FEDERAL INCOME TAX LAW ADVICE
PART I
|
|
I have a national tax advice consulting practice. I charge $150/hour for tax advice, tax research, and problem resolution.
|
|
|
|
|
|
|
|
|
|
|
|
ANSWER: What is the basis of property received as a gift?
To figure the basis of property you get as a gift, you must know its adjusted basis to the donor just before it was given to you. You also must know its fair market value (FMV) at the time it was given to you. and whether any gift tax was paid. If the FMV of the property at the time of the gift is less than the donor`s adjusted basis, your basis depends on whether you have a gain or loss when you dispose of the property. Your basis for figuring gain is the same as the donor`s adjusted basis, plus or minus any required adjustments to basis while you held the property. Your basis for figuring a loss is the FMV of the property when you received the gift, plus or minus any required adjustments to basis while you held the property. See Adjusted Basis in Publication 551, Basis of Assets.
If you use the donor`s adjusted basis for figuring a gain and get a loss, and then use the FMV for figuring a loss and get a gain, you have neither a gain nor loss on the sale or disposition of the property.
If the FMV is equal to or greater than the donor`s adjusted basis, your basis is the donor`s adjusted basis at the time you received the gift. Increase your basis by all or part of any gift tax paid, depending on the date of the gift. See Gifts received before 1977 in Publication 551, Basis of Assets. Also, for figuring gain or loss, you must increase or decrease your basis by any required adjustments to basis while you held the property. See Adjusted Basis in Publication 551, Basis of Assets.
For more information on the gift tax, see Publication 950, Introduction to Estate and Gift Taxes..
References:
* http://www.irs.gov/faqs/faq10-1.html
* Publication 551, Basis of Assets
* Publication 950, Introduction to Estate and Taxes
Based on the foregoing, the client's basis in the property, which he received as a gift from his father for $1, is his father`s adjusted basis in the property at the time of transfer. One complication added at the end, in my last phone call with the client. The father deed the property to his two sons. Therefore, our client received a gift of 1/2 of the property and his basis is 1/2 of his father`s adjusted basis at the time of the property gift transfer.
Michael A. S. Guth, Ph.D., J.D.
Tax Advisor
QUESTION 2: I am 56 and am retired and recently took an early 401K withdrawal from a US corporation from which I terminated service in 2004. Given my age and the fact that I no longer work, do I qualify for an exemption to the 10% early withdrawal penalty?
ANSWER: It is easier for me to collect some information in writing, rather than explain the provisions of the Internal Revenue Code (IRC) over the phone. Basically, you are asking if there is any way for you to avoid the 10% early withdrawal penalty on funds you have already withdrawn from your 401(K) plan.
There is good news and bad news for you to digest. I will start with the good news.
GOOD NEWS
Section 72(t)(2)(A) of the Internal Revenue Code provides limited exceptions for withdrawals of retirement plan funds without incurring an early withdrawal penalty. You may qualify to take a penalty-free withdrawal if you meet one of the following exceptions:
· You become totally disabled.
· You are in debt for medical expenses that exceed 7.5 percent of your adjusted gross income.
· You are required by court order to give the money to your divorced spouse, a child, or a dependent.
· You are separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.
· You are separated from service and you have set up a payment schedule to withdraw money in substantially equal amounts over the course of your life expectancy. (Once you begin taking this kind of distribution you are required to continue for five years or until you reach age 59 1/2, whichever is longer.)
Employers are not required to offer these types of hardship withdrawals; however, the IRS will allow them to code the withdrawals as penalty-free if one of those five exceptions are met. Therefore, you would need to contact your 401(K) plan administrator and specifically refer to Section 72(t)(2)(A)(v) of the IRC. Your 401(K) plan administrator will be able to tell you if it permits former employees to utilize the provisions for penalty-free withdrawals under Section 72(t) (2)(A).
BAD NEWS
You indicated that you separated from your employer in 2004, when you would have been about 53 years old. The “separation from service” exception applies to people who were age 55 or older in the year of separation, not necessarily at the moment of separation.
If you had separated from service when you were 55 or older or during the calendar year in which you turned 55, you could receive the lump sum distribution now without being subject to the 10% tax. But in your case, because you were age 53 at the time of separation, it appears the “separation from service” exception does not apply to you.
