Question:

A year ago my mother was diagnosed with lung cancer with the prognosis less than a year. A good friend of my mom’s and dad’s visited and told my dad in private of a female friend of hers that married a recently widowed man, indicating that it was a win win situation for both. He received a housekeeper and she received a permanent pension. He then proceeded to tell my mom and sister of the private conversation which upset my mom and rightly so.

My mom passed three months ago and my dad, with a prognosis of less than one year, has mentioned this mutual friend on many occasions such as marrying her in a joking way. He recently mentioned that he would think it appropriate if she received something from his will if she was his long term companion.

My question is if he did marry her, but not change his will, what would she be entitled to? He lives in a house that my mother struggled to pay off years ago so they would be debt free in addition to putting away a nice savings.

Putting aside our feelings toward this lady that betrayed my mother, we want to do what is best for my dad.

Answer:

She would be entitled to everything as a normal course of the law. Normally, the living spouse is entitled to all community assets. Children are normally in line after spouse. Even if there was a will she would have a strong case to contest it.

Your father could set up a living trust, separate the assets and put you children on as beneficiaries of the trust. But this has a lot of snags and loopholes that can get sticky.

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 Question:

I would like to buy a second home for my in-law in Kentucky. Our principal residence is in Virginia. We plan to collect no rent for this second property but would like to understand if some rent should be collected to increase the possible tax deductions/losses that can be claimed for this property. Our annual income is approximately $180k and my mother has no annual income and is a resident alien.

Answer:

Is your annual income derived as a w-2 salary, or are you in business?

Contrary to common belief, deductions are not a prize to seek. Deductions are not good, deductions make bad things less bad. If you collect rent you will have the privilege of attaching Schedule E on your 1040 form. Increasing your potential for IRS audit 18.5 times. http://www.irs.gov/pub/irs-soi/07db09ex.xls

Some of the deductions you would not be eligible for would be your own time and efforts to repair, maintain, improve or manage the property, since you are not real estate professionals. At your AGI you may start to lose some of your personal deductions through “Phase Out” which would actually increase your taxes.

 I am not suggesting that buying a home for your mother to live in is bad, nor am I saying that you should not consider the business side. I AM saying that if you are looking at doing this business you should DO THAT Business as all the most successful businesses do, do it as a Corporation.

 Lower taxes, better deductions far fewer audits, easier separate book keeping, etc.

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Question:

2 members are starting an LLC, 1 Member is contributing $75k in cash as initial capital contribution for a 50% interest (capital, profits & loss) and the other is bringing to the LLC his background, experience and expertise in the industry and ability to get business for the LLC for his 50% interest (Capital, profits & loss).

I was told 2 different scenarios, 1 is that the 2nd members interest was a contribution of an intangible asset, goodwill, and would not result in any taxable income to him for his 50% capital interest.

 Then I was told, his expertise etc. was NOT considered good will, that he is actually obtaining his interest in the LLC for future services, therefore resulting in taxable income of $75k (value placed on his experience etc.) to him.

Which is the proper treatment and could you please reference a code section on reference for the correct treatment.

Answer:

Allow me to point out that capitalization is not a taxable event. So your contribution or his contribution will result in no tax due. Contributions set the “basis” for the ownership interest. Basis is used to calculate gain or loss when the ownership interest is sold.

So there is no tax event when you are starting up the business, period. The contributed value of the ownership interest creates no tax event while the business is operating, from year to year. The contributed value of the ownership interest may never create a taxable event.

The only time that the contributed value of the ownership interest would even have a tax consideration is when the owner either exchanges his ownership interest for money (sells it), or closes and liquidates the business and gets a distribution of assets (effectively selling the ownership interest back to the business to wind it up). At that point the difference between the adjusted basis and the sale price would either be a wash (same amount in and out), a gain (more came out than went in), or a loss, more went in than came out. Taxes would be calculated on that.

Now the basis does adjust, as the LLC is profitable, attributes tax liability to but does not give you money your basis is adjusted up.

Now I have to ask, why be an LLC? It provides no tax benefit over being the biggest of tax victims the General Partnership; It has been unsuccessful at limiting liability.

I know, your accountant said it was the best option, but did you really grill him on why? Because I am certain he will fall back to, it is the way that everyone is doing it.

