Tax Guru – Ker$tetter Letter

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Q:

Subject: Question on lease/credit transaction

 

Kerry,

 

A friend of mine has asked me to run some lease/credit transaction through my company. I’m a bit hesitant as I don’t know if there are any potential issues (tax and/or legal) with it. Could you let me know what you think about it?

 

Here are the details from this friend’s mail:

 

———————-

Basically, our company has a lease credit line of like an additional 90K. We need the cash to pay for current expense as behind a bit on cashflow in expansion. We’ve used the lease credit before for all kinds of product/services purchases.

 So, what I’d like to do is get a software product/services Invoice from you for 80K. The leasing company will pay you 80K. Then you can issue us a credit back of 75K, that will be paid to you company anyway for normal development services over the course of few years. I need to discuss this with you quickly, as it will take a few weeks to get this finished. On your books it will look like 80K income for product/services and a credit or expense of 75K out.

 ———————–

 thanks

A:

From an income tax perspective, there would be no problem with this transaction, as long as you report the full $80,000 received as income and then the $75,000 paid out as an expense.

From the perspective of legality, it sounds like a completely different story.  I’m not an attorney, but there are aspects to this that smell very bad to me.

What could potentially be a problem is with the leasing company.  This sounds suspiciously like a fraud against them.  You should contact that company before submitting an invoice because I am guessing that they are either planning on using the product you are selling as collateral for a loan or as an actual purchase by them to be leased to your friend.  If they were to find out that no such product exists,  they could sue you, or file criminal charges against you, for theft.

It would be like selling someone an item and not delivering it after being paid for it.  It may be possible that future consulting services would be acceptable to the leasing company, but that is not very likely.  I would be amazed if it was acceptable.  They generally prefer to work with tangible assets that could be re-possessed and resold or re-leased.

It’s obviously your call; but unless you can get assurance from the leasing company that there is no problem with your submitting an invoice for future work to be done, I would stay away from this.  Although your friend is instigating this, the leasing company would have very strong grounds for legal and criminal action against you for the full $80,000 because you are the one they are paying that to.  The fact that you are only keeping $5,000 of that money won’t do you a bit of good in this kind of case. 

The final decision is yours; but I hope this helps you make a safe and rational decision.

Good luck.

Kerry

 

Q:

Subject: Estate Tax

 

My mother is selling her home of 20 years and moving closer to us. My father died 10 years ago. Does she qualify for up $500k estate tax exemption or is she only qualified for the $250k? Her home is on the market for $400k.

 

Thanks

A:

This is the kind of thing your mother should be discussing with her personal professional tax advisor rather than relying on second hand advice from strangers on the internet.

What you are referring to is income tax not estate tax.

Assuming your mother is single, she would be entitled to a possible maximum exclusion of $250,000 of profit from the sale of her home.

Your father’s share of the profit was already wiped out when he passed away.  When a person dies, his heirs receive the property at its stepped up fair market value (FMV) as of the date of death (DOD), effectively cancelling out the accrued profit. 

In your mother’s case, she would have inherited half of the home from your father.  You didn’t say where she lives.  If she lives in one of the nine community property states, the cost basis for the full home was stepped up to its FMV at the DOD, and her gain will only be based on the appreciation since then.  If she lives in a non-community property state, the cost basis of her original half remains the same as before your father’s passing; but the cost basis of the half she inherited is stepped up. 

She really needs to work with a qualified tax professional to calculate her cost basis in the home, which will take into account the FMV as of your father’s death. as well as the cost of any improvements to the property she has paid for since then.  When her tax pro figures her adjusted cost basis and deducts that, plus selling costs, from the $400,000 sale price, I am betting that the net profit will be well below the $250,000 threshold, making all of it tax free for her.

I hope this helps.

