness is an entirely inappropriate concept.  Just because the AMT has evolved into an insane, unfair, immoral, unethical, convoluted mess is not reason enough to eliminate it, as long as it is still producing dollars for our rulers to spend.  If our rulers had any concept of decency, travesties like the AMT would be removed without regard for the money involved.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/21/2005 12:55:00 PM Send this post:

It’s a shame that there are still so many people, including far too many tax and real estate professionals, who are unclear on how Section 1031 like kind tax deferred exchanges work.  One common misconception that I often encounter is that the exchange can only be one for one; dispose of one property and replace it with a single property costing at least as much as the original property’s net price.  That has never been true, and has actually been a very unwise move when working with very expensive properties.  Diversifying by replacing one expensive property with several of lower value is a great way to avoid the classic investing mistake of putting all of one’s eggs in a single basket.  The most replacement properties I can recall in an exchange I worked on was twenty, several years ago when a client sold some Bay Area property and replaced it with 20 homes in Texas.

Which brings up another common misconception; that the replacement property has to be in the same state as the original.  While there are a very few states that may tax exchanges that move equity beyond their borders, that is not true for the IRS.  In fact, more than half of the exchanges that Sherry has been handling for the past 11 years have been between states, and none of them were taxable for Federal or State purposes. 

What triggered these comments was this article from the Wall Street Journal on how an investor replaced one $3.7 million Atlanta property with 33 properties in Florida.  He did run into the biggest problem in working with multiple properties; closing them all within the 180 day statutory replacement period.  He ended up with some taxable gain because some of the properties didn’t make the cut-off.  This is why it’s so important to start working on the replacement process as early as possible, ideally before the disposal leg of the exchange has even been wrapped up.  Too many investors make the big mistake of not even starting to look for their replacement properties until near the end of their 45 day identification period. 

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/19/2005 04:03:00 PM Send this post:

Q:

Subject: C Corp and LLC

I saw some of your research online and have a quick question.  

Here is my situation.   I currently have 2 LLC’s operating as partnerships.   We are considering making 1 a C Corp in order to take advantage of 15% tax bracket.   There are other benefits of making one a C Corp as well.  If we make 1 a C Corp, can we take a full 179 deduction at the C Corp and again at the partnership level?   Essentially we would be getting the 179 deduction doubled, once inside the C and once at the member level of the LLC?   I cannot find any IRS ruling or anything relating to this.   Any help would be greatly appreciated.

Thanks,

A:

In a way, you almost make it sound as if you would be claiming two Section 179 deductions on the same assets. 

What I have long been trying to explain as a big benefit of using C corps is the fact that they are eligible for their own full Section 179 allowance and the shareholders are also eligible for their own full allowance on their 1040s.  This does double the overall potential Section 179 deduction for single owner C corps.  The potential multiplier would be more for multi-owner C corps. 

This is why it is important to divide new business asset purchases between those made in the corp name and in the name of the shareholder or other entity (partnership or S corp).

I discussed this on my main website in a number of places:

http://www.taxguru.org/incometax/Rates/Sec179.htm

http://www.taxguru.org/corps/scorp.htm

Good luck.  I hope this helps.

Kerry Kerstetter

 

Labels: 179

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/16/2005 12:41:00 PM Send this post:

Q:

Kerry:

I have a tax question for you.  I met a tax professional, we were discussing charitable gifts of fully-depreciated property.

He indicated that if a person had given an apartment complex (that was fully depreciated) to a charity as an outright gift (not retaining a life income), the donor would have to recapture the depreciation on his tax return (count as income) then deduct the FMV of the property on Schedule A.  He told me that he knows this because he researched it for a client last year.

I have always heard that such gifts would not require recapture to the donor, since they are not receiving anything in exchange for the gift (except a charitable deduction).  Because recapture would not be required, the charitable deduction would be reduced by any amount of ordinary income (depreciation subject to recapture) had the property been sold.

So, there would be no taxable income to the donor, but a reduced charitable deduction.

If you have time, I would like to know if I am correct or not (or if the tax pro is correct).  Thank you for any advice you could give me.

A:

It doesn't work quite that way.  The amount claimed on Schedule A for the gift does have to be reduced by the amount that would have been reported as ordinary income or short term capital gain.  However, that amount does not have to be actually reported as income.