Thus, if you had separated from service after attaining age 55, the 10% penalty tax would not apply. Likewise, if you had separate from service at age 54 and you attained age 55 during the same calendar year of the separation, the 10% penalty tax would not apply. See Notice 87-13, 1987-1 C.B. 432, Q&A-20. It appears you cannot benefit from this exception by separating one or two years before you reached age 55.
The legislative history with respect to Code section 72(t) indicates that this exception to the penalty tax will NOT apply if the employee separates from service in a year prior to the year he or she turns 55 (for example, at age 52) and begins receiving benefits after attaining age 55. Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, P.L. 99-514, 99th Cong., 717 (May 4, 1987); H.R. Rep. 841, 99th Cong., 2d. Sess., Vol II, Title XI, 456 (1986). A 1992 IRS private letter ruling appears to confirm this position. Priv. Ltr. Rul. 9224056 (3/20/92). In an earlier private letter ruling, however, the IRS concluded that the exception would apply to a participant who retired at age 50 and began receiving distributions after attaining age 55. Priv. Ltr. Rul. 9135060 (6/7/91). Given the legislative history and the more recent IRS ruling, however, it appears that the earlier ruling was an anomaly.
CONCLUSION
If you wish to avoid the 10% early withdrawal penalty on your 401(K) distribution, the key is convincing your plan administrator to file an (amended) information return with the IRS indicating your 401(K) distribution should be treated as a penalty-free withdrawal. Based on the facts provided in your inquiry, your plan administrator will likely tell you that your distribution does not qualify for the IRC “separation from service” exception. But you have nothing to lose by asking your plan administrator to determine if you qualify for this exception.
Michael A. S. Guth, Ph.D., J.D.
Tax Advisor
QUESTION 3: What are the IRS requirements for filing for a disability exemption from the IRS 10% early withdrawal penalty from a 401k plan? Would severe chronic,demonstratable alcoholism qualify for this ?
ANSWER: Disability is one of a handful of situations where you can tap your 401K before age 59 1/2 without incurring the 10% early-withdrawal penalty. To qualify for the disability exemption, you must be able to prove that you have a physical or mental condition that will last indefinitely, and that you`re unable to work because of this disability. A search of the Tax Court cases database showed no case in which alcoholism qualified -- but in fact the issue has never been raised before.
Normally, people with disabilities qualify for "handicapped placards" to hang in their cars and park at special handicapped parking. That would not be the case for alcoholism, so my judgment is this is not the kind of illness that the IRS would consider disabling. Treatment centers for alcoholism exist; it probably would not qualify as a short term disability.
A separate issue relates to how the information is reported to the IRS. To avoid the penalty, you would need to supply the institution that handles your 401K with medical records proving your ailment. That institution would then code your 401K withdrawal in such a way that it would not trigger the automatic penalty. In your case, the information return has already been generated. Therefore, the IRS will feel justified in assessing a penalty, because it will assume you were unable to convince your 401K custodian that you qualified for the exemption.
Michael A. S. Guth, Ph.D., J.D.
Tax Advisor
QUESTION 4: Per our recent phone conversation, I am including the details from the 1099-B form that I received from Ameritrade.
There are two items that I'm having trouble with:
2/17/06 Placer Dome Inc Contra-Do Not Sell 725906978 Tender 300 shares $753
3/10/06 Barrick Gold Corp Com 067901108 Cash in Lieu 0 shares $26.66
My monthly statement for 3/10/06 states Cash in Lieu of Fractional Shares (ABX)
I originally purchased 300 shares of Placer Dome Gold (PDG) on 5/28/02 for a total of $4000, including commission. Thus, my original cost basis is $4000. In 2006, Barrick Gold purchased Placer Dome Gold and I received cash plus Barrick Gold (ABX) stock in exchange for my Placer Dome shares. I received the $753 + $26.66 shown above plus 220 shares of Barrick Gold stock in exchange for my 300 shares of Placer Dome stock.
Please explain to me how I should report this transaction on my 2006 1040 and Schedule D tax forms.
ANSWER: You have received a like-kind exchange of stock in one company (PDG) for another (ABX) with cash to boot. Apparently, in purchasing PDG, ABX offered both its own stock and cash.
Because you have not decided to sell your ABX stock, you have not realized the capital gain or loss on your original transaction. In this case, the boot should be used to reduce your basis.
Your original basis was $4,000 for the PDG stock, which is now your basis for the ABX stock. You have now received $753 + $26.66 = $779.66. You should reduce your basis in the ABX stock by $4000 - $779.66 = $3220.34.