Kerry Kerstetter  

 

Q:

Subject: S Corps & Rentals

Kerry

 

    I read with interest the e mail about short term housing being a Sch C business. I currently have plans to turn

a vacation home into a short term rental. I approached my tax guy about this problem and he said I could

include the rental in my already existing S Corp (retail) and file Form 8825 on the rental income thus avoiding FICA.

I receive a hefty pay check from the corporation. Can this dual purpose exist in a single corporation?

 

    Later I got to thinking about the liability issue. Wouldn’t the corporation have to own the rental property? On the other hand,

my original corporation operates out of my home. Is my home at risk because the business operates out of it? My tax person

didn’t seem sure on these points. What’s the best setup?

 

    Thanks  

A:

I can’t possibly know enough about your unique circumstances to advise a specific course of action.

However, you mentioned several issues that you need to explore in more detail with your current tax pro, or one with more experience in this area.

First is the fact that a corporation can conduct more than one kind of business and is not restricted to only the original activity.  It is very common for corps to add new business ventures all the time, just as individuals do.  Your existing S corp could operate rental properties.

The issue of avoiding FICA tax only applies of there is going to be a net profit after all expenses, including depreciation.  If you’ve seen my comparison of C and S corps,  you know that profitable businesses can often have lower taxes via a C corp.

Depreciation can only be claimed by the actual owner of the property.  While transferring ownership of your property to a corp might sound like a good idea, the long term effect could be expensive.  Capital gains tax rates are generally higher for corporations than for individuals. 

What some people do is own the property in their own personal names, and then lease it to their corp, which in turn operates the B&B or other rental activity.  Any experienced tax pro should be able to help you with such a configuration.

There are obviously a gamut of pros and cons to every possible scenario, making an easy “one size fits all” answer impossible to find.  Make sure all of these points are covered in your discussions with your tax pros.

Good luck.

Kerry Kerstetter

 

Q:

Subject: additional paid in capital

 

C-corp has accumilated additional paid in capital,  can this capital be taken out of the corp by shareholder? is this taxable to the shareholder or just the shareholder taking out his equity?

 

thanks

A:

This is the kind of thing you should be discussing with your personal professional tax advisor rather than relying on  advice from strangers on the internet.

Basically, any time you are repaid for your capital investment in a corp, you will need to show that on Schedule D of your 1040.  It won’t necessarily be taxable because you can deduct your cost basis that you allocate to that particular payment, which is normally the exact same amount for payments taken from the Paid in Capital account.  It’s not costly tax-wise, but is a big nuisance to have to report.

This is why it is generally better to keep the capital accounts as low as possible and use loans to transfer money between the corp and the owners. None of the principal payments in either direction has to be reported on your tax return, although interest payments obviously do.  This is something I learned almost 30 years ago, when I first started working on corporate tax returns, and any experienced tax pro should understand.

Your personal tax pro can give you more specific advice for our unique situation.

Good luck.

Kerry Kerstetter

 

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Q:

Subject: How long to wait for a refund?

Dear Mr. Kerstetter,

I wonder if you could point me to a simple explanation of what happens if you think you deserve a rebate but the taxing authority thinks you’ve paid the right amount?

I would assume they would at least have to tell you that they disagree with your tax return.

Also, how long should it take to hear back?  I filed my taxes in the last week of March, and received my Maryland refund a couple of weeks later, but I still have not heard anything from California.

Thanks for your time.

A:

It is normal practice for IRS and State tax agencies to send taxpayers a notice if any change is made to the tax return that was filed.  The explanations often leave a lot to be desired, but there is notification of a change.

If you have heard nothing from the FTB, you may want to contact them to see if they even received your 540.  Tax returns do get lost in the mail every day.  You may need to send a replacement copy if they have no record of receiving the one you mailed in March.  You should also know that they advise to wait eight weeks after submitting a tax return before getting concerned.  They process a lot more tax returns than any other state, and thus take more time to get refund checks out.

You can call the FTB at 1-800-852-5711 or try to locate info on your taxes online via their website.

Good luck.

Kerry Kerstetter