Tax Guru – Ker$tetter Letter

Helping real people win the tax game.

Archive for November, 2007

Shifting Corp Income?

Posted by taxguru on November 30, 2007

Q-1:

Subject: RE: Fiscal Year

Kerry,

I read your online article I have a question with respect to the following paragraph:

Fiscal Year
One of the most useful tools in the tax game arsenal is the ability to shift income between taxable years.  Individuals report their taxable income based on the January 1 to December 31 calendar year.  S corporations are required to also use the calendar fiscal year, allowing no opportunity to shift income between years.  C corporations, however, can end their fiscal year at the end of any month.  The first tax return will almost always be less than a full 12 months, so don’t worry about coordinating it with the incorporation date.  How this saves on taxes is pretty straight forward.  Toward the end of your personal fiscal year (12/31), you bleed off some of your taxable income to your C corp by paying it for something like rent or marketing services.  In January, your corporation can pay it back to you.  Near the end of the corp’s fiscal year, bleed its net profits out by paying yourself This back and forth income shifting can go on for a long time.  Sometimes income is never taxed; or if it is, we make sure that it is taxed at the lowest rate possible (15%).

Specifically,
  
I am a physician, a radiologist to be exact.  I am currently in the military, and I owe 2.5 more years.  In addition to my “day job”, I do moonlighting for various local locum tenens agencies.  I followed the pattern of some other people here, and got hooked up with an accountant here who got me set up in some entities.  I do not know if this is the right way to go for my particular situation.  I am in essence a “sole proprietor” in that it is just me, as a physician, doing this work.  My goals were to provide a liability shield, and tax advantage.

How this is set up is: I have a S-type professional corporation under the auspices of which I take on these local jobs, either on a daily or a weekly basis.  This is strictly a fee-for-service type arrangement.  The accountant also had me set up a traditional C-Corporation as a management entity. His plan is that the money I earn from my moonlighting each month (in the professional S-corp) is paid to the management C-corp.  He made the tax year-end dates for the S-corp 31Dec, but gave the C-corp a 31 Jan end, ostensibly putting the taxes on those earnings off a year.

My question boils down to the legitimacy of shifting my S-corp income to the C-corp to avoid the taxes; doesn’t the IRS flag this arrangement, which I believe is what you are refering to in your article?

Thanks,

 

A-1:

It sounds like you are working with a good tax advisor, if you believe in using legal means to minimize your tax bites.  That sounds exactly like scenarios I have set up for clients, which I learned from other tax pros before me.  Shifting income in this way isn’t avoiding taxes.  It allows you to control the timing and rate at which you pay taxes on your income. 

As long as all of the transfers and shifting are done properly and consistently, you are not breaking the laws.  IRS would obviously prefer that people just bend over, grab their ankles, and not do such things and just continue to pay them higher and higher taxes every year; but if you do take proper steps, under the guidance of an experienced tax pro, that is your right to do.

Whether taking legal steps to reduce your taxes is an unpatriotic thing to do is something I have been accused of my entire career. 

My guiding philosophy has always been the following 1934 quote from Judge Learned Hand:

“Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”

Good luck.  I hope this helps.

Kerry Kerstetter


Q-2:

Thanks, Kerry, for the quick reply.  I guess what I really meant to ask you is about the part where you say “…In January, your corporation can pay it back to you.  Near the end of the corp’s fiscal year, bleed its net profits out by paying yourself…”

I get the point about bleeding the money out of the S-corp to the C-corp as a “management” fee, but not about how to legally get that money back to the S in January, so that the “shift” can go on. 

One last thing,  is it legitimate in your opinion for me to in fact “shift” 100% of my profits in the S corp to the C corp?  That is what my current CPA is having me do.  I have taken no salary nor distributions from either account.  I have however, repayed to myself the original money I put in to both entities from my personal account to open the business accounts.  I have heard some sources say that this is a no-no, as the IRS my somehow consider this a “second class of stock” and revoke your S-status?