When you ultimately sell your ABX stock, you should record $3220.34 as the basis for your stock. I recommend that you print out a copy of this email message and place it directly behind your Schedule D form, so the IRS will know you were aware of the two transactions and have adjusted your basis accordingly.
Michael A. S. Guth, Ph.D.,J.D.
Tax Advisor
(865) 483-8309
QUESTION 5: The client called with a question about a strategy for him to deduct maintenance payments made to his ex-wife for the first 9 months of 2006, before his divorce became final in October. For the last 3 months, he made alimony payments as required in the final decree. In essence, this man paid his wife a considerable sum of money over the first nine months and he has to pay taxes on all that income, when in fact she is the person who received and consumed the income. He was wondering if there was any way for him to deduct the payments made in the first nine months.
ANSWER: The IRC allows for the exclusion of income paid as alimony to another person. The client's problem in this case is that he made maintenance payments that were not part of any court-ordered alimony. The IRS would not interpret alimony broadly to include payments to an ex-spouse prior to divorce. The client could have resolved this problem by having the ex-wife agree to allow him to exclude that income on his return in exchange for her declaring the income and paying taxes on it. However, no such agreement was ever reached. In addition, the payments are complicated by the fact that he paid for a mortgage directly to a bank and for insuranc premiums directly to an insurance company, rather than making checks payable to his ex-wife. These payments make it appear to be more of an ongoing bargain that formed the basis for the final divorce, rather than as agreed upon "pre-alimony" payments.
I recommended that the client, if he insisted on trying to find some way of getting back these taxes, go back into his state court that granted him a divorce and seek a court order declaring that he can exclude the nine months of payments made to the wife, and the wife must report that as income on her return. However, I told him that he stands less than a 25% chance of success on this motion. The wife would be hit by surprise by his request and would not have a pile of money stored away to pay the taxes. She could argue that she was more generous with him in the divorce, because he paid the mortgage and insurance and other payments. If she had to pay taxes on that support then she would have bargained for a tougher divorce on him. Also, she can argue that if the tax treatment of the income was important to him, he or his lawyer should have brought that up during the divorce settlement. It is too late now to go back and disturb the divorce. In any event, if a state court orders the income exclusion and declaration, the IRS typically assumes the state court has weighed the equities and decided upon a fair distribution of income. It would then refund the taxes overpaid by the ex-husband and seek payment from the ex-wife on an amended tax return.
Mike Guth
Tax Advisor
QUESTION 6: My 80 yr old mother-in-laws family trust (she is sole survivor, I handle the trust and personal tax under her Social Security number. Only one business property with $750 per month income, her Soc Sec income, and some interest from stocks / bonds) is in the process of selling its business property rental for $525k (before realors fees, repairs for clossing.). It was purchased in 1965 for $45k (plus some closing costs).
Her 2007 income will Soc Sec (less than $25,000), and resulting from the sale, well invest the proceeds in a CD for total interest income of aprox $25k.
Question, it appears we will have aprox $440,000 in capital gains for 2007. What should we project for 2007 Fed and 2007 Ca State state consequences of this sale? Thanks
ANSWER:I can only address the federal income tax portion of your question. I am not familiar with California's tax code provisions, but I assume they would follow the federal model.
Under the facts stated, you anticipate that you will have approximately $440,000 in capital gains from the sale of business property. You should use Form 4797 to report the income from the sale of this property, and follow the instructions for that Form to learn more about the tax treatment of the capital gains. It will be added to your mother-in-law's Schedule D under long-term capital gains filed with her 1040 form.
The tax treatment of long-term gains is somewhat complicated, and depends on the taxpayer's income. Long-term gains are taxed at 5% if the taxpayer is in the 10% or 15% federal tax brackets (for tax year 2004, up to about $58K for married filing jointly, and less for others). Long-term gains are taxed at 15% if your mother-in-law falls in one of the higher income-tax brackets (e.g., 25%, 28%, and so on). The long-term gains are included when figuring out your bracket. However, the 5%/15% rate doesn't apply to all long-term gains. Long-term gains on collectibles, some types of restricted stock, and certain other assets are instead subject to a different rate, which may be as high as 28%. And certain kinds of real estate depreciation recapture are taxed no higher than 25%.
