The estate tax made Paris Hilton what she is today. – If the thought of more of her kind around doesn’t scare everyone to support repealing the communistic estate tax, we have a tougher battle than I thought.

Q:

I have just finished reading your comparison on the S vs C corporations. I currently have a $ 12 million computer supply business that is a C corporation. I have repeatedly been told by attorneys and others that I should be an S corp because of the large bonus that I take at year end.  They say that the IRS could say that this is a dividend. I don’t understand because as it is now I pay full  taxes on the bonus also. After reading your comparison, I believe I should stay C. for the reasons you explained. Am I missing the point here? Thank you for your very enlightening article.

A:

I would say that keeping at least one C corp would have more tax saving opportunity than running all of your income through an S corp.  Just having an S corp piles all of your income into just the individual income tax brackets, missing the chance to use the lower C corp brackets.

How to pull the income out of the corp with the lowest tax hit is always an adversarial game between you and the money hungry IRS.  IRS would love for you to consider the payments nondeductible corporate dividends because that would allow them to actually tax the same income twice, once on the 1120 and again on your 1040.

The best plan is to use a combination of deductible corporate payments, such as wages, interest, leases, and royalties, in order to avoid the double taxation. 

Fringe benefits paid by the corp and which are tax free to the employees, are also much more lucrative with C corps than with S.

The term “reasonable” is subjective and the cause of skirmishes with IRS, which obviously wants that number as low as possible in order to classify everything above that as double taxed dividends.  Good documentation of how your numbers are calculated, as well as good records, and consistent treatment between the 1120 and 1040, are the best was for you and your tax advisor to make this immune to IRS challenge. 

Having both the corp and your personal taxes use the cash basis of accounting is also an important aspect to avoiding IRS problems.  If the corp uses the accrual method, that is so open to abuse that IRS auditors will have a field day  ripping apart the accrual methods used.     

Of course, when a business become large, I am a big believer in not putting all of your eggs in one basket and using multiple entities at the same and in staggered levels of ownership to help reduce your tax burdens, as well as the inevitable liability and lawsuit exposure that success brings.  These can include an assortment of C and S corps, as well as LLCs and trusts.

These are a just a few ideas I had, as I unwind from the April 15 crunch.

Good luck.

Kerry Kerstetter 

 

Q:

Subject: forfeited $12,200 by withdrawing from RE purchase

 

Dear Tax Guru,

 

My 92 yr old dad put up $12,200 in May 2003 to buy a house but decided to withdraw from the purchase in March 2004 and forfeited the $12,200 — how does he claim the loss for tax purposes?

A:

 It depends on what kind of property it was for.  There is a long standing double standard in our tax code that losses on personal property are not deductible, while profits on them are taxable.

On the other hand, if the house was being acquired to be used for rental or investment purposes, the loss would be deductible on Schedule D (investment) or Form 4797 (rental).

If the loss qualifies as deductible, it should be claimed on your father’s 2004 1040, since that is when the deposit became worthless.

Good luck.  I hope this helps.

Kerry Kerstetter

 

Q:

Subject: Personally paid corp expense article

 

Would the same technique described in option 2 be kosher for a corporate member of an LLC? The corporation has its own business credit lines and it would like to extend their benefit to said LLC.

I assume then the books would look like this:

Corp:

debit Loans to LLC, credit Corporate Mastercard

LLC:

debit expense, credit Loans from Members

A:

You can do it that way or through the capital contributions account.

Kerry Kerstetter

 

Q:

Kerry,

Thanks for the information in url http://www.taxguru.org/re/loanorigincosts.htm. I am glad i found the link. I have one question. I was filling out Section IV in form 4562. I am not able to find the proper Code Section (Column d) to use for the ‘Loan expenses’ for my rental property. I am not sure if i should use 195. Any help would be much appreciated.

Thanks

A:

I have always used Section 461, and IRS has never complained.

Kerry Kerstetter

 

Shortly after I posted the item about IRA accounts being off limits in bankruptcy, I received this from a reader.

Subject: Re: Supreme Court: Creditors Can’t Seize IRAs

 

I find it interesting that, like most, you focus on OJ’s exemption of his *residence* equity when OJ also used Florida law to fully exempt another large asset: his NFL pension. I assume the $1 million cap on exempt pension assets in the bankruptcy bill is an anti-OJ provision, since I can’t think of any other high-profile cases where a wealthy debtor used Florida’s or Texas’ unlimited pension exemption. Note that unlike homestead it has no safe harbor after which state law applies.

Given the defendant’s modest means, I suspect this is a result-driven decision. I doubt the SC would have ruled the same way had a debtor with a $2 million IRA came before them even though the decision technically protects them too. Given that, I doubt they will give any relief for the BK bill’s $1,000,000 cap, should it pass and a suitable case come before them.

I should note the BK bill has a serious flaw: the new federal caps on homestead and pension exemptions are not inflation-indexed. It won’t take long for their value to be eroded significantly, and I suspect political will to revisit the bill and raise the exemptions will be quite lacking.

My Reply:

You have some very good points.

I guess the reason we focus on the homestead exemption more than the one for pensions is that it is easier for lawsuit fugitives, such as OJ, to plow money they want to shelter into the purchase of an expensive home than it is to legally add it to an existing pension plan.   

Kerry Kerstetter

 

Q:

Dear Kerry,

I was reading your website and I hope you will be able to answer a question for me.

I moved across country from my primary residence in order to go to a highly ranked school.  I can’t afford to maintain the property any longer and wish to sell it. 

I left my primary residence for school.  Does that qualify as a change in place of employment so that I may get the tax break?

Thanks.

A:

While the law and related IRS explanations don’t specifically mention school related moves in relation to the reduced pro-rated tax free gain exclusion, such a justification should be eligible for at least a few reasons. 

In many other parts of the tax code, being a full time student is equated with being an employee.  This seems like a perfect place to do the same thing.

To qualify, you do need to be ready to prove if asked that the move to the school was unknown at the time you bought or moved into your residence.

Another way to justify it would be an unexpected change in your finances.  If you had originally believed that you would be able to afford keeping the home, and the new schooling situation changed that capability, you have met that test.

This is definitely a good example of one of the many gray areas in taxation.  Unlike most other tax pros, who want to interpret gray areas in favor of the IRS, I have always done the opposite.  If the law doesn’t specifically say that unexpected education related moves don’t qualify, I say you should use it.  

Those are just the thoughts that came to mind.  You should work with your personal tax advisor for more specifics.

Good luck.

Kerry Kerstetter

Follow-up Q:

 Kerry,

  Thank you for the prompt reply.  Proving going to school was unanticipated at the time I moved in is easy since I lived there for a couple of years and worked a couple different jobs before deciding to go to law school.  I even though I’d go back, but didn’t manage to get a job offer in California (where the home is) but did get one in Maryland.

  If you could point me to some other parts of the code that discuss full time students, I would appreciate it.  I’ll keep doing my own research but any support to convince my wife would be helpful.  She thinks like the tax pros you refer to (though she’s an engineer, not a tax pro).

Thanks again.

Follow-up A:

I don’t have time to dig up all of the references to students as equivalent to employees.  I have a ton of tax returns and extensions to finish by April 15.

The one that I do encounter quite often is Form 2441 for the credit child and dependent care expenses.  In order to claim this credit, both the taxpayer and spouse need to have earned income.  However, if either of them is a full time student, they are imputed a certain amount of income to qualify for the credit. 

I hope this helps. 

Good luck.

Kerry Kerstetter