 But let me ask you, is that really true? Who is everyone, certainly not any of the most successful businesses . . .

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 Question:

I understand where retained earnings come from(accumulated earnings over years). But when it climbs significantly higher in one year, and I have all “said” info entered, (owner takes no draws or cash out for anything, he gets healthy W2 wages all year) then it seems like there’s something missing-possibly money spent toward assets?

Like, on the Sch M1 & M2:

Is there ways to reduce Ret. Earnings? What about the payments he makes toward big assets during the year? Can they be used anywhere? I have used the interest on these loans as a deduction and they are set up on depreciation.

  I know Sch. L has to balance. I’ve been told to adjust either A/R or loans from shareholders to make this happen. What do you suggest?

Answer:

Any retained earnings would normally be added to investor equity. Since they already paid the taxes on it (and BIG personal taxes they did pay as a sub-s). Investor equity is the buffer, as the business becomes more profitable and retains profit the value for each unit of investment goes up, if the business is strapped and is operating out of the money originally invested then the investors value drops.

As far as reducing retained earnings; spend the money is one way, that would allow for purchases of big assets. This is where the 179 deductions plays in. For 2008 the 179 deduction is $250,000 for anything that depreciates in less than 20 years.

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 Question:

What are the options in the following situation:

Dad dies and the estate is left with an outstanding mortgage on a building that has 2 children living in 2 of the 3 apartments. They both want to stay, what happens with the mortgage? Only one child might be interested in continuing to pay the mortgage. Is that even possible? Can the mortgage be transferred to the interested child or does the dwelling need to be formally sold publicly first? Who decides the sale price?

Answer:

The lender would probably not allow for a straight assumption, the buyer would have to qualify for a new loan.

The sale price would be determined by the buyer and seller. If you can’t agree there is no sale.

Everyone needs to decide what they would be willing to buy it for and what each of them would be willing to sell it for. If you are not sure what you would sell it for, you could get an appraisal, realize that it is not going to sell at appraised value, especially not in this market. You could put it on the market and see what offers you get, and then if anyone wants to buy at that price they can.

  The one that does not want to buy should get ready to move or negotiate a fair rent to stay in it.

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 Question:

 I am a working artist who, like most creative folks, has a full time day job as well to make ends meet.

 I have a Live / Work Studio that I declare the work portion of each year, I have material costs throughout the year, and I also have promotional expense to promote my work in the world, of which I also declare.

As for art related income, some years I have sales, some years I do not.

I keep track of all my art related expenses and income.

What are my risks for an audit, and how can I reduce them?

Answer:

The potential for audit and the potential to lose in an audit are two separate concerns. Obviously we want to avoid both. And the third part of this is the “1 in 3, 2 in 5 rule”

 Having good records will give you argument points if you are audited. When individuals are audited, there are some very common areas where they cheat: understating income and overstating deductions are quite common. As long as you can justify the expenses (according to IRS rules, not just your perception of the rules) and you track all the income, then if you are audited, you’d probably win.

Avoiding the audit in the first place however is a worthy goal.

As an individual in business, You have a high likelihood of audit. Check the numbers: www.irs.gov/pub/irs-soi/07databk.pdf look at page 23 and 24. You’ll see that as an individual tax return that does not have a schedule C attached has about a 0.4% chance of audit, attaching a schedule C can raise your audit risk to 9.7% (a little over 25x more likely)

While doing your business as a Real corporation would reduce your risk, just by the numbers, assuming you are not carrying a balance sheet, would be 0.5% audit risk as a real corporation.

 Not only would your risk of audit be far less, you’d enjoy lower taxes as a real corporation.

 The 3rd item above was the “1 in 3 and 2 in 5 rule”: The IRS can re-categorize any business that fails to make a profit, one out of three and 2 out of 5 years. This would result in disallowing all deductions and attributing that is income to you which you would have failed to pay taxes for and now would be subject to penalties and interest.

SOooo, let’s make “profit” a priority. If you have not made profits in enough years to fit within that rule, then close the doors of the business, hunker down and wait 3 years. Once you get past that, you are safe. In the mean time you could open a corporation to do business; THAT CORPORATION has a new 1 in 3 and 2 in 5 clock that starts.