Based on the facts given, you did not mention that this business rental property has been depreciated over the years. If it has, the capital gains of $440,000 will be taxed at a marginal rate of 25%. If the property has not been depreciated, then it appears it will be taxed at the 15% marginal rate for long term capital gains.
Mike Guth
Federal Income Tax Advisor
QUESTION 7: I am an insurance broker. My wife worked for me last year while she was studying for her insurance license which she received in September. She did filing, office supply procural, accounting, accounts payable, getting the mail, etc. We want to write off our daughters childcare and my wifes car. I did not have her on payroll nor did I pay her. I did not know the rules. Now that she has her license and is selling insurance its not an issue this year. But we need the writeoffs for last year. Do we have until April 15th 2007 to pay her a salary for 2006 and thus get her car written off and the childcare? Is there another way to legitimately write these off at this time? We did the same thing in 2005, but she was not on payroll then. Maybe to late to do anything then.
ANSWER: If you wanted to deduct the expense of paying your wife a salary, then you had to make actual payments to her in 2006. You would have had to have filed a W-2 information return with the IRS showing payments made and FICA taxes withheld from her pay.
You have not provided any facts that would suggest your wife's car or daycare expenses were in any way related to your insurance business. The IRS has aggressively litigated and won court cases in which the agency challenged the lack of "busines purpose test" applied to the deducted expense. It seems to me that you are treading on dangerous ground by seeking to save on taxes for ordinary living expenses. The IRS assumes people need a car to commute to work and get groceries, etc. Such ordinary expenses of living are not deductible.
For 2007, you are going to run into trouble trying to deduct your wife's car. You cannot simply expense the car payments, unless that car is used 100% for business, and all other personal mileage is done on another car. Even if that were the case, the IRS requires you to keep a written record of each trip made and the exact mileage of each trip and the business purpose of the trip. It sounds like you have inadequate record keeping to take a vehicle deduction in 2007, but you may be able to set up records for the calendar year if you have some way of proving what business trips were made with her vehicle.
You need to investigate IRS Publication 535 BUSINESS EXPENSES, and Publication 583 STARTING A BUSINESS AND KEEPING RECORDS. There are a variety of ways to deduct daycare expenses -- whether you own a business or not. Daycare expense could be an employee fringe benefit. It could be expensed through a flexible savings account. You can also receive a TAX CREDIT (much better than a deduction) on line 48 of the 1040 form for child care expenses. You will have to file Form 2441 to receive the credit. For any vehicle expenses, you will have to file Form 4562 and attach it to your 1040 annual return.
Mike Guth
Federal Income Tax Advisor
QUESTION 8: I cashed out a 401k in August 2006 for $45,000 and had to have them take out 10% in taxes at that time. When I went into TurboTax to do my taxes and input the info from my 1099-r as well as all my deductions (property tax, etc), it came back that I owed $4013 to Federal and $2983 to State. Totalling $6996 which is more than I have. I also have to pay property taxes (which are KILLING me) on my condo which is $1784.92 on 4/10. So Im in a world of hurt right now and I am looking for any help I can get. I also need to talk to someone about any way I can reduce the property taxes I have to pay each year. I am just being killed every 6 months and I need to get this under control.
ANSWER:
When you made an early withdrawal of funds from your 401K plan, your 401K Plan Administrator withheld 10% of your proceeds as the IRS penalty for early withdrawal of your funds. That early withdrawal penalty of 10% is separate from paying federal income taxes on the $40,000 remainder of your 401K plan. If you are taxed at the 10% bracket, then $4013 sounds about right for this additional income you received.
You should have realized that the 401K money was contributed with pre-tax dollars, so you would have to pay income taxes on your subsequent withdrawals. But I won't lecture you after the fact. Instead, I suggest you contact the IRS and explain you lack funds to pay all these taxes at once. The IRS is HAPPY to negotiate a payment plan with you, because they do this with thousands of other taxpayers.
The IRS would much prefer to have someone make payments on a tax debt than to ignore the debt completely.
Your state income tax and property tax issues are beyond the scope of my federal income tax advice. However, like most people who live in CA, you are finding that you are being eaten alive with the high cost of living there all stemming from the inflated real estate prices (and inflated taxable values of those properties). Abbot Labs has a large presence north of Chicago. You may have to trade off colder weather for a cheaper cost of living.
