Fiducial | We help your business grow and be profitable.

TOP TAX QUESTIONS OF THE MONTH

This is a monthly reference source. By providing these samples of questions and answers, we hope to help you understand that we provide a superior service in our ability to get answers to your questions. There are some general caveats that go along with this presentation. Understand that tax law is fluid and always changing; the answer that is correct today may be incorrect tomorrow. Also be aware that changing one small fact may change the entire answer. We are not trying to give a complete outline of any particular subject. We are attempting to give a general direction that can be taken to resolve a problem or obtain an answer. We can call and talk over your particular situation with the Research Department before we try to answer the specific problem YOU may have. You may not rely on any answer given to avoid a penalty assessed by IRS.

1. I have employed my children for some time in my business (sole proprietorship). They are currently 15 and 13. I am forming a single-member LLC for liability protection purposes. Does the exemption from FICA and FUTA continue to apply?
   

   The exemption from FICA and FUTA for the children of a sole proprietor will continue to apply if no election is made to be taxed as a corporation. The exemption from FICA applies until the child is 18 while the exemption from FUTA applies until age 21. For tax purposes, a single-member LLC is a disregarded entity unless an election is made to be taxed as a corporation. As a disregarded entity, the LLC continues to be reported on Schedule C and the business is treated for tax purposes as a sole proprietorship. If an election is made to tax the business as a corporation the wages paid to the children will be treated as any other employees and will be subject to all payroll taxes.

2. I have a rental property that I plan to sell in the near future, but it is not on the market yet. I am going to refinance the property now to take advantage of lower interest rates and I may get some cash from the refinance. Will this endanger my chances of exchanging the property tax -free?
   

   No. As long as the refinance is not related to the exchange (i.e., it is not done to equalize debt given up and debt received on an exchange) it should not impact the exchange directly. Given that you do not receive cash (or have access to cash) and the replacement property costs as much as the sales price of the property given up, the exchange should be tax-free. You should understand that if you take on less debt than you give up on the exchange, it is considered the same as receiving cash. You should note that if you take cash on the refinance and use the proceeds for personal purposes, the interest attributed to the cash taken will not be deductible.

3. I am planning a Section 1031 tax-free exchange and will use a facilitator. I intend to acquire multiple replacement properties for my building. It turns out that the cost of acquiring 1 of the 3 properties I identified will equal the selling price of the property I relinquished. If I identify 3 properties, must I settle on all three to avoid gain recognition?
   

   To defer gain under Section 1031, it is not necessary that all of the properties identified as replacement property be acquired. As long as the requirements of Section 1031 are otherwise met (you do not receive cash, are not relieved of more debt than you take on, identified the replacement property within 45 days of the initial transfer and receive the replacement property within the lesser of 180 days of the initial transfer or the due date of the tax return for the year of the initial transfer, including extensions) you need not settle on the third property for the gain on the disposition of the property you relinquished to be deferred.

4. My partners and I are members of an LLC. The LLC operating agreement calls for special allocations of depreciation. We now want to use the “check the box” rules to be taxed as a corporation and make an S corporation election on Form 2553. Any problems?

   There is one very significant issue that should be taken into account. An S corporation must make allocations of profit, loss and deduction based on stock ownership. In other words, there are no special allocations permitted. Such allocations would create a second class of stock and cause the S election to be terminated (leaving the entity taxable as a regular corporation). Therefore, either the LLC operating agreement should be amended to remove the special allocation or a separate corporate entity should be formed instead of using the “check the box” rules. After the change, the shareholders may agree that compensation for each party be adjusted based on services actually rendered the corporation and that may provide substantially the same tax benefit as a special allocation of depreciation.

5. I am the sole shareholder of an S corporation. The corporation sold all of its assets six years ago on an installment basis. The corporation did not liquidate. The installment note is scheduled to be paid off over the next three years, but I would like to liquidate the corporation now. Is there any reason to keep the corporation going?

   If the corporation is liquidated at this point, the installment note will “collapse” at the corporate level and the remaining gain will be recognized. If an S corporation liquidates within 12 months of entering into an installment sale, installment reporting is preserved at both the shareholder and corporate level. As more than 12 months have passed since the sale, a distribution of the note will cause the all the remaining deferred gain on the note to be recognized by the S corporation (and pass it through to you, the shareholder).

6. I have three C corporations, all in the same line of business. One is profitable, but the other two are not. Is there any way the losses in the second and third corporation can offset the income of the first corporation?

   You may consider merging the two corporations using a tax-free, statutory merger (Type A). Such a merger requires complying with certain legal requirements which include filing articles of merger with the State. While the losses in the second and third corporations cannot be carried back against the income of the first corporation, the losses can be used to offset the income of the combined corporations after the merger.