Q:

Subject: I liked your article

I liked your article.  I’m still a little naive.  Today I just sent in the S corp 2553 form my accountant gave me, signed and all, to the Dept of commerce of the state of utah.  And now after reading your article I’m a worried I should have put my foot down and demanded a C corp filing.  Up until it gets filed in a few days I’m just, and have been for the last couple of years, a sole proprietor, DBA, or what ever you call it.  2004 I made only 95k and this year I think I’ll only barely break 100k.  For what I make do I still have to be worried and switch to a C corp.  I origionally thought the C corp was the way to go but when I told my accountant this he just said, “oh you don’t want to be double taxed,…so we’ll go with an S corp.”  Me not knowing any better I just agreed. 

 

I am a consultant in that I contract directly (as apposed to subcontract) with clients to go in and help them out with back-log stuff.  I charge them an hourly fee and every week I submit my invoice and they pay me a couple weeks later.  I’m 34, married, and in 2 months will have 3 kids, and travel all over the U.S. twice a month.  So what should I do as far as my S or C corp. filing?

A:

Only your personal tax advisor can properly assess which entity type is best for your particular situation.  As I’ve noted, many tax and legal do take a “one size fits all” approach and set up S corps without properly looking at the big picture.  You should have your accountant go over the points I raised in my article and make sure he has properly addressed them for your circumstances.  You should be concerned if you hear a lot of “oh, I didn’t think of that” from him.

From the confusing way you describe things, it may not be too late to choose a C corp status.  Form 2553 is filed with IRS after the corporation has been chartered by your state, and a Federal ID number (FEIN) has been obtained.  Until the 2553 is sent to IRS, and it is accepted, the corp is a normal C corp.

Good luck.

Kerry Kerstetter

Follow-Up:

Thanks for responding.  I have already dropped the Articles of Incorporation with the 2553 form in the mail,..so its on its way to be filed as an S corp.  I’ll print off your article and go over it with him.  Thanks again

Q:

Subject: Gift & Estate Tax

First, let me say thank you for posting your website.

It is very informative and I appreciate the time it took to provide this information on the web. 

If I may, I do have a couple of follow-up questions?

I and my father are residents of another state.  He is now 75 yrs. old and owns property in AR with a current estimated value of $600,000.  His total estate is less than $1M.  He is planning on gifting the property to me now.  I understand the value of the property would be subject to Gift Tax, but could be used against his lifetime exclusion (2006 at $2M).  Are there any AR State taxes that would come into play now or upon the sale of the property?  Thank you for your time.

A:

You and your father really should be working with a competent professional tax advisor to work out the best plan because there are some big issues to consider. 

Mainly is the issue of cost basis.  While gift and estate taxes are based on the property’s fair market value, the basis of the property for you as recipient will be the same as it was for your father.  This means that you will be accepting responsibility for future capital gains taxes (Federal + Arkansas) if you sell it.  This is very different from the cost basis you would have if you were to inherit the property from your father’s estate.  In that case, under current law, your cost basis would be the fair market value as of the date he passed away, essentially wiping out all of the accumulated gain.

There is a very simple and frequently used method to transfer property while your father is alive and avoid the basis problem.  He could sell it to you at the current market price and carry back the sales price as a note.  This would establish the higher cost basis for you.  You could then either pay off the note or your father could gift you forgiveness of all or parts of its balance.  Any competent tax advisor could help you structure this technique.  

If you all and your advisor do decide to do a straight gifting of the property, you will have to file a Federal Gift tax Return (Form 709).  Arkansas does not have a gift tax. 

You are mistaken on the lifetime exclusion amount for gifts.  It did used to be true that this amount was the same as the estate tax exclusion.  For some reason, our rulers in DC decided to uncouple the two figures  While the estate tax exclusion is $2,000,000 for people passing away in 2006, the lifetime gift exclusion is still only one million dollars and will not be increased in future years, even though the estate tax exclusion will be going up in the future, until it drops back down to one million dollars in 2011 if our incompetent lazy-ass rulers in DC don’t take any action. 

I hope this gives you some ideas of what you and your father should be discussing with your personal tax advisor.  Good luck.

Kerry Kerstetter

Follow-Up:

From your message I take it that there is an AR tax on the gain from a sale of the property?  thanks

My Reply:

That’s correct.  It normally works out to be 5.0% for long term capital gains.

KMK

 

Q:

Subject: Tender Offer for Cash

 

Recently BASF announced a tender offer of $37/share in cash for Engelhard.

For a long time shareholder of the latter, this takeover can be a capital gains tax nightmare. Is there a provision in the tax law which would allow for an even exchange with no tax consequences if the proceeds were invested in BASF?

Thank you.

A:

There would be a tax free swap if BASF were to give you shares of BASF stock in exchange for your Engelhard stock.  However, if you actually receive cash, that will be a taxable event; even if you turn around and buy the BASF shares on your own.

Kerry Kerstetter

Follow-Up:

Thanks for the info; another income tax disaster when long time holders are bought out for cash; reminds me of the 1994 cash buyout of American Cyanamid by American Home Products  – another capital gains windfall for the IRS. Although I regard it as an involutary conversion the IRS would say otherwise.

 

As a side note, BASF bought the American Cyanamid division from American Home Products in 2000 for $3.8 billion in cash.

 

 

Survivor winner and tax cheater Richard Hatch is trying what many of us call the “Willie Nelson defense,” as in this quote from a recent article on his trial.

Hatch …was relying on the advice of a self-employed accountant who was “in over her head.”

 Hatch also conned another accountant:

One accountant Hatch hired estimated he owed about $230,000 in taxes for 2000, Reich said. The television star asked for a second return showing his estimated tax bill had he not won the million-dollar prize.

Despite warnings that the second analysis was for comparison only, prosecutors said, Hatch filed the return with the IRS.

 

If Speculators Get Itchy, Residential Market Could Fall – As big a fan of real estate investing as I may be, I have always known that buying property based on the same kind of “greater fool” theory of investing that propelled the late 1990s dot-com stock market bubble, is just as reckless with real estate. 

Art Berkowitz, the CPA whose spreadsheet I mentioned earlier regarding keeping track of the different states’ rules for licensing of out of state CPAs, has a blog devoted just to this topic, called CPA Out-of-state licensing.   He has some interesting feedback from other CPAs who are just now learning about these new rules around the country.

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My opinion on the foolishness of relying on do-it-yourself tax prep software for the actual returns that will be sent  to IRS and State tax agencies hasn’t changed any.  However, as I mentioned on several occasions, they can be useful tools for organizing data for your personal tax professional, especially when doing trial runs before April 15, when you need to know how much, if any, to send in along with your extension.

I came across the following helpful articles.

Tax Software – What Do You Really Get in That Box? – From NATP (1/13/2006)

PC Magazine’s review roundup of tax prep software.

Kay Bell’s tips on getting the most from tax software.

QuickBooks QuickMaps in Lacerte – Intuit guide to transferring data from QuickBooks into Lacerte tax programs.  I’m looking forward to giving this a try. Since all of our corporate tax clients are required to use QuickBooks, I’m hoping it will speed up the tax prep process.