QUESTION 9: The client deposited $4,000 into a Roth IRA in 2005 in the first part of the year. He then got married and decided to file an income tax return as "Married, Filing Separately." That filing status automatically disqualified his Roth IRA contribution. He contacted the account administrator and requested that the deposit be refunded to him. The administrator sent him back the $4,000 contribution and also sent him a 1099-R for 2006. The client is wondering if he needs to file an amended return for tax year 2005 and where to report the 1099-R income.
ANSWER: The client deposited funds to his IRA Roth account using after-tax dollars. Accordingly, when he received his $4,000 back, he did not have to declare this as income, because he had already paid tax on it. Thus, he will not have to file a 1040X Form (Amended Return) for 2005. The interest income shown on the 1099-R form for 2006 should be reported on Line 16(b) (pension income) on his Year 2006 1040 Form. With that, everything will be properly reported and paid.
QUESTION 10: The client's wife works as a physician for a hospital. She is apparently employed as an "employee" of a medical group, but the hospital considers her as an independent contractor. For 2006, she earned approximately $93,000. She has received both a W-2 form from the medical group as well as a 1099-MISC form from the hospital for this same income. Her husband contacted me and tried to convince me that there were no errors, and this procedure is how physician income is reported to the IRS. In addition, the hospital is going to repay the physician's educational loans, but they are obligated to pay back this loan from the hospital unless she works there a certain number of years.
ANALYSIS: I advised the husband that it is improper and illegal for an employer to report income as both W-2 wages and 1099 independent contractor earnings for the same service. A person can be either an employee or indep. contractor, but not both, in providing a particular service. As a result of the information returns reported for his wife, this couple will have to pay income tax on $93,000 x 2 = $186,000 for Tax Year 2006, even though she only received $93,000 in compensation.
The rather obvious error here is that the hospital paid $93,000 to the medical services group, which in turn released $93,000 to the physician as wage income. However, the hospital did not report the $93,000 payment to the medical services group but instead filed an information return with the IRS that implied it separately paid his wife $93,000.
The husband thought there was some federal regulation that allows physicians to cancel out income from one form (W-2) as against another (1099). I told him that both forms are used to report positive income to the IRS, neither is negative, and the IRS is expecting taxes to be paid on $186,000 unless he obtains a corrected 1099 form for his wife.
He thanked me for the advice, but he remains convinced both W-2 and 1099 forms are correct, and he is not going to pursue a corrected 1099 form from the hospital. In that case, the IRS will likely flag his married-filing jointly income tax return, because he is going to try to cancel out income reported as wage income from the income reported as business income on the 1099 form. The business income will be declared on Schedule C, and there is no line there to exclude income that was previously reported as wage income on the 1040 form.
I gave this client my best tax advice, but if he does not want to obtain a corrected 1099 form, then he will have to explain to the IRS why he did not pay taxes on the $186,000 reported income.
br>
QUESTION 11: QUESTION: The client just began trading in the stock market in 2006. He called to ask if the various brokerage fees and exchange fees and administrative fees are tax deductible.
ANSWER: Yes. All of the costs of earning investment income are deductible from those earnings. I explained that the brokerage firm had reported the net gains from proceeds of sales to the IRS using form 1099-B. These proceeds are to be reported in the column called "proceeds" on Schedule D of the 1040 form. However, from the proceeds, the taxpayer must subtract his basis. Each individual taxpayer must keep records to support his basis calculation. In this case, the client says he has all his records showing the fees he paid, although they are not organized yet. He will need to figure out exactly what fees he paid for each transaction and add those fees to his basis. Those fees, through the basis, get deducted from his reportable capital gain income.
QUESTION 12: The client is a radiologist who received business income from a hospital, which he turned over to his Radiology Associates partnership. He is treated as both a partner and an employee of the partnership. Problem: the hospital has issued a 1099-MISC form to him for tax year 2006, which indicates he received various fees totaling $35,000. In fact, he turned over these funds to his partnership.
ANSWER: From the IRS's perspective, it appears that the client received wage income from his partnership and, in addition, miscellaneous business income as an independent contractor from the hospital. The transfer of the income from the doctor to the partnership appears on first impression to be a gift. No information return has been sent to the IRS to indicate otherwise.
