Q:

Subject: Corp Tax Question

Can / Are principle payments made to shareholders who have loaned money to an S Corp considered / accepted by the IRS as a “cost of doing business” and therefore included along with other cost (material, wages etc.)?

Thanks for your insight

A:

The fact that you would ask a stranger such a question is a perfect illustration of how dangerous it is for anyone to try to run a corporation without competent accounting assistance. 

This is basic accounting and nothing tricky.  Principal payments on loans are balance sheet entries, which do not affect the profit and loss.  Interest payments are deductible as an expense.

Another issue that you need to consider is that all payments being expensed on the corporate books will need to be reported as income by the recipients. 

Get with an accountant ASAP before you go any further down the wrong road with your corporation.

Good luck.

Kerry Kerstetter

 

Q:

Subject: Sale of residence

 

I appreciate the information found on your website, and would like your advice on the facts and circumstances surrounding a sale of residence.

A client of mine had leased a home between 2001 and 2004, then purchased the home in 2004 because of its private wooded surroundings and park-like back yard.  In mid 2005, a neighbor of there’s offered to purchase every home on the street.  His intent was to subdivide the land and fit new homes on the existing parcels…

My client turned the first offer down, but when approached a second time, the investor stated that the rest of the neighbors had already agreed to sell, and if they did not sell to him, they would end up with new construction surrounding there property that would diminish the quality of the surroundings.  My client eventually sold, and purchased a similar property elsewhere.

I would greatly appreciate your advice on qualifying this as an unforeseen circumstance.

Thank you,

A:

The key requirement for using the pro-rated exclusion is that something unanticipated happened after the home was purchased that materially changed the living conditions in the house for its owner and other occupants.  If IRS were to question the application of the exclusion, the homeowner would have to be able to convince them that, if he had known ahead of time what the change would be, he wouldn’t have bought the place.

In your client’s case, the change from a home with no big construction projects around it to one that is surrounded by construction is a material enough change to alter the living conditions enough to warrant a move.  Construction sites are noisy (making sleep difficult) and dangerous, especially if your client has young children. 

It seems that the only real burden your client would have is being able to convince IRS (in the unlikely event of a challenge) that he had no advance knowledge of the developer’s plans for his neighborhood and it only came to light after he had taken ownership of the home.  If that’s the case, he should have no problem qualifying for the pro-rated tax free exclusion.

Good luck.  I hope this helps.

Kerry Kerstetter

 

Q:

Subject:  Class Action Settlement – IRA qualified?

 

Kerry –

 

I recently received a payment from a prior employer as a consequence of a class action discrimination suit. The payment had deductions made for Social Security, Medicare, Federal and State income taxes. This strongly suggest to me that the payment is being treated as “back wages.”

 

My question is this. Can I make an IRA contribution based upon the monies received in this settlement? I am presently retired and do not have earned income with which I might otherwise qualify for an IRA contribution.

A:

It certainly sounds as if they will be reporting the income on a W-2, which will make it eligible to be treated as earned income for IRA purposes.

You didn’t specify your age.  If you are or will be over 70.5 during this year, you will not be allowed to contribute a traditional deductible IRA; but a Roth IRA is still possible.

Your personal professional tax advisor will be able to provide you with more specifics for your particular situation.

Good luck.
 
Kerry Kerstetter

 

Q:

Subject: Tax Question RE: liquidation of LLC to c-corp

 

Hello Mr. Kerstetter, we have researched the web and the print world and found your most helpful and valuable information. Thank you for your contributions to the web. We have a few questions that we are having a difficult time finding answers to, and would like to ask you if you’ll allow us. In our work, we’ve found we get what you pay for, so we are willing to pay for your advice. Let us know what arrangements need to be made for payment.

 

A multi-member LLC has liquidated it’s assets and each member is to receive distribution of the proceeds. If the member has not yet taken possession of the proceeds, how can the member direct the proceeds to invest in a c-corporation without receiving the proceeds directly?

 

Thank you for your time.

A:

You definitely need to be working with a tax pro on matters such as this.  In fact, you should have been working with one from before you even set up your LLC.

As you describe the situation, it might be too late to do anything to reduce your taxes, depending on how you had elected to report the LLC income. 

If it has been taxed as a partnership or S corp, the gains from liquidating the assets are a done deal and are to be passed on to the members via their K-1s, whether they take any cash out or not.  That is the main principle of pass-through entities.

If your LLC has been taxed as a C corp, there may possibly be ways to transfer the assets to a new C corp tax free.  It could be relatively complicated.

It would have been a much better idea to work with a tax pro before liquidating the LLC’s assets because there would have been more options available.  By waiting until now to consider the tax problems, it may be too late. 

If you have been operating your LLC for all of this time without the benefit of professional tax assistance, you have probably learned an expensive lesson. 

As it says below, we are too swamped with client work to be able to take on any new ones.

Good luck.

Kerry Kerstetter

 

Sale of Data by Tax Preparers Draws Protests – This is a ridiculous idea and is just one more aspect of your relationship with your tax preparer that you will need to keep on top of. 

As I mentioned in my earlier discussions of tax prep offices outsourcing their actual work to outfits in India, it wouldn’t be a bad marketing tactic for USA tax prep firms to explicitly guarantee to their clients that their highly confidential data will not be released to anyone without the express written consent of the client. It used to be implicitly understood that such was automatically the case for CPA firms; but things have obviously changed.

As I hope everyone has noticed, I don’t like to waste time repeating what others have already written so well; so check out the excellent coverage of this issue by:

 Joe Kristan of Roth & Company

 Professor James Maule

 

 

Q:

Subject: home rental by my own business

For years I have leased the garage portion of my personal home to my partnership for the purpose of storage.  The garage is approx. 25 percent of the total square footage.

I have taken 25 percent of my mortgage payments and utilities as business deductions.

Now I would like to know if it is  legal to lease my entire home to my business, and then sublease it back from my business, so that my business can deduct the usual deductions for for rental property?

The home is presently titled in my name.  I am hoping that I do not have to get a new title for the house, in the businesses name, to do this.

If yes, are there any federal taxes at the sale of the property?

Could you please email the answer in case I can’t find it on your web site.

Thank you very much.

A:

There are ways to do this, most often by transferring the home to a corp.

You should really give this plan some deep thought, along with some in depth consultations with your personal professional tax advisor.  Most of the people I have seen do this later regret it when they discover that the home no longer qualifies for the Section 121 tax free exclusion of up to $500,000 of profit.  That exclusion is not available for rental property or for property owned by anyone other than an individual.  More often than not, that tax free gain more than offsets the “lost deductions” from not being able to claim the home as full rental.

Good luck.

Kerry Kerstetter

 

Q:

Subject: C Corporation

 

Hi Kerry,

 

Thank you for the excellent advice.  I’ve met with at least 30 attorneys and CPAs to discuss setting up a corporation.  Most tell me to start an S corp..and some an LLC…none of them understand the benefits of the C corp.  Is there an an Accountant you recommend to people who write you?  I would love to work with someone who just know what they are talking about!

 

Thanks for your help.

A:

C corps aren’t always the proper approach; but it is amazing how many tax pros don’t even properly consider how they can be of use.

You will need to work directly with an experienced tax pro who can analyze your unique circumstances.

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.

I’m sorry I couldn’t be more help.

Good luck.

Kerry Kerstetter