IRS Warns Consumers of Possible Scams Relating to Hurricane Katrina Relief

Q:

Subject: Tax Question

 

If a sole surviving parent deeds his house to his child for one dollar before he passes away, doesn’t that house represent a short term capital gain of some sort to the child for the market value of that home at the time of transfer in excess of the one dollar paid? No trust was involved, and the transfer was individual to individual.

 

If a tax is due, who pays it and when is it due? If the donor is required to pay, but can’t because he transferred all his assets to that child, does the child pay? If not, who pays? I know of a situation like this where the donor did just that before checking into a VA retirement home and he is now broke. Did the child who was the recipient of the home for one dollar now get it without any tax consequences? If so, it seems like a loophole

 

Look forward to your response,

A:

The sale for one dollar was in actuality a gift of the house from the father to son.  This is tax free to the son and is required to be reported on a Gift Tax return (Form 709) by the father.  Unless the father had already used up his million dollar lifetime exclusion, there shouldn’t be any actual gift tax required to be paid.

The next issue is the cost basis of the home to the son.  With gifts such as this, the father’s cost basis transfers to the son.  If his wife had recently died, the cost basis will have been stepped up at the time of her death.  If they lived in a community property state, the entire cost basis was stepped up.  If they were in a non-community state, only the wife’s half is stepped up and added to the father’s cost for his half.

The only potential actual tax would come when the son sells the house, looking back to his cost basis.  Of course, if he lives in it for two years before selling it, he can exclude up to $250,000 of profit.

Any competent tax professional should be able to work with your client to make sure everything is being handled properly.  None of this is very complicated.

Kerry Kerstetter

Follow-Up Q:

Thanks Kerry!

I thought you could only gift up to $11,000 per year and any amount over that is a tax to the donor in that year.

A:

That $11,000 threshold is only for the requirement to file a Gift Tax return (Form 709).  For gifts over that during a calendar year, a 709 is required to be filed.  However, no tax is required to be paid if the donor chooses to use part or all of his million dollar lifetime tax free exclusion, which is available to everyone in addition to the $11,000 per year ($12,000 starting in 2006).

I have this all explained on my main website.

Kerry Kerstetter

 

For quite some time, Ohio CPA Dana Stahl and I have been reviewing and discussing the long running controversy over whether or not income from an LLC is subject to the 15.3% self employment tax on the members’ 1040s.  Dana recently attended an NSA seminar in Baltimore specifically because they had advertised that they would be covering new developments on this issue (“Solution for SE Tax-Finally? This May Not Be What You Want to Hear!”).  I asked Dana to pass along what he learned there, which he did in this email.

Subject: NSA Meeting Update

 

Mr Guru – got back today from that NSA seminar in Baltimore.  The LLC/SE issue was covered on Day 2.  The speaker was a fellow named Bob Jennings (RJ) who apparently has extensive experience as a presenter for such seminars.  Anyway, here’s a brief summary:

 

1.    After a history of the issue, RJ stated that there really is no immediate answer to whether Members are subject to the SE tax on payments classified as distributions.

 

2.    However, he cited a concern with tax shelters.  Should the LLC experience losses after not paying SE tax for profitable years, the potential exists that the IRS could classify the LLC as a tax shelter subject to Form 8271 filing (Registration as a Tax Shelter).  How?  By saying that an LLC Member is a Limited Partner and not paying SE tax on the LLC profits, in loss years, then, we would be distributing the loss to Limited Partners in effect.  Therefore, if more the 35% of losses are distributed to Limited Partners, then we have in effect a tax shelter rather than an LLC.  By not filing the Form 8271, we’d be subject to a minimum $25,000 fine.  Something to consider, I guess.

 

3.    Finally, the question was raised that couldn’t IRS simply reclassify distributions taken from a multi-member LLC as guaranteed payments?  If no money is taken out, I assume there’d be no problem, but most of my LLC Member clients make a living from their LLC businesses, so they do withdraw money.  We’ve always classified them as distributions, but now I wonder if that was wise.

 

That’s about the gist of the session.  Any comments?  As alway, I continue to be concerned about how I’ve treated the LLC/SE issue pertaining to my clients.

 

Talk to you soon,

DS, CPA

Dana:

Thanks for the info from the seminar.  I’m not familiar with Mr. Jennings; but some of the info you attributed to him makes him sound like a bit of a worry-wart.

1.  It sounds as if they were a bit misleading in their advertisements for this seminar in claiming that they had an answer to the SE question. Saying that it’s still up in the air doesn’t seem like it’s worth the trip.

2.  A few years of losses doesn’t make something into a tax shelter requiring registration.  Those rules involve completely different kinds of business ventures and intentions than those our clients are using to operate their for-profit businesses.  It sounds like Mr. Jennings is just grasping for obscure things to worry about that have very little application to the real world.

3.  Same thing.  If we did nothing but worry about the millions of things IRS could possibly do, we would all go nuts.  The status of this issue seems to be the same.  Until Congress enacts a law requiring SE tax on LLC income, IRS seems too nervous to require it by their own regulations.  They were slapped down a few years back when they tried to make LP income subject to Medicare tax; so they are very unlikely to stick their necks out trying to do the same thing with LLCs.

Nothing you said makes me worry about needing to change our approach to treating SE tax as optional for LLC members on both their K-1 income, as well as capital distributions. 

Those are my reactions to what you passed along, for what it’s worth.

Kerry

Follow-Up:

I have spoken with Dana on the phone since this email exchange and he assured me that, in spite of not nailing down the LLC-SE tax issue, the seminar was very worthwhile and Bob Jennings was very skilled at presenting the material and had a lot of excellent tips on how professional accountants can avoid lawsuits.