The client advised me he is under a legal obligation to transfer the partnership any administrative fees he receives from the hospital. Taking that fact as true, I advised the client to do the following: (1) on the dotted line of Line 13 of the 1040 form for busines income, write in "(35,000)". (2) Fill out Schedule C and include $35,000 as gross receipts for income. (3) Under the expenses section of Schedule C, write in $35,000 for the category "Other Expenses," and explain the expense on the reverse side of Schedule C. (4) Use the phrase "I was legally obligated" to turn over the money to the partnership as per my partnership agreeement. (5) Obtain from the partnership a receipt showing that every cent he received from the hospital was deposited to the partnership. (6) *** Most important *** place a copy of that receipt directly behind Schedule C. The purpose of Item 6 is to forestall the IRS from sending out an information request asking for verification that the money was actually transferred to the partnership and not consumed by the client. Declaring the income this way will comply with the IRS's expectations that no taxpayer ignore or disregard information returns concerning income.
QUESTION 13: The client called about where to report his investment expenses including such things as purchasing financial data, paying for an investment consultation service, using 60% of his computer for investing, etc. He planned to put these expenses on Schedule A under the miscellaneous category.
ANSWER: I advised the client that the IRS did not expect to find investment related expenses in that category. In fact, the IRS publishes a list of other expenses on the instructions for Schedule A, and investment income expenses are not included.
Instead, I told him that these costs should be spread out over the cost basis for the stocks and commodities that he trades and reported in the basis column on Schedule D. Thus, if he spent $200 on consultation services and completed 5 transactions, he might add $40 to the cost basis for each of the 5 transactions.
Depreciating his computer will be more problematic, because he will need to file Form 4562 on depreciation of capital assets, determine the dollar value of the depreciation for this tax year for that asset class, and then spread 60% of that number across his various cost bases.
Finally, he believes his broker is underreporting his investment income, because the broker failed to report income where he sold an option and it expired worthless. I told him that SEC and IRS regulations require brokerage firms to have accurate reporting systems for their clients. It would be surprising if a licensed broker did not have proper accounting for clients who sold options that expired worthless -- something that happens millions of times each month. The brokerage firm would be in serious trouble if it permitted these trades to go unreported. He is going to check with his brokerage firm and see if the error is in his calculations or with the broker.
QUESTION 14: The client fathered a child out of wedlock in 2006 and began making voluntary child support payments to the ex-girlfriend. He would like to claim the child as a dependent exemption on his 2006 return, but he knows his ex-girlfriend will claim the child as well. He wanted to know the consequences.
ANSWER: I told him it might take some time, e.g., up to two years, for the IRS to realize the same child has been claimed as an exemption on two different returns. The IRS would then disallow one of the exemptions, require taxes be paid, plus interest, which is usually 10%. Therefore, if he lost the exemption battle, he might have to pay back taxes + two years interest (or however long it takes the IRS to note the problem), but probably not a penalty.
I told him the preferred way to resolve this dispute is to petition the court in Florida where he is battling his ex-girlfriend for custody to issue an order concerning the tax exemption for Tax Year 2006. If he loses the exemption for 2006, he should ask the judge for the right to use the exemption in odd-numbered calendar years.
Although payment of federal income taxes is a federal issue, the IRS defers to the judgment of state courts as to which of two parents can claim the exemption for a dependent child.
QUESTION 15: The client had questions about whether he could expense $25,000 in costs associated with rental property when his income from the property was only $15,000. In particular, he felt he was excluded from excluding the total loss, because his AGI exceeded $200,000 per year.
ANSWER: I told the client this was a case of first impression for me in which AGI factored into whether expenses on rental property could be fully deducted. As a general rule, the expenses of maintaining rental property that generates income are fully deductible. However, to verify that the client did not meet an income test for the deductions, I asked him to fill out IRS form 6198 and sent him the link to both the IRS form and the instructions for the form. http://www.irs.gov/pub/irs-pdf/f6198.pdf The instructions are at http://www.irs.gov/pub/irs-pdf/i6198.pdf.
Once the client fills out the form, the bottom line on the form will indicate what percentage of the 25,000 in expenses he can deduct. I expect that the client will be able to deduct 100% of the expenses. However, if there is an income limitation, it will show up on that form, and the client will have the answer to his question.
QUESTION 16: ISSUE: The client rolled over 401(K) funds from one account to another. The new custodian of his 401(K) funds failed to file an information return with the IRS showing his deposit. The IRS then filed suit against him in Tax Court.
