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 am in the process of buying a business. We are negotiating the amount I will pay for goodwill and for a covenant not to compete. I want more to be allotted to the covenant because the covenant will only be for 3 years and I can write it off faster. Am I on the right track?

   Under Section 197, goodwill and a covenant obtained with the acquisition of a business after August 10, 1993 are both capitalized and are amortized over 15 years. Therefore, regardless of how you allocate the purchase price between a covenant and goodwill, the amount paid will be amortized over 15 years. The seller, on the other hand, will have capital gain for goodwill (unless the seller amortized goodwill- in which case the amortization is subject to recapture as ordinary income) and gain on the covenant is ordinary income.

2. I am selling artwork by a well known artist that I purchased over ten years ago. I will have a substantial profit. Does the gain on the sale qualify for 15% long-term capital gain treatment?
   

   Collectibles, which includes artwork, stamps, antiques, gems and most coins, is subject to being taxed at a rate of up to 28% even if held more than 12 months. Unlike the sale of most capital assets held more than 12 months, the maximum rate is not capped at 15%.

3. I am the principal member of a two member LLC that is taxed as a corporation (a regular corporation). The LLC operates a retail store. I am buying out my partner. For legal reasons I am maintaining the LLC. As the LLC will now be a single member LLC, must I report the activity as a sole proprietorship?
   

   A multi member LLC that has elected to be taxed as a corporation does not change its status by becoming a single member LLC. The election to be taxed as a corporation continues. Form 1120 is filed to report the activity unless it is decided to liquidate for tax purposes. You may confer with your attorney as to the continuation of your LLC for legal purposes and any possible changes that may be required or recommended for the LLC operating agreement.

4. I had a large NOL the year before last. It was carried over to last year. Last year I had some income, and my prior accountant’s calculations show a very large alternative minimum tax. Does this make sense?

   In addition to the regular NOL, you likely have an alternative minimum tax NOL. It must be separately calculated and many tax preparation systems will not automatically do so. If you wish, I can send in the prior years’ returns to the Research Department at Fiducial, and we can help calculate the alternative minimum tax NOL.

5. I own my own business; a corporation. I just discovered last week that an employee has been embezzling from the corporation over several years. We reported all of our income, just some of the deposits never made it to the corporate bank account. The employee is promising to repay the stolen funds if criminal charges are not brought. I have grave doubts that anything will be paid as the employee is asking for time to get the funds and has no security to offer, but prefer being repaid rather than sending someone to jail. Can the corporation claim a deduction for the embezzlement loss?

   As long as there is a reasonable expectation for repayment of the embezzled funds, a deduction cannot be claimed. Usually, in cases such as this the embezzled funds are long gone. If you can get the corporation’s attorney to confirm that repayment possibilities are small, a loss can be claimed for the year that the embezzlement was discovered (the current year). The loss may be claimed even if criminal charges are not brought. If repayment is made in the future, income would have to be recognized.

6. I am going to give my nephew annual gifts in trust. The trust will hold it until he is age 21. As the gift each year will be cash of $12,000, may I make the gift without reporting it to IRS?

   There are several issues. First, a gift to a child made to a trust that does not have a ‘Crummy” provision (which allows the child the right to take the gift out of the trust within a given period) is considered a present gift of a future interest and does not qualify for the $12,000 annual exclusion for gifts. The second issue is that even if there is a “Crummy” provision in the trust, the $12,000 annual exclusion applies to the total of all gifts (not to each gift) given during the year. If a birthday present, graduation present or holiday gift is given, for example, those gifts count. Even if the gift is reportable on Form 709, unless total lifetime taxable gifts exceed $1,000,000, there will be no out-of-pocket tax consequence (but there will be a reduction in your lifetime estate and gift tax credit).