Q:

Subject: When is my AIG NOT really AIG?

 

I  have tried to do a section 179 on my business expenses for 2006. It seems as thought I cant exceed the 22k that was reported on my W-2’s even though the IRS is saying my early withdrawal of IRA funds is being reported, taxed, and penalized as 2006 income. My total income was about 67K but i cant go higfher in my business losses than the 22k reported on my W-2? Something doesnt seem right here. The IRS is counting my 1099 income as income only when it is beneficial to them? Why wont they count it as income for my business losses?

 

  Thanks in advance,

A:

The rules are very clear. The kind of income that qualifies as an offset to Section 179 is “earned” income, which is the kind that is subject to Social Security taxes.  IRA withdrawals are not subject to SS tax, and thus do not count, even though they are subject to normal income taxes.  The same thing applies to all other kinds of unearned income, including pensions and investments (interest, dividends and non-business capital gains).

You should be working with a professional tax advisor before making any of these kinds of moves so that you aren’t surprised by the consequences.

Good luck.

Kerry Kerstetter

 

Q:

Subject: tax question

 

thanks for your interesting blog.

 

i have question for you.

 

suppose i invest 10k in an oil well.do i get to write it off? is the income it produces, say 5k/yr deductible against my initial investment?

 

regards

A:

There is no one size fits all answer because of the multiple varieties of investments that could be involved.

For example, if you are purchasing oil drilling equipment, it could possibly be expensed under Section 179.

If you are buying the royalty rights to a well, there is a potential to deduct the investment over time as the oil is extracted, as a depletion allowance.

You really need to be working with your own personal professional tax advisor who can look at your proposed investment and give you more accurate advice for that particular situation. 

As I’ve pointed out in other examples, the last person you should trust for this kind of tax advice is the person trying to sell you the investment.  Those kinds of high commission sales people will tell you anything to make a sale and will be long gone when you discover that the lucrative tax deduction was a lie.

Good luck.

Kerry Kerstetter

 

Q-1:

The barn I am depreciating is a specialized barn to be used for horses only. I’ve read somewhere that it could be all deducted in one year if that is so. Could the barn be written off against the yearly 100,000$ deduction for equipment or specialized barn in this case? Thanks.

A-1:

The Section 179 expensing election absolutely does not apply to barns or other buildings that have multiple uses.

I hope this clears up any confusion you have.

Kerry

Q-2:

Kerry, the 179 expensing thing, The barn was constructed for horses with horse stalls, horse bath, tack room and birthing room. Since it can only be used for horse , I thought it could all be expensed in one year. Did I miss something? Thanks.

A-2:

I have no idea who told you that a barn could be expensed in the first year.  That has never been possible.  I have prepared hundreds of tax returns with barns over the years, and would have known if they could be expensed.

So that you know this isn’t just my personal opinion, I have just faxed you copies of two pages from my QuickFinder Depreciation reference book, where it lists what types of property qualify for Section 179 and which don’t.  You will note that Barns is second on the list of types of property that DO NOT Qualify for Section 179 expensing.

Kerry

Q-3:

Kerry, I’m sorry. The info I had was that a specialized building such as a barn could be expensed in 5 YEARS.  Sorry ’bout that. Is that correct? Thanks.

A-3:

I have never hear of using such a short depreciation life.

I just checked my QuickFinder Depreciation reference book and it shows barns being depreciated using lives of from 15 to 25 years.  No mention of 5 years.

Is your new tax accountant suggesting these crazy things, or is it you coming up with them?  You may want to let him look it over and make any changes you want before mailing it in.

Kerry

Follow-Up:

No, I heard it from the people I bought the prefab barn from. Thanks.

My Reply:

That’s a perfect example of why it’s dangerous to believe tax advice from someone who will say anything in order to make a sale.  I constantly hear stories of big tax breaks being promised by car, boat and RV salespeople that turn out to be completely bogus.  Whether the salesperson intentionally lied or actually believed the information to be correct is irrelevant because the consequences are exactly the same. 

The smart thing to do when a salesperson makes such a claim is to verify its accuracy with an actual tax pro before making the purchase because it will be too late to do anything about it later.   Salespeople can’t and won’t stand behind their tax advice and you have no recourse when their tax claims evaporate.

Kerry

 

Q:

Subject: Quick Question

 

Hello,

 

I have a quick question, a friend and I were talking and he works for a large auto dealer, he is interested buying a Lincoln Navigator from his dealer because he said he can use it as a rolling bill board and write it off under section 179. I have friends that do use their suv to take clients to homes and show real estate but would my friend qualify for section 179 working at the Dealer and using it as a “rolling bill board”?

