Saturday, November 27, 2010

Sale of Business Property

Form 4797 is used to report the sale of business property and other depreciable and amortizable property. On part I are reported losses on property held for more than one year, which recieve ordinary loss treatment. On part II are reported sales for property held for one year or less and on Part III property sold held for more than one year for which depreciation is a taxable component. Part IV included recapture of depreciation and amortization under Section 179 and Section 280F when business use declines below 50%.

IRC Section 1231 provides the best of both worlds on the sale of business assets and residential property. If cumulative Section 1231 losses have exceeded Section 1231 gains from the prior 5 years then the difference is treated as ordinary income.

Taxation for Investor and Traders

For tax purposes the tax treatment for a trader in securities or commodities depends on their tax classification.

A trader is engaged in the business of buying and selling securities for one's own account. To be classified as a trader the trader must seek to profit from daily market fluctuations in the prices of securities or commodities and not from dividends, interest or capital appreciation. Factors that are considered for this include the typical holding periods for securities bought and sold, the frequency and dollar amount of trades during the year, the extent to which a taxpayer pursues the trading activity to produce income from a livelihood, and the amount of time devoted to the activity. A trader who chooses to elect mark to market accounting methods reports both gain and losses as ordinary income instead of capital gain and losses on form 4797.

An investor typically seeks to profit from investment earnings and capital appreciation.

A dealer in securities in the business of resale to customers and typically profit from the business transaction and not from appreciation in the security.

Dealers report transaction on a Schedule C, Investors report transaction on Schedule D, and Traders on schedule D, unless they market to market which they then report on Part II form 4797.

Monday, November 15, 2010

Personal Service Corporations

Personal Service Corporations exist where corporations are formed for professional services such as accounting, actuarial science, architecture, consulting, engineering, health, law and the performing arts.

A qualified personal service corporation is taxed at a flat rate of 35% of taxable income. A corporation is a PSC if it meets both of following tests

1. Substantially all the corporation's activities involve the performance of personal services
2. At least 95% of the corporations stock by value is owned by a. employees performing personal services b. retired employees who were involved with the corporation c. an estate of an employee or retiree d. any person who acquired the stock of the corporation as a result of the death of an employee or retiree.

A PSC has a safe harbor of $150,000 for accumulated earnings. IRC 535.

C Corporation Rental Agreements

The IRS may challenge the following rental situations between shareholders and a corporation:

  1. If the rent has the character of a distribution of profits from the corporation (i.e. variable rate rent that minimized the profitability of the corporation)
  2. If the rent is paid to an employee, IRS may attempt to recharacterize the payments as wages
  3. A self rental rule blocks taxpayers from offsetting passive losses with income from rental property
  4. Payments made to employees for equipment that is required as a condition of employment are taxable wages, unless the amount is paid under an accountable plan
  5. Rental of personal property must be clearly segregated from employment activities

While rents can be used by taxpayers to gain income from property rented to a wholly owned C corporation, the IRS is cautious to minimize the advantage of self interests in rental agreements.

Monday, November 8, 2010

Meal and Travel Expenses

Most usually, meal expenses are limited to 50% of the expense. When providing meals and entertainment to clients the following rules apply.

  1. entertaining clients must be directly related to or associated with the active conduct of business such as discussing deals before, during or after the meals
  2. the taxpayer or employee must present when the meal or entertainment occur
  3. if a group or business acquaintances take turns picking up the tab whether business activity occurs or not, the expense cannot be deductible
  4. lavish or extravagant meals and entertainment are not deductible
  5. only the cost of face value of a ticket is deductible

Travel primarily for business outside the United States is prorated on the expense for personal and business. If all travel is for business then the entire expense is deductible, however, if some is for personal purposes, then that % is a nondeductible expense. For instance, if a taxpayer travels outside the US for 30 days and 15 days are for business purposes, then 50% of the trip cost is deductible.

Saturday, November 6, 2010

Nontaxable Transfers - IRC Section 351

In a Section 351 transfer no gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation, and immediately after the exchange such person or persons are in control - as defined in Section 368(c) - of the corporation.

Control of the corporation is defined as ownership of 80% of more of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation. IRC 368(C).

One or more persons may include individuals, trusts, estates, partnerships, associations or corporations. Money is treated as property for purposes of Section 351. Services do not qualify as property for purposes of Section 351.

Transfers in bankruptcy do not qualify for the Section 351 treatment.

If a transferor receives boot in the exchange, the gain is realized to the extent of the money or property received (boot).

Group control in a Section 351 exchange must include substantial contributions by shareholders. For instance two shareholders cannot contribute to meet the 80% control test if the contribution by either shareholder is less than 10% of fair market value of stock and securities already owned by the person.

Liabilities contributed in a Section 351 exchange reduce the basis of the shareholders stock. If the liability contributed exceeds the basis, the excess is treated as gain.

Controlled Groups

In order to minimize an owner or groups of owners from dividing one corporation in multiple corporations for the sole purpose of lowering tax liabilities, IRC Section 1561 limits the benefits to equalize as if multiple corporations under that same ownership were one corporations.

The types of controlled groups are:

1. Parent - subsidiary group: one or more chains or corporations connected through stock ownership with a common parent

2. Brother -sister group: two or more corporations owned by the same five or fewer shareholders

3. Combined group: three or more corporations, each of which is a member of a parent-subsidiary or brother - sister group and one of which is a common parent and also included in a brother - sister group.

4. Consolidated group: members of a parent subsidiary group that file a consolidated tax return.

C Corporations which are part of a controlled group, must file a Schedule O Form 1120 under regulation Section 1.561-1T(a).