I may be looking for a new CPA… any interest? You obviously know this game quite well.

Thanks,

 

A-2:

The shifting of income back and forth is a very common technique.  Various methods can be used, such as leases and royalties, or a catch-all category of Business Services, to accomplish full deductibility on the return from which it was paid. 

Having just a one month overlap in the tax year-ends makes it a little tighter time-wise to plan the amounts needed to shift, but it is entirely possible to do.

It’s not always necessary to bleed out 100% of the net profit; but that’s a judgment call made with the assistance of your professional tax advisor, who will need to work with up to date accounting info.  The weak link in this game plan is almost always out of date bookkeeping, making it a shot in the dark in regard to determining how much income needs to be shifted.  The more up to date the books are for all of the entities involved (1040, 1120 and 1120S in your case), the more effective the income shifting will be.

I wish I could be more help; but I already have too many clients to take care of properly; so we are still trimming back on the difficult clients and are not accepting any new ones at this time. 

Unfortunately, we don’t have anyone specific to whom we could refer you. I did recently post some names and links for some like-minded tax pros around the country. 

If you haven’t already done so, you should check out my tips on how to select the right tax preparer for you. 

I wish I could be of more assistance; and I wish you the best of luck.  

Kerry Kerstetter

 

  

Posted in corp | Comments Off on Shifting Corp Income?

How our rulers continue to address the Insane AMT…

Posted by taxguru on November 29, 2007

Posted in AMT, comix | Comments Off on How our rulers continue to address the Insane AMT…

Winning the lottery?

Posted by taxguru on November 29, 2007

State mistakenly sends man check for $2,245,342 – A bit more than the $15 he was expecting. This man did the right thing and sent the check back. The Utah officials claim they would have eventually noticed the mistake if he had cashed it and would then ask for the money back. However, with that much dough, who knows where he would actually be by that time?

Posted in StateTaxes | Comments Off on Winning the lottery?

Posted by taxguru on November 29, 2007

There used to be a saying warning not to take any wooden nickels. That has to be updated now to don’t take any million dollars bills, after this idiot in South Carolina actually tried to deposit this bill into a bank account.

Posted in comix, Money, Morons | Comments Off on

Posted by taxguru on November 29, 2007

IRS and States Team Up on Payroll Taxes – Not really a new technique; but more of a warning that IRS and the States are desperate for those lucrative payroll taxes that are avoided when working with independent contractors instead of W-2 employees.

Another reason to check out using corporations.  I have known several small businesses that refuse to hire employees and will only utilize workers who are incorporated because only humans can be employees and corporations are not human. When you hire human employees, you allow our rulers in government to dictate every aspect of that relationship.  This is only going to get worse, as employers are forced to provide higher wages and more benefits and are at the same time denied the ability to fire people because of the ever increasing number of categories of discrimination criteria.  Working with corporations is a much purer form of capitalism and free market economics than is ever possible with employees.

 

Posted in corp, Employees | Comments Off on

Posted by taxguru on November 29, 2007

Flat tax for middle class – I wouldn’t hold my breath waiting for this type of change, especially if the Dims retake the White House.  They will never give up their beloved Marxist “progressive” tax rates that screw over the evil rich.  Remember that Middle Class and Evil Rich are subjectively defined by those in power.

 

Posted in FlatTax | Comments Off on

Selling mixed use property

Posted by taxguru on November 28, 2007

Q:

Subject: Exchange Question

 

My wife and I live in the front house. When does the rental back house cease becoming a 1031?  Does not receiving rent make it no longer a 1031(for how long)? Is there a statute of limitations for it to qualify as exempt?  I don’t want to pay a capital gain tax on it when I sell this 2on1 Calif. property.

Tx,


A:

This is the kind of thing you really need to be handling with a professional tax advisor to ensure that you are doing things properly.

