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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 incorporating my sole proprietorship. I currently have a 401k plan that my employees (and me) participate in. Once I incorporate may I continue that same 401k? I am very happy with it, as are my employees.

   As the corporation is a separate entity, a new retirement plan must be established. That is the bad news. The good news is that in talking to your plan provider it is possible to establish the identical plan in the corporation and it is a simple matter to roll the accounts (a trustee to trustee transfer) over so that the transition will be almost seamless on termination of the sole proprietor plan. In addition, as the transfers may be arranged as a trustee to trustee transfer, there will be no tax consequences.

2. I am the principal member of a two member LLC that is taxed as an S corporation. The LLC operates a restaurant. I am buying out my partner. For legal reasons I am maintaining the LLC. As the LLC will now be a single member LLC, may I report the activity as a sole proprietorship?
   

   A multi member LLC that has elected to be taxed as an S corporation does not change its status by becoming a single member LLC. The election to be taxed as an S corporation continues. Form 1120-S 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. If you choose to be taxed as a sole proprietorship (change status to a disregarded entity single member LLC), for tax purposes you are deemed to liquidate the S corporation. The S corporation will pass through gain to the extent the fair market value of assets exceed net book value. You will have gain or loss on liquidation depending on your basis and the fair market value of assets received net of liabilities.

3. I lent $25,000 to my corporation (an S corporation) over the past few years. No interest was ever paid on the loan and it was never documented. I have not collected a salary over the same time due to cash flow problems. No distributions were taken, either. The corporation went under early this year and I did not get a dime. Can I write off the $25,000?

   To the extent you have any remaining basis in the loan you may treat the loss as a non-business bad debt, which is treated as a capital loss. The loss may offset capital gain, with any excess loss applied against up to $3,000 of ordinary income per year. To receive business bad debt treatment (and ordinary loss treatment), you must be able to show the corporation was your primary means of support, the loan was documented (and subject to interest at least equal to the applicable federal rate) and was made to continue your employee status. As you took no salary during the period you made the loans, the business bad-debt argument would be rejected.If you used the basis in the loan to claim losses, you must reduce your basis in the loan. Only to the extent you have basis in the loan may a loss be claimed.

4. My father died this year. He had an annuity that was cashed out by his estate. Doesn’t the annuity get stepped up to fair market value date of death? The insurance company is saying part of the payment is taxable.

   The payment of the annuity is considered to generate income in respect of a decedent (IRD). IRD assets, such as IRA accounts and annuities do not get an automatic step-up in basis to fair market value on the date of death. This is due generally to the fact that the decedent has not recognized accumulated income as of the date of death. To prevent what is considered inappropriate tax forgiveness, IRD assets have a basis that carries over rather than stepping up. The basis of your father in the annuity passes to his estate. It is likely the insurance company can provide a breakdown of the taxable and non-taxable portions of the payment.

5. I moved out of my old house about 8 years ago and began renting it. I prepared my own returns, and I never depreciated the house. If I start depreciating it now, is that OK?

   A Form 3115 may be filed with IRS to catch up on the foregone depreciation. Otherwise, you have to account for allowed or allowable depreciation and you would lose the benefit of the depreciation from the closed years. The additional depreciation may be claimed on the current year return, as long as a Form 3115 is filed with the IRS national office before filing a copy with the timely filed return.

6. I cosigned a note for a good friend as a personal favor. That “friend” has disappeared and I have to pay the bank. Can I get a deduction?

   As you are not in the trade or business of lending money, the payment of the obligation would give rise to a capital loss as payments are made. You would be considered to have a non-business bad debt. A capital loss is deductible against capital gain, with any excess loss able to offset ordinary income of up to $3,000 per year.

7. I have a one-member LLC and I am reporting it on Schedule C. I have not paid my payroll taxes on time, and IRS is questioning me. I told them that since I have an LLC I am not personally liable for the payroll taxes. Is my argument valid?

   At least one district court has decided that the sole member of an LLC (disregarded entity) is personally liable for federal employment taxes regardless of any state LLC laws.