ADVICE: I told the client to obtain a written receipt from the new custodian of his 401(K) funds, Fidelity Guaranty of Lincoln, NE. Under these circumstances, the IRS should have verified the deposit with Fidelity Guaranty and withdrawn its lawsuit. However, the IRS is refusing to withdraw the Tax Court suit. Accordingly, I advised the client to file a Motion for Summary Judgment in the Tax Court case and attach the deposit fund receipt as an exhibit to his motion. American taxpayers rollover funds from IRA accounts and 401(K) plans probably hundreds of thousands of, if not a million, times per year. The IRS knows that is a perfectly legitimate transfer of funds authorized by statute. This client deposited his roll-over funds within 30 - 90 days. It looks like an open-and-shut case in favor of the client.
Mike Guth
Federal Income Tax Advisor
QUESTION 17: We have an S-corporation, an Internet software company and have some confusion about prepaying taxes. We are signed up through EFTPS but do not know whether to prepay through EFTPS as an individual or an S-corp S-corp taxes are filed as part of the individuals tax return so shouldnt the prepay be done for the individual not the corporation? Also does the self employment tax and state tax apply to even Internet commerce companies? We know that Internet companies do no have to pay state tax but when filing as part of the individuals taxes does the state tax have to be paid?
ANSWER: Generally, an S corporation is exempt from federal income tax other than tax on Excess Net Passive Investment Income, Capital Gains, or Built-in Capital Gains. Is your S Corporation paying you a salary? Will it issue you a W-2 form? If so, then the corporation needs to being paying FICA taxes to the federal government as it pays you or anyone else a salary.
Without seeing what kind of income and expenses your S Corporation has, I cannot definitively say whether it needs to prepay any taxes. Most S Corporations end up passing all their income to the shareholders, who in turn declare this income on their individual returns.
|
If you are an S corporation then you may be liable for... |
Use Form... |
|
Income Tax |
1120S (S corporation) |
|
Estimated tax |
1120-W (corporation only) and 8109 |
|
Employment taxes:
|
940 |
Employment Taxes
If the business has one or more employees, various employment taxes may be required. These could include: 1) the federal income tax withheld from your employees' wages; 2) social security (FICA) tax, both the amount withheld from employees' wages and the amount paid as an employer; 3) federal unemployment (FUTA) tax. Social security (FICA) and withheld income taxes are reported together quarterly on IRS Form 941. See Circular E, Employer's Tax Guide, IRS Publication 15 for deposit rules.
Federal Unemployment Tax (FUTA) is reported and paid separate from FICA and withheld income tax. IRS Form 940, an annual return, is used to report FUTA tax. Quarterly deposits are required if unpaid tax exceeds $100. For more information on FICA, FUTA and income tax withholdings, see Circular E, Employer's Tax Guide, IRS Publication 15.
Excise Taxes
The federal government imposes excise taxes on certain business activities. Your software company does not manufacture or sell alcoholic beverages, tobacco, or firearms. You also would not have to pay excise taxes for operating large vehicles on public highways.
If
an S Corporation is required to pay tax at the federal level, it may be required to pay tax at the
state level. Normally, S Corporations
are subject to corporate income tax due to Excess Net Passive Investment
Income, Capital Gains, or Built-in Capital Gains.
We are signed up through EFTPS but do not know whether to
prepay through EFTPS as an individual or an S-corp S-corp taxes are filed as part of the individuals tax return so
shouldnt the prepay be done for the individual not the corporation?
For ordinary income, the prepay should be done on the individuals who will ultimately receive the S Corporation’s income at the end of the year.
Also does the self employment tax and state tax apply to
even Internet commerce companies?
Yes of course. Someone ultimately receives that income, it does not float around in cyberspace. The federal and state governments have a right to tax that income when it is received within their territorial jurisdictions.
We know that Internet companies do no have to pay state
tax but when filing as part of the individuals taxes does the state tax have to be paid?
Internet companies do not pay state sales taxes if they have
no physical presence in the state.
However, Internet companies have to pay income taxes just like any other
company that earns income. If your S
Corporation owes no federal income tax in 2007, then it will probably owe no state
income tax. However, that does not mean
your S Corporation can avoid paying FICA taxes on wage income. If you owe federal income tax on the income
you receive in distribution from the S Corporation, then you will likely have
to pay state income tax on this same money.
It is only taxed once (at the individual level) and not taxed at both
the corporate and individual level when the business entity is an S
Corporation.