A:

Your friend should be discussing matters such as this with his own personal professional tax advisor rather than relying on second hand advice from strangers on the internet.

I’m sure your friend’s personal tax advisor will  answer this question in the same manner as I have in the number of times I have addressed this exact same issue in postings on my blog. 

Business deductions for a vehicle, including Section 179, are purely based on the business usage, which is measured by business miles driven as a percentage of total miles driven for the year.  What is painted on the vehicle is completely irrelevant. 

Another thing your friend will discover from his personal tax advisor is that, as an employee of the auto dealer, his miles back and forth between his home and the dealership count as personal non-deductible commuting miles, which will lower his business use percentage for the vehicle.

Kerry Kerstetter

 

Q:

Subject: Tax vs. Book depreciation – quick question

 

Dear Mr. Kerstetter,

I had a quick question for you – I have looked around to try to get a definite answer to this, but to no avail yet.  I was wondering if you could help me.  Based on the S Corp tax summary outlined below, I was wondering if you would be able to tell me what the actual depreciation charged to book/financial income was by looking at this?  Thank you in advance, and I enjoy your website!  Thank you – Greg Torgerson, from Iowa

 

S Corporation Tax Return Summary:

Form 1120S

Total Income                                                     $1,266,997

Depreciation  (ln 14a)                                        $ (87,612)

Other Deductions                                              $ (1,156,919)

Ordinary Income                                               $ 22,466  (flows to Sch K, ln. 1)

 

Schedule K                                                       $  22,466

Charitable Contributions                                  $ (215)

Section 179                                                       $ (100,000)

Income                                                              $ (77,749)

 

M-1 (col. 1)

Net Income, Books                                            $ 90,770

Expenses recorded on books,

not included on Sch. K:

Depreciation      $45,928

Other                   $1,132                                    $ 47,060

                Total                                                       $ 137,830

 

M-1 (col. 2)

Deductions included on Schedule K not

Charged against Book Income (Depreciation)$ 215,579

                                                                          $ (77,749) (ties to Income Sch K) 

A:

Greg:

It has always been my policy not to answer homework questions.  I only deal with real life issues for real life people.

You should ask your professor and teaching assistant for help.  That is what they are paid the big bucks for.

Good luck.

Kerry Kerstetter  

 

Q-1:

Subject: Section 179 expensing

 

Mr. Kerstetter,

 

I am writing to see if you may be able to help me with my confused state.  In 2004 I purchased an airplane with the plan of placing it into service at a local airport as a rental for student pilots.  I was advised, by my accountant, to form an S Corp and purchase the airplane.  I placed the airplane into service in the 1^st quarter of 2005 and kept it in service during all 4 quarters.  As it turns out it was not a profitable venture and I was negative approximately $15,000 (Profit/loss).  I had planned on taking a 179 expense however due to the business income limitation I cannot take the expense however I can carry it over to 2006.  As an aside a business venture such as this has no hope of ever being significantly profitable.

 

My question is would I be in the same situation if I had set up my company as an LLC?  As an LLC entity would my ordinary income be included in the business income limitation?  Is the business income limitation handled a little differently from an S Corp and a LLC?  Is there anything I can do to remedy this situation?

 

Thank you in advance for your assistance.

A-1:

Multi-member LLCs are treated essentially the same as S corps tax-wise, including with Section 179.

If you had set up a single member LLC and elected to treat it as a Schedule C sole proprietorship for tax purposes, the Section 179  expense would have been matched up against all of the earned income on your 1040, including from W-2s, most likely increasing the actual usable deduction.

Did you go over these different options with your accountant beforehand, or was he the kind who believes in a “one size fits all” S corp for everyone approach, without adequately analyzing the various factors first?

Kerry Kerstetter

Q-2:

I guess my accountant was the “one size fits all mentality.”  I thought I was doing the right thing by going to him BEFORE I set up any business entity and even told him specifically (in 2004) I wanted to be able to take advantage of section 179.  I also spoke with an “aviation specialist” tax attorney who also recommended incorporation as an S Corp.

Without the 179 expense I owe $14,500 in Federal taxes, if I could (magically) be able to take advantage of the 179 expense I would have a $25,000 refund.

I have filed an extension and not have filed any returns as yet.  Do I have any options?

Best regards,

A-2:

With no income expected, it does seem rather careless to use an S corp if your goal was to maximize the Sec. 179 deduction.

What I have seen in cases just like this that I have worked on is that it often comes out okay by forgoing the Sec. 179 and just claiming normal or accelerated depreciation, which can be used to create a net loss that can flow through to your 1040 via the K-1.  If your preparer enters for Sec. 179 in his tax prep program, that will create a carry-forward for that amount and reduce the depreciable basis, resulting in much lower depreciation deduction.  While you won’t get the huge Sec. 179 deduction all in one year, you will still get large losses for the depreciable life of the plane.

