Question:

Both seller and buyer have a list of sale allocation (furniture and fixtures, personal property, and goodwill). Seller (me) did not dissolve the original corporation, however, the DBA name and operations were transferred to the buyer/  I had to leave the corporation open to collect on previous (large) land installment sale.  I do have a no compete agreement and I continue to work for the buyer at the present time.  I am changing my entity type to not reflect the current business sold.  How do I show the goodwill allocation proceeds on the 1120 return for 2007 (an extension was filed)? Future returns will mostly have interest income from the installment portion of this sale and  the previous land installment sale.  I now pay myself salary and pay taxes for such on a personal level and I pay taxes on the interest income on the corporate level.  I would change to an S corp, but I was told my original sale may become taxable immediately, even though I still receive payments.

Answer:

You are stuck with opposing problems that can’t be solved well with a single corporation.

Right now you are in the best position as a Real corporation for the sale of your business, lower taxes, better deductions, fewer audits.

As you move forward, the corporation that you have now, as it is structured would pay higher taxes on the passive income (interest in your case). You would be deemed a personal holding company.

If you are looking for the best tax treatment you can’t get it from simply making a single switch.

If you want to call, I can give you a starting point to understand where you are and where you can be.

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Question:

I have a close friend who’s small business is probably not going to make it. They are incorporated. A company they were doing business with never paid them and they are trying to recover. They owe a lot in monthly sales tax to the IRS. Are they going to have to pay this back if they go out of business? They live in Washington state.

Answer:

Sales tax is not collected by the IRS, it is collected by the local business license authority and the penalties are stiff for not paying the collected sales taxes. You see, sales tax was never the businesses money. It was the governments money directly, that your friend had the obligation to deliver to the business license department.

Pay this one at all costs.

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Question:

I have an SBA loan on my business property under S-Corporation. The loan is in the amount of $500K; suppose I do a short sell on the property for $400K and suppose the lender forgives the debt of $100K and issues a 1099-C. What would be my tax liabilities?

Answer:

The loan does not directly figure into the tax liability.

What is your basis in the property?

If you bought the property for $200,000 and depreciated by $50,000 then you have a $200,000 gain, and $50,000 of recaptured income. The recapture will be taxed at your prevailing income tax rate. The gain would be taxed as either short term or long term.

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 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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