I confirmed this with my two main reference sources, Page 5-12 of the 2004 1040 QuickFinder Handbook and Paragraph 4119 of the Kleinrock Total Tax Guide, which I quote here.


4119 Reduction of Amount of Contribution for Certain Appreciated Property

In the case of contributions of appreciated property (i.e., property with a FMV in excess of the taxpayer’s basis), deducting the FMV of the contributed property is especially beneficial because the contribution ordinarily is not a recognition event, and the taxpayer does not recognize the gain inherent in the property. To prevent abuse, the taxpayer must reduce the deductible amount of a charitable contribution by the amount of gain (other than long-term capital gain) that would have been recognized if the property had been sold at FMV at the time of the contribution. §170(e)(1)(A). This rule requires a reduction for both ordinary income and short-term capital gain.

A similar rule requires a reduction for the amount of long-term capital gain that would be recognized if the contributed property had been sold for its FMV at the time of the contribution. However, unlike the rule for gain other than long-term capital gain, this rule applies only in three situations: (1) if the property is contributed to certain private non-operating foundations; (2) if the property contributed is tangible personal property and the charity’s use of the property is unrelated to its tax-exempt purpose; or (3) if the taxpayer elects to reduce the FMV by the amount of capital gain. §170(e)(1)(B).

In addition, contributions or gifts of capital gain property are subject to special percentage limitations. An individual’s deductible contributions of capital gain property to public charities are limited to 30 percent of the contribution base (§170(b)(1)(C)) and contributions of capital gain property to a charity other than a public charity may not exceed 20 percent of the individual’s contribution base. §170(b)(1)(D).

I hope this helps.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/15/2005 12:34:00 PM Send this post:

I have noticed a lot of confusion among clients as to the expiration dates of the extensions we filed in April for 2004 tax returns.  The extension (4868) for the individual income tax return (1040) doesn’t expire until August 15, at which time Form 2688 can be filed to request two more months time.

It is different for pass-through entities, such as partnerships (1065) and trusts (1041).  In some twisted kind of government logic, even though these tax returns usually have their figures end up on 1040s, the first extensions that were filed in April (8736) only last for three months, expiring on July 15.  Another three months time can be obtained by filing two copies of Form 8800 with IRS by July 15.  The approved copy is then supposed to be sent back to you or your designated preparer.  This extends the due date to October 17.  The 15th is a Saturday.  I just finished preparing about 20 of them last night, which Sherry is now taking to the post office.   

Extensions for one kind of pass-through entity, S corporations (1120S), don’t expire on July 15.  The 7004 was due in by March 15 and was good for six months, just as it is for regular C corporations (1120), setting the due date as September 15.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/14/2005 12:25:00 PM Send this post:

Banks Open Doors To Illegal Immigrants – Anyone who has had to jump through the various hoops to obtain a mortgage from a bank should be spitting mad that our own government is actually making it easier for ILLEGAL aliens to get home loans.  This falls into the same insane category as what many of the states are doing, allowing ILLEGAL aliens to to have free or severely reduced tuition for state colleges; lower than what is charged for LEGAL taxpaying citizens. 

We have gone through the looking glass when ILLEGAL behavior is so rewarded by our rulers. The obvious answer to this flagrant abuse of power by our rulers is to vote them out of office.  Unfortunately, that is only going to become more difficult, as they continue to expand the abilities of ILLEGAL immigrants to vote.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/13/2005 01:21:00 PM Send this post:

States Move To Beef Up Estate Taxes – Another big reason why where you establish your official tax home is important.

Find the Right Tax Mix – Good look by Gail Buckner at how to factor taxes into retirement withdrawals.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/13/2005 12:46:00 PM Send this post:

One of the main arguments used by the defenders of retaining the Marxist estate (aka death) tax is that only the very richest (and thus most evil) among us have to pay it.  They like to cite statistics showing the small percentage of people having to pay estate tax.  This recent article by David Cay Johnston, a person who wrote an entire book decrying the tax breaks for the evil rich, is a perfect example. 

What I have never seen discussed is the number of people who are required to file estate tax returns (Form 706), and the exorbitant cost of having those prepared, even when no estate tax is due.  As I explain on my main website, estate tax is due on the net taxable estate, which is the gross fair market value of everything owned by the decedent, reduced by debts, charitable bequests, final expenses, and the unlimited bequest to the surviving spouse.  However, IRS requires anyone who has passed away (actually the survivors) to file a 706 if the fair market value of the gross estate is over the estate tax exemption amount, which is currently $1.5 million. With the current rise in real estate values, millions more Americans are being pushed into the realm of having to file 706s every day.  

