FEDERAL INCOME TAX LAW ADVICE
PART 3
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I have a national tax advice consulting practice. I charge $150/hour for tax advice, tax research, and problem resolution.
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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.
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If you are an S corporation then you may be liable for... |
Use Form... |
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Income Tax |
1120S (S corporation) |
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Estimated tax |
1120-W (corporation only) and 8109 |
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Employment taxes:
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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.