From your very short description, it sounds like you have what’s called a mixed use property; part residential and part rental.  For IRS purposes, it is treated the same as two separate properties, with the personal residence portion of interest and property taxes deducted on your Schedule A and the expenses for the rental portion on Schedule E.  The actual allocation of joint expenses may not be 50/50 if the two halves of the property are not equal in size and/or value.  An experienced tax pro can help you come up with an appropriate allocation between the two halves.  The cost basis of the property also needs to be allocated between the personal residence and rental portions, with deprecation claimed on the rental portion, which will reduce its cost basis (aka book value).

In regard to the treatment of a sale of the property, the portion of the sales price that is allocated to your primary residence will be treated as a Section 121 possibly tax free sale, as I have explained on my website.  

The portion of the sales price allocated to the rental half will not be eligible for the tax free exclusion, and will need to be set up as a Section 1031 exchange if the taxable gain warrants it.

If I’m reading into your question properly, and you are asking how long it will be until the rental portion of the property can become eligible for the tax free Section 121 treatment, the answer is never, as long as it is being rented.  If the tenants leave and you convert the rental part to be an extension of your own primary residence, the clock can start on the personal use test, which is generally two years.

You didn’t say how you acquired this current property.  As an added twist, if you acquired it via a 1031 exchange, you will have had to own it for at least a full five years prior to its sale in order to be able to utilize the Sec. 121 tax free exclusion.  Again, an experienced tax pro can assist you with this rule.

I hope I hit on your situation.  Working directly with a professional tax advisor will result in more usable numbers for your precise situation than the generalities I have to use.

Good luck.

Kerry Kerstetter

 

 

Posted in 1031, humor, realty | Comments Off on Selling mixed use property

Which has better career potential?

Posted by taxguru on November 28, 2007


Q:

If you don’t mind me asking, if you had to do it all over again, would you still go the route of the CPA?  I have often thought it more lucrative to do a law degree than the CPA.  But, my heart and my god given skills are more directed towards the CPA than a Law degree and, after all, money isn’t everything (as you are well aware based on your move from California to Arkansas. 

Anyways, sorry to talk your ear off.  You are kind of like the Michael Jordan of CPAs, so I certainly enjoy speaking with you and listening to an advice you may have for a budding CPA.

Sincerely,

A:

You really should do what you feel most passionate about so that your career doesn’t become the kind of drudgery that most people who are W-2 wage slaves find themselves in.

As you may or may not know, I entered college with a major of Political Science, with the intention of going on to law school and then possibly into politics.  I accidentally ended up in a class called Accounting For Non-Business Majors just because at that time Freshmen registered last and that was the only class I could find to take along with the first Poli-Sci class.  It was eye opening for me and it clicked as nothing has ever before.

Looking back those 30+ years, I was indeed fortunate to have found myself in that class and I would not change my career to anything else.

Looking forward, it is obvious that there will never be a shortage of work for accountants, whether in taxes or management accounting.  Tax laws are changing daily and will never reach the level of simplicity that we all wish for.  Our rulers will never allow that to happen.  The levels of record keeping and reporting to so many different constituencies continues to grow almost exponentially, with new laws, such as The Sarbanes-Oxley Act, mandating more accounting details. 

I don’t know the numbers, but it seems that there are far too many lawyers already out there.  There are so many that they have to run all kinds of ambulance chasing style TV ads to recruit clients.  I have had attorneys as clients who openly expressed envy at the fact that my clientele is forced by law to use my services each year, while theirs only showed up for special situations.  

I obviously don’t have the crystal ball answer you may be looking for; but I hope this helps in your career path.

Good luck.

Kerry

  

 

Posted in cpa | Comments Off on Which has better career potential?

IRS Drops Interest Rate

Posted by taxguru on November 28, 2007

They just announced that, for the first quarter of 2008, their rate will drop to 7.0% from the current rate of 8.0% that has been in effect since July 1, 2006.

 

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How far will IRS go to collect money?

Posted by taxguru on November 27, 2007

Courtesy of Freaking News

Posted in comix, IRS | Comments Off on How far will IRS go to collect money?