Having prepared pretty much every kind of tax return there is over the past thirty plus years, the 706 is the one I most hate doing because it is definitely the most complicated and the most time consuming, especially when there are assets that are difficult to value with any precision, such as closely held corporations and artwork.  The fact that IRS audits an extremely high percentage of these returns requires much more diligence on the part of us preparers. The biggest fees I have had to charge clients for tax returns have been for these, often well over $10,000. 

While repealing the Marxist estate tax would obviously reduce the income of estate tax return preparers, it would save many millions of people huge sums of fees, to say nothing of the time involved in assembling the information for the 706 and in defending the values against IRS challenges.

Thanks to Ohio CPA Dana Stahl for passing along the Johnston article.  I have the same reaction as Rush has to the NY Times:

 "I must be honest. I can only read so many paragraphs
of a New York Times story before I puke." --Rush Limbaugh

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/11/2005 05:58:00 PM Send this post:

Q:

Greetings,

First, thank you for the article, it is enlightening.  I understand your position and you may be to busy to answer my query but here it is.  I have quite a few folks telling me that it makes no sense that I open a C corp as I am a starter business that will not be amassing great income initially.  They tell me that S is the way to go and go to C if I start making the big bucks.

 

These folks own their own businesses and are quite successful.  If you can please advise as I am a novice myself,  I don't want to misstep as the first thing I do.

Thanks

A:

Unless one of those friends of yours who is advising you to be an S corp is a professional tax practitioner who has access to all of your personal tax and financial details, you should not base any real decisions on what they say.  Second hand tax advice from non tax pros is extremely dangerous.  If they are truly successful in their businesses, I'm sure they have tax pros to help guide them.  However, what may be suitable for their situations may be 180 degrees off the mark for yours.  It is really no different than having your friends diagnose your medical conditions and prescribe the appropriate medication based on what worked for them.

As I have explained on countless occasions, there are appropriate times and places for using both C and S corps.  Using an S just to pick up the first year losses, with profits expected in the subsequent years, is a very shortsighted approach to take because of the higher overall taxes on S corp profits.

Deciding which is best for you at this time is not something I can help you with.  You need to hire a tax pro who understands the pros and cons of using corporations to give you that kind of guidance.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/10/2005 06:47:00 PM Send this post:

Q:

Subject: Exchange Question

 

we would like to sell a second home and buy another second with the equity earned.  would we qualify for a tax-free exchange? 

 

thank you.

 

A:

Check out this post from almost a year ago:

Kerry Kerstetter

Follow-Up:

Kerry,

Thank you and your reply is helpful.  We usually spend only a couple weeks there a year and have made dramatic improvements over seven years.  During that time the property has tripled in value.  From your answer of last year, it seems we would be okay.  Please let us know if you disagree.

Thanks again for your help.

Reply:

If that's all the time you visit the property each year, you could make the case that it is time doing maintenance to protect your investment and not having a personal pleasure vacation.

As we always need to keep in mind, the burden of proving the case in tax matters lies with you.  You should do everything possible to document the investment intent and usage of the properties (old and replacement) so that you will have no fear of any IRS challenge in the extremely rare chance that they ask about it.

One thing you can do to better document the property as investment is to describe the interest and property taxes on your Schedule A as being for "Investment Property" and not for a personal or second residence.  You should do that on any tax return that you haven't yet filed.

Having qualified the property as being eligible for a 1031 exchange, all of those rules would apply.  This means that you need to reinvest the entire proceeds into new property, not just your equity.  As is explained on the Tax Free Exchange Corporation website, your target replacement price for a completely tax deferred exchange is the selling price of the old property less the direct selling costs.  Mortgages that are paid off as part of the disposal leg are considered part of the proceeds and will require you to either take on an equal or higher mortgage on the new property or use your own cash to make up the difference.  Any amount by which you miss the target replacement price will be taxable gain.   

Good luck.  I hope this helps.  You should work with your own personal tax advisor to calculate your potential taxes on the property sale in order to properly weigh the advantage of doing a 1031 exchange.

Kerry Kerstetter

 

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/10/2005 06:40:00 PM Send this post:

Q:

Kerry,

What final tax documents must be given to Exchanger at the end of the exchange?  What tax documents must be given to the other party to the exchange?