Good luck.

Kerry

Q-3:

Kerry,

 

Thank you. I am not sure careless is a strong enough word, as I said I was specific with my accountant that I wished to take advantage of the 179 expense.  Since the business was not profitable I “retired” the aircraft from service.  At present I am only looking at a deduction for 2005.

 

I will also be looking for a new accountant.  Can you make any referrals in the Denver area?

 

Again, thank you for your assistance.

 

Best regards,

Q-4:

Unfortunately, we don’t have anyone to whom we could refer you. If you haven’t already done so, you should check out my tips on how to select the right tax preparer for you.:

Good luck.

Kerry Kerstetter

Follow-Up:

Kerry,

 

This has been an expensive lesson for me.  My accountant has become a friend and I hope to keep him as a friend but he has proven to me that he can no longer be my accountant.  This misstep in tax planning impacted a commercial investment which hinged on the tax savings from the 179 expense; a plan I have discussed in detail with my accountant.

 

I would like to thank you again for you kind and thoughtful advice.  I can’t tell you how much I appreciate it.  I have lost some sleep over my situation

but I realize I have many other blessings in my life and I am thankful for them.

Best regards,

 

Q:

Subject: Sale of sec 179

 

Is the below comment true (specifically the ‘not subject to the self-employment tax’)? I want to know the penalties of a Section 179 that I made for 2005 for $32,000 and a business truck.

“If a taxpayer disposes of property on which the taxpayer has claimed the Section 179 deduction, the Section 179 deduction is subject to recapture in the same manner as depreciation. A taxpayer reports the sale of such property on Form 4797. The recapture of depreciation and the recapture of the Section 179 deduction on a sale of the property are not subject to the self-employment tax (Section 1402(a)(3)(C)).”

Found on the web here.

A:

That is true; but it nothing new.  Gains from sales of business equipment, including depreciation recapture, have always been reported on Form 4797, which is not counted as self employment income.  Section 179 is really just a form of very accelerated depreciation.

Your personal professional tax advisor can explain how this affects you in more detail.

Good luck.

Kerry Kerstetter

 

Q:

Subject: Sec.179 on S.Corp – Income Limitations

Kerry,

I came across your website while searching the web for a question I had related to Section 179.

Can an S.Corp. (single shareholder), claim a Section 179 expense deduction and flow it through to its shareholder for an amount in excess of the amount of taxable income given the fact that the shareholder is also claiming a salary form the S .Corp?

Example:

Shareholder salary from S.Corp $60,000

S. Corp net income before Section 179 $50,000

Section 179 Qualifying Property $100,000

Is the max deduction $$50K or $100K?

Thank you in advance for any insight you may have.

A:

This is the kind of thing that you should be working with your personal professional tax advisor on.  If you are trying to handle S corp taxes on your own, you are asking for big problems and will most likely end up paying a tax pro more to straighten things up after the fact than if you were to use his/her services from the beginning.

Your question is a good one for educational purposes.  The S corp taxable income limit for Section 179 purposes is the net bottom line with several adjustments.  One of those adjustments is adding back the W-2 wages paid to shareholder employees.  With your example, and assuming none of the other adjustments apply, that would mean that the full $100,000 could be deducted on the 1120S, which is then passed through to the shareholder via K-1. 

Your tax pro’s tax prep software should be able to make the appropriate calculations of the applicable taxable income limitations.  I also found a very handy worksheet for this on Page 5-4 in the 2005 Depreciation QuickFinder Handbook.

Good luck.

Kerry Kerstetter

 

Q:

Subject: Sub S Corp Question

Mr. Kerstetter,

First, I would like to thank you for your informative web site.  You have effectively detailed many of the pros and cons of incorporating. 

My question is, do expenses such as buying a company car offset any income acquired by the corporation?  I was reading about the man who earned 300k but only took out 30k for himself on your website.  Didn’t the corporation make the 300k profit?  If so, and it was retained within the corporation for operating capitol, why did he have to show it as income?

A friend and I are considering forming a Sub S Corp and I am trying to learn as much as I can prior to beginning the process.  As things are, I will own 49% of the stock and Eric will own 51%.  We have the potential to generate well over 500k within the first year and a half to two years.  After that, there is the potential to make literally millions.  For this to work, we will need to keep a majority of the profits within the company for the second and third phase of our business plan.  We will only be taking out 30k to 35k apiece.  Is there any way to keep the income within the company without having to pay through the nose for income that we are not seeing the benefit of?