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 Question:

I am a contract employee. The company I work for is located in Boston, Ma. The company I am assigned to work at is in Phoenix, AZ. My home is in New Mexico. The GSA per diem rate is about $80.00 more per day than what the companies are paying me. Are they required to pay me the GSA rates?

Answer:

No. They can pay as much or as little as they can negotiate. The GSA per diem is really a Maximum number; they are limited to not being able to deduct more than the GSA per diem rate. So if the negotiation was for $275 a day, they would only be able to deduct part of the $275 (within the rates in IRS pub 1542).

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 Question:

I have been a consultant and am now an account exec with a staffing and recruiting company. My particular practice sells consulting services more than we do staffing and it seems that the taxes for our jobs are complicated and I wondered if it was just a lack of knowledge from our tax department.

Here is an example:

A consultant is assigned to a company that is based out of Tampa, FL. The consultant lives in Pittsburgh, PA and does some of their work from home. At other times they are working at customer sites in Ohio, or Illinois, or elsewhere in the country.

What taxes (for which states) should be taken from the consultant?

And which taxes should be billed to the customer?

Answer:

As to what to bill the customer? That should be decided and stipulated in the contract, whether the customer is paying “cost-plus” or simply a gross amount.

For taxes, the Federal taxes are consistent from state to state, so All the Social Security, All the Medicare, All the workers comp will be the same for each dollar earned, regardless where it was earned.

The “income tax” will need to be paid to each state based upon the state rules. If the person resides in PA then all of their income is subject to the PA income tax of 3.07%. They can deduct taxes paid in other states, so if they work for a company in Illinois they’d owe Illinois 3% of the income derived in Illinois.

Ohio has a tax rate that starts at 0.618% and slides up to 6.24% so it can be very confusing.

The fact that the company is in Florida (a no-state tax state) has no benefit for the PA residing employee.

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 Question:

We’ve been incorporated since May 1, 2007 and started renovation & improvement of leasehold property in August 2007. It took more then a year and we are still not open for business. We signed shareholders agreement, minutes and bylaws only in August 2008, 15 months after incorporation. Our fiscal year ends on December 31. Should we file initial report for 2007 ending 12/31/2007 if it has only assets & liabilities and other lines are zero? The second question is some of the fixed assets and leasehold improvements accrued in 2007 when the corporation was not operating . 2008 will be the year when we start operating business and in the 2008 report we will claim to expense fixed assets and leasehold improvement accrued in 2008, and what about 2007s purchases and improvements ?

Answer:

The corporation is required to file a tax return every year.

Filing for 2007, will allow you to memorialize expenses that did occur and can be carried forward into 2008 and beyond.

Follow-up Question:

I’m very satisfied with your answer and I dare to ask you one more time. I’m so called treasure of the company but people don’t obey my requests and that’s what happens sometimes. We have construction going on and have employed incorporated small business companies that have EIN, that they provided. When they bill us for performed work, it has happened to be not me who signs the checks, for example president of the corporation, and he signs checks not to the company name but to John Smith, because that’s how he knows him. So we have bills from the corporations and payments issued for the company owner . And that’s what was going on for a long time. Should I consider that payments were made for corporate business or it was made for persons, request their ss and and file 1099 ?

Follow-up Answer:

The IRS will not allow the business to deduct payments to individuals without a completed 1099.

The IRS will require that you (your business, each individual that has signing authority on a bank account, etc) pay unpaid payroll and income taxes on payments to individuals, if that individual is considered a common-law employee and fails to pay their own taxes.

If the payment was to the individual then it is incumbent upon you to file accordingly.

Penalties are bad.

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 Question:

I’m a self-employed website designer. Can I deduct the following as business expenses?

Answer:

First: are you profitable?

If you are not, then the deduction does not do any good for the business. If you are not profitable, you are paying no taxes. It doesn’t go lower than that.

If you are not profitable, and you try to pass the deduction to you so you can take it personally, you are going down a slippery slope. If you will not be profitable, the IRS has policies in place to disallow your deduction later and have you pay all the back taxes and penalties and interest. Not good.

If you are not profitable, change that. That should be your only focus.

If you are profitable, then the laptop is expensable under section 179.

The travel, including the airfare can be deductible as long as you are confident that you can convince an IRS auditor that it was a necessary and reasonable business trip.

The apartment could be partially deductible, as long as fit within the rules.

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