 

I want to know the tax documents the accommodator gives to the exchanger and the Seller (if any).  I do know tax documents have to be given to the exchanger; but I am not sure which documents eg:  8824   must be sent.  I want to make up a tax package for the client but am unsure which tax document I must send.

Thanks for your help.

A:

In regard to the exchange accommodation services, there are no official IRS tax forms that need to be provided to any of the parties involved in the exchange.

If you are also handling the closing as the escrow agent, you do need to prepare the 1099-S with the gross selling price to be sent to IRS and to the seller.

The 8824 is completed by the exchanger's tax preparer from the settlement statements from all of the exchange legs, disposal and replacement. 

I hope this is what you needed.

Kerry Kerstetter

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/10/2005 06:16:00 PM Send this post:

Q:

Subject: Employee Fuel Allowances

Hello Kerry,

 

I am working at a client’s office today.  All of his employees drive in from out of town.  He has asked if it would be a good idea for him to provide his staff with fuel allowances.  If so could he cut them a vendor check instead of including it in there payroll and would this be a good write off for his S-Corp by deducting it as employee fuel allowance?       

 

Thanks for your input.

A:

The ability to do what you are proposing - give tax free auto allowances in lieu of taxable wages - became illegal decades ago. 

There are some tax free commuting expenses that employers can provide; such as parking and mass transit passes.  However, paying for driving from home to work is not tax free and has to be included in taxable W-2 wages.

For business related trips, such as misc. errands, the employees can be reimbursed tax free if they turn in the number of business miles driven.  This is what IRS considers an accountable plan.  Those reimbursements, as long as they are no higher than the IRS"s official rate, do not have to be included on the W-2.

The other kind of plan, where a flat amount is provided for an auto allowance without any documentation of actual business miles drive, is called a non-accountable plan.  Those payments must be included in the employees' W-2s as part of their gross wages.  They can then deduct on their Schedule A their actual business miles.

Kerry

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/06/2005 07:34:00 PM Send this post:

Q:

Subject: QB for Personal use

Kerry, I was searching the web and found your site when I did a search on google for “QuickBooks for personal use”.

My wife and I use QB for a couple of business we own, but have refrained from using QB for our personal, be cause we are really not sure how to scale it down rather set it up for just regular home expenses and so forth. Do you have any recommendation other than buying Quicken in addition to QB to set up our personal finances in QB?

Thank you so much for your site, it has GREAT information.

A:

You need to read over the material I have on my website, and you will see that I do not recommend using Quicken.

If you are unincorporated, you should have every single business and personal account you own posted into one QB company file.

You keep straight what is business and what is personal by the use of Classes, as I describe on my site.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/06/2005 07:18:00 PM Send this post:

Q:

Subject: Benetrends

Hello Kerry,

I saw your article on Benetrends website regarding their Rainmaker plan. It looks great and I'm looking to do this. However, I'm a little concerned with how I could get usage of the money. I currently already run a franchise under a LLC and also work another job in the computer field. What I want to do is quit my job and focus full-time on my franchise. What I need the money in my 401K for is to survive on (working capital) during the first year of business. I've really already taken care of all the start up costs so I won't need too much investment there. I was wondering what the tax implications are with:

Investing the funds from the Rainmaker plan in to my LLC. Am I able to write a check to my LLC from my new C-Corp as an investment? Then the LLC can do what it wants with the money? Would the LLC have to pay taxes on this money?

Thank you if you are able to answer.

A:

While you really need to pursue this in more detail with the people at BeneTrends and your personal tax advisor, you need to be very clear on exactly what the Rainmaker, or similar, plan entails.

As you hopefully know, taking money out of your retirement account for personal use is subject to ordinary income taxes, plus early withdrawal penalties if you are under 59.5 years old.

Basically, the BeneTrends program allows your retirement account to invest some or all of its cash into capital stock in a corporation that you will operate. The money will be posted on the corp books as capital stock in the equity section of the corp balance sheet. This is not income to the corp.

As manager of the corp, you have a very strict fiduciary responsibility to protect and maximize the value of the investors' equity and must refrain from personal enrichment at the investor's detriment. In this case, your investor is your retirement account. This means that the money that is invested into your corp must only be used for prudent and reasonable business purposes. This can often include a reasonable amount of compensation for corp management.