Eric is strongly in favor of the Sub S because he says that the dividends that we are paid are not subject to social security tax.  I am concerned that he is being a little short sighted.

Thank you so much for your time.

A:

While I do appreciate the fact that you are doing research on the issues surrounding working with corporations, there is no book or online reference (including any of mine) that can substitute for the real world services of a qualified tax professional who can thoroughly analyze your particular circumstances.

You do seem to be very confused about the workings of pass-through entities, such as S corps, partnerships, and LLCs that elect to be taxes as partnerships or S corp.  For Federal income tax purposes, these entities do not pay any income taxes.  Their net income or loss is passed through to the income tax returns of the shareholders, who are required to include it on their 1040s regardless of how much actual cash (if any) the shareholders received.  The example to which you referred is a very common situation, where the S corp has a very large net taxable profit, but doesn’t distribute any actual cash to the shareholders because of investment or operating requirements.  The shareholders are still required to pay income taxes on that income and come up with the cash to pay them from whatever sources they can utilize.

Depreciation and Section 179 expensing of business equipment, including some kinds of vehicles, can reduce the corp’s taxable income.

A C corp pays income tax on its net taxable income, which could be high if excess cash revenues aren’t spent on deductible things.

There is no easy one size fits all answer to your needs.  You should also be open to the fact that you may not want one entity to cover every aspect of your business.  Multiple C and S corps may very well work out best for you and your business partner.

Again, it can get very complicated and is something that you definitely need to work on with a competent tax pro.

Good luck.

Kerry Kerstetter

 

Q-1:

Subject: Sec. 179

 

Dear TaxGuru,

 

My husband and I have two sole proprietorships that is offset by his regular job salary.  One is a farm that does not make money, but keeps vets and blacksmiths busy and the other is a new classic car business.  We purchased a Ford F350 truck with crew cab that weighs 13000 lbs for the purpose of both businesses.

 

Does this truck qualify for the full purchase price of $47,000 to be written off in one year under the Sec. 179 2005 rules.  The truck was modifed to handle a gooseneck horse trailer, but also serves to pull a car trailer for restoration projects.

 

I am thinking that if the full amount can be written off, I should put it under the farm as farms are recognized as not money makers.  However, do I have the option of splitting the truck’s cost between the two companies.  Expenses are greater that profits for the car business as it takes a long time to restore the cars, find them, etc.  The farm could show a very modest profit ($1,000 or so) if I do not use all allowable deductions.

 

What is your suggestions, recognizing that I should consult a tax pro.

 

Thank you.

A-1:

Check out this post from last month.

Any deductions for the truck would have to be allocated to the various business schedules that you are using, based on miles driven.

If you are actually using the same facilities and equipment for both your farming and car operations, you should consult with a tax pro as to the feasibility of combining them on the same business schedule with your 1040.  It makes things a lot easier than having to split everything up.  That’s what I have been doing here for the past 12 years we have been living on this ranch for pretty much all sorts of different kinds of income (including sales of animals, hay, timber, jewelry and ceramics), except for my CPA work.  IRS has never had any problems with that.  

Good luck.

Kerry Kerstetter

Q-2:

Kerry,

 

Thank you for your quick response.  It sounds as though I should put the truck on the car business where the miles are at this time.  This would prevent me from reporting the mileage deduction, so do I need to show business miles in order to support the truck?

 

I wanted to confirm that my Ford F350 Crew Cab with a normal bed that a sheet of 4×8 plywood can fit into qualifies in 2005 for the full deduction of $47K?

 

Thanks again.

A-2:

As you noted earlier, you really need to be working on matters such as this with a tax pro so that you don’t screw things up on your own.

One of the most basic requirements for the Section 179 deduction is that the asset be placed into service before the end of the tax year.  For vehicles, this means that it must be driven for business reasons.

You will need to get the specs for the truck you are looking at and compare them with the dimensions as specified in the tax law for qualifying for the larger deduction.  In the post that I sent you earlier, the defining point was the length of the truck bed.  I researched that specific case because it was for a long-time client who actually paid me for that time. I do not have time to do this for you; especially right now, as we close in on the April 17 crunch date. 

I would be very careful of relying on the dealer’s claim that the vehicle meets the specs for Section 179.  I have seen dozens of cases where they will say anything the customer wants to hear just to make the sale, and the buyers are left holding the bag later on when they discover that the vehicle in fact didn’t meet the requirements, most often for the 6,000 pound weight threshold; but the bed length is also a key factor.  Needless to say, car dealers aren’t exactly known for standing behind their tax opinions when push comes to shove.  You would be much safer working with a tax pro who can make reliable determinations.

Good luck.  I hope this helps.

Kerry Kerstetter