Tax Guru – Ker$tetter Letter

Helping real people win the tax game.

Archive for January, 2006

Can’t afford property taxes

Posted by taxguru on January 31, 2006


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Posted by taxguru on January 31, 2006

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It’s all our fault…

Posted by taxguru on January 30, 2006

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Posted by taxguru on January 29, 2006

Eleventh-Hour Ideas for Paying for College – From Gail Buckner

 

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Posted by taxguru on January 29, 2006

IRS affidavit says deals on property sales fraud – When I was teaching seminars to Realtors around Arkansas, I used to include a section on the requirement to file Form 8300 with IRS for transactions where more than $10,000 in cash or cash equivalents was involved.  There was a lot of skepticism as to this happening with real estate purchases.  However, this case shows that it is a very common method of money laundering. 

While the article doesn’t say anything about the parties receiving the money, IRS has a good case to prosecute them for failure to file Form 8300.  Anyone receiving 30 cashiers checks totaling $120,000 should report it on one or more 8300s, even though no one check was for more than $10,000.

 

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Wrong Number

Posted by taxguru on January 29, 2006

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Working With LLCs and S Corps

Posted by taxguru on January 29, 2006


Q:

Subject: SE Tax Avoidance Strategy

Hello, Tax Guru. I’d like to become one myself. Forgive me for the length of this email, but I wanted to present what I think are all the relevant facts so that you could give me your expert opinion. I’ve really enjoyed reading all the articles you have on your website and I, too, feel that we give too much of our money away to Uncle Sam because of fear. But I must confess, I have a little fear because it’s just me and my own little mind. Here goes.My wife and her unrelated partner have two businesses. A lawyer suggested they set one up as an LLC and the other as an S-Corp. Both of these are split 50-50.

The LLC bought a commercial building (28K sqft) and pay a mortgage. The LLC leases this building to the S-Corp. Through an informal “triple-net-lease?”, the LLC requires S-Corp to pay the RE taxes and insurance on the building.

The S-Corp is in the Art Business. They rent out space to artists, usually with 6-mos to 1-yr leases. The rent out wall space a month-at-a-time. They rent out floor space for weddings/receptions, corp meetings, karate instructors – you name it. They try to rent the air above the building. The S-Corp also sells art for the artists when they are not there, taking anywhere from a 10-30% commission, plus credit card fees for these sales. Both owners put in at least three days a week into the biz.

In the beginning, Oct 2003, both partners put money in the biz to get rolling. An accountant told me to put $100 each into Quickbooks (QB) equity accounts called Owners Capital. The rest of the money he had me put into accounts called Loans From Owner. I set these up as Equity accounts, but maybe they should be liabilities, short-term or long? I guess you know by now I do the books and taxes for the babes (they don’t like to be called ladies because that implies old).

Up until now, the owners have been taking 2K each out of the businesses. I book these by reducing the Loan From Owner accounts. Now, one of the partners has gotten her original investment out, so we’re talking about salaries, etc.

The S-Corp, in my mind, is never going to generate enough money to pay wages and dividends. I know from reading your website and others that wages are subject to FICA and dividends not.

Then I had a thought that the S-Corp may be in the rental business and thus the income would not be subject to SE/FICA tax. But I now think that because substantial services are rendered to the artist tenants and the hours the owners put in are relatively substantial, the S-Corp is really an active activity and not a passive rental activity. More like Property Management, I guess, which I read is also an active activity.

Next thought was that LLC is truly a rental, passive activity and that money earned in the LLC is not subject to SE tax. If this is true, then why not reduce S-Corp’s income down toward zero by increasing the rent paid to the LLC?

The only potential flaw in this strategy, in my mind, is that the IRS could say this structure is only for the purpose of evading SE taxes because the rent amount is “unreasonable” and exorbitant. To that end, we’re going to see what the going commercial lease rate is in this city per square foot.

There you have it. If you haven’t yet gone to sleep or deleted the email – what do you think about this?

Just as an aside, I’ve always done my own taxes and have been aggressive (like hiring my wife in my IT consulting business and deducting all health expenses), borrowing money from my IRA late in the year and having 99% of it withheld to avoid penalties for not paying estimated income tax during the year (is this a cool trick or what?!) and have done lots of reading. I’m a math major and always interested in numbers (and saving taxes). Since I got outsourced to India (I hope those six guys are happy) about the same time as this Art business, I decided to professionally prepare taxes for people last year (actually made a few hundred dollars) and I’m doing it again this year.

Thank you very much for listening and I would appreciate any advice you could give me on anything herein.

Sincerely,


P.S. When the Babes take non-wage money out of the biz and the Loans From Owner account have already been paid back, what is this disbursement called and where do I book the Debit in QB? (Obviously I’m a self-taught bookkeeper, too!).


A:

I don’t want to rain on your parade here, but working with LLCs and S corps is not something you can learn as you go on your own without making a lot of costly mistakes. You really need to be working with a competent professional tax advisor who has experience with coordinating these kinds of things. As you pick up on what s/he is advising, you can gradually take on more of the tasks yourself.

If you are serious about becoming a professional tax preparer, you should consider doing some tax season work for an established CPA or other tax prep service, where you can learn how to handle various kinds of tax issues. There is no substitute for real life experience in the tax profession, and most tax services are desperate for busy season help. I used to have several CPAs work for me during tax season back in my offices in the PRC. I taught them how to work with corporations and partnerships, skills they were able to take out on their own.

Good luck.

Kerry Kerstetter


Follow-Up:

I guess I really didn’t expect an answer for free. I’m already professionally preparing taxes anyway and have always learned everything I know from doing it myself, whether it’s computer programming technology or taxes. You’re right that I should be hanging around seasoned pros, which is why I sent the email to you and am constantly seeking other opinions – face-to-face, emails and by researching on the internet.

Anyway, I’m pretty confident in my assessment re: avoiding SE tax in the partnership. I found some more ammunition at the following website.

Thought you might be interested in it.

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Purchase or Loan?

Posted by taxguru on January 29, 2006

Q:

Subject: Exchange Question

My father-in-law owns highly appreciated raw land in Florida which he bought many years ago for $8,000.  He is receiving sale solicitations in the neighborhood of $400,000.  He wants out because he is tired of paying the increasing real estate taxes.

 The Q is: Can he use the 1031 rules to buy fraction shares in both my home and my brother in laws home (reduction in our mortgages) – with the understanding that we would pay him on the note (a monthly dollar amount equal to the non-deductible equivalent of principal and interest amounts – using a 25 year amortization). 

He would conceivably be placed on the deed and would leave us the share of the home in his will if he were to die before the 25 years was up.  He is 80 years old today (in good health)???

Basically we would be paying him 5.00% instead of paying the bank.

Thanks in advance for any help.

 

A:

There are several complicated twists to the scenario you are proposing, which all parties concerned need to discuss in detail with qualified professional tax advisors.

Your father in law could reinvest into your homes as long he will be acquiring equity ownership interests in them and he will be treating them on his books as investment, business or rental property.  He cannot treat them as personal usage. 

For this to work, you and your brother-in-law would have to report the sales of the partial interests on your 1040s, which may or may not be taxable to you.  There is also a restriction on 1031s between related parties if the replacement properties (your homes) are disposed of within two years, except for extraordinary circumstances (such as death or illness).  

Your FIL would also have to comply with all of the rules for 1031s.  The amount reinvested would have to be equal to or higher than the net sales price ($400,000 less selling costs) and there would need to be proper documentation of all legs of the exchange.  The handling if the cash proceeds would have to be set up so that he doesn’t have access to it.

However, the way you are proposing structuring the deal sounds more like he would be investing his money into the mortgages as a lien-holder instead of an actual equity owner.  Such an arrangement would not qualify as a like-kind replacement for his old property.  A lien-holder interest is not the same as an equity ownership.  Your repayment plan makes it even less likely to fly because you would be treating him as a lien-holder by paying him interest and not as a co-owner.

One possible way around this would be for you and your BIL to rent your FIL’s share of the homes from him and pay him monthly rent, which he would report on Schedule E of his 1040.  That would properly document the replacement properties as rental, which qualifies a like-kind for his Florida investment property.  This would also give him some monthly cash income to live on.

How your FIL wants to distribute his shares of the homes after his passing is completely up to him and doesn’t really affect this possible transaction.

These are just some of the details that all of you need to discuss in much more detail with qualified professional tax advisors.

Good luck.

Kerry Kerstetter

 Follow-Up:

Kerry,
 
Thank you for such a thoughtful response.  Is this the type of work that you could (better yet, would be willing to) do for us if we decide that this is the way to go?

Based upon your response – I think I would sell him my house and pay him rent (I qualify to exclude the gain on my 1040) – my house has an appraised value of in excess of his land purchase.

Best,

 

My Reply:

My wife, Sherry, has her own company, Tax Free Exchange Corporation, that handles 1031 exchanges all over the USA.

You can learn more about her services, as well as her fees, on her website.

Good luck.

Kerry Kerstetter

 

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Real Estate Office Accounting

Posted by taxguru on January 29, 2006

Q:

Subject: RE setup

I am setting up an accounting system for my daughter and it seems like a lot of people would like to use QBooks for a RE brokerage. Is QBooks a good piece of software to use for a RE brokerage firm and all the types of transactions associated with it?  Escrow, pending sales, non pending listings, multiple commission schedules, in house marked up services, closings, paying agents.

A:

I doubt that you will find one computer program that will handle everything needed to properly run a real estate office.

QuickBooks can do all of the basic accounting that you will need to prepare the business’s financial statements and tax returns, as well as 1099s and payroll.

It isn’t suitable for keeping track of the status of escrows and actual real estate transactions.  I know that there are various specialized software packages that are set up for his kind of thing; but I don’t have any names to pass along at this time.  You should check with other Realtors, as well as the NAR and local Realtor associations for recommendations.  

Good luck.

Kerry Kerstetter

 

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Medical Reimbursement Plans

Posted by taxguru on January 28, 2006

I’ve frequently discussed the additional tax breaks for C corporations as opposed to S corps.  One of those tax benefits is to have the C corp cover all of the employees’ medical costs.  As described here, those medical costs can even include things that wouldn’t be deductible on the employees’ Schedule A, such as over the counter medications. 

I have no idea what this company provides for $147; but I doubt that it’s much more than the forms already included in CFS Tax Software’s Small Business Tools program, such as this Medical Reimbursement Plan template.

 

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