You can check with the folks at BeneTrends to see if their governing documents include any restrictions or limits on how much compensation you are allowed to take for yourself. Likewise, there may be restrictions on the use of too much of the capital investment in corp investments, such as the LLC you mentioned.

If the LLC investment is allowed under the governing documents, it will not be income to the LLC. It will be posted to the member equity account for your corp on the LLC's books.

As with all tax matters, the burden of proving that you are doing everything properly lies with you. This means that you need to be extra prepared to defend any decisions you make as manger of the corp regarding the use of the funds against any possible IRS accusation of self-dealing or personal enrichment.

Good luck. I hope this helps give you some issues to discuss with your personal professional tax advisor and the BeneTrends people.

Kerry Kerstetter

Follow-Up:

Thank you Kerry. I am just trying to see if this is a feasible plan so I can spend 100% of my time building my new business.

I recently learned of another company providing a similar service in setting up, SDCooper Company in Huntington Beach, CA.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/06/2005 07:15:00 PM Send this post:

Contest Winner Declines 'Free' Airline Tickets – He doesn’t want to pay the taxes.  It would obviously be a different story if IRS and the State of New York were willing to accept some of his tickets as payment of the taxes; but it doesn’t work that way.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/06/2005 02:03:00 PM Send this post:

Q:

Subject: Primary residence

Tax guru:

What if you have more than $500,000 gain on your primary residence?

Is it fully taxable?

Can you do a 1031?

Do you have to reinvest at a higher level for your primary residence?

If you can help...

Thanks

A:

If you are married and have a gain of more than $500,000 on your home sale, the excess is taxable as long term capital gain.  There is no reinvestment opportunity for residences; so whether or not you buy a new home is completely irrelevant.

1031 exchanges are not allowed for personal use property.

However, a common strategy in situations such as yours is to convert the home into a rental and later dispose of it via a 1031 exchange.  This makes the disposal ineligible for the Section 121 tax free exclusion.  You would also be required to reinvest the proceeds into other business, rental or investment real estate; and not directly into a new personal residence.

There are obviously a lot of pros and cons to the various strategies available to you.  You definitely need to consult with a tax pro who understands these kinds of real estate transactions.

Good luck.

Kerry Kerstetter

 

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/04/2005 04:29:00 PM Send this post:

Q:

Dear Mr Kerstetter,

                  if I change from an S corp to a C corp and also change from fiscal to calendar tax returns, is there a time period that I have to wait till I can  exercise all the benifets of a C corp,

                  sincerely, and thanks,

A:

There are far too many variables involved with a conversion from an S to C corp for me to be able to give any advice.  You need to work with a professional tax advisor who can help you accommodate your special circumstances.

For clarification, S corps are only allowed to use calendar tax years, ending December 31; while C corps can end their years at the end of any month.  As I have mentioned on my website, after converting from an S to a C, IRS will not allow you to change the tax year because they know how easy it is to reduce taxes with a non-December fiscal year.

What I have found on several occasions working with clients who had first considered converting from S to C, was that it turned out to be a whole lot easier to just set up a brand new C corp, where we didn't have any of the restrictions that a conversion requires.  That could very well be what your personal tax advisor will recommend for your satiation.

I hope this helps.  Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/04/2005 04:00:00 PM Send this post:

Q:

Subject: Laws

Can I hide child support through a corporation regardless of  a S or C. Can the state of PA look at my records for child support? How about if I have someone else as my Director? Can they track this? Thank you K

A:

I'm assuming that you are referring to hiding your income from child support requirements.  Those laws are state specific; so you will need to consult with a PA attorney who is familiar with your state's requirements for disclosure of income related to child support.

I do know that it is a common technique to use corporations to hide income and appear more impoverished.  Back in California, one of the CPAs who I used for tax prep assistance during tax seasons had me pay his corporation for that very reason.

If the court only requires you to present a copy of your 1040 each year for the determination of the child support amount, it does make a big difference whether you have an S or C corp.  As with the real life case from here in Arkansas that I described on my website, a profitable S corp's earnings will show up on your 1040, inflating the gross income, even when the actual cash you may have received was much less, or even nothing.

As I always warn everyone, the establishment and use of a corporation of any kind is not the kind of thing you should be doing without the aid of a competent professional tax advisor.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 7/04/2005 01:57:00 PM Send this post: