Copyright 1999 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject.--ISSN 1089-1536
LLCs--Selling, Buying, Accepting New Members--Taking on new owners (members) in an limited liability company isn't as easy as adding stockholders. The IRS has issued new rules on the subject.
Roth IRA Update--If you're thinking of converting a traditional IRA to a Roth, check out the new rules first.
Net Operating Losses--They can be carried back and forward to offset income in other years. And, unfortunately, getting the most benefit is much trickier than in the past.
Computing Your Basis in S Corporation--It's important for a number of reasons. For many business owners it's a mystery, but we've made it simple enough for anyone to do.
Meals Provided to Employees--Not all meals are subject to the 50% rule. And sometimes you can provide your employees with free meals that don't have to be included on their W-2.
Picking an Investment Advisor?--There are a lot of questions to ask before you select an investment advisor. Here's a checklist.
In Brief:--Tax, business, and personal finance tips.
If you thought not having required information was a good excuse for filing a tax return late, think again. In LFAM Corp. (83 AFTR2d Par. 99-370) the taxpayer filed its return on May 19, just over two months late. The taxpayer argued that it shouldn't be liable for a late penalty since it was waiting for a K-1 from a partnership in which it had an interest. The Court sided with the IRS. The taxpayer could have filed for an extension. In this case it might also have escaped the penalty by simply filing without the additional income on the K-1 and amending the return later. The income from the partnership was unexpected.
Senator Christopher Bond has introduced a bill in the Senate the would provide a simple safe harbor test to determine if a worker was an employee or an independent contractor. The bill, S. 344 Independent Contractor Simplification and Relief Act of 1999 has the support of several Senators. The tests in the bill are simply and should be beneficial to most businesses.
Just because you say you sold property doesn't mean you have a completed deal for tax purposes. Signing over formal title is important, but you also have to relinquish the 'benefits and burdens' of ownership. In the case of Ferydoun Ahadpour (T.C. Memo. 1999-9) the taxpayer didn't meet the second requirement.
If you're a shareholder/employee in a closely held corporation, the IRS often tries to assert that your compensation is unreasonably high. By recharacterizing it as a dividend, it becomes nondeductible, yet it's still income to you. In William N. and Beth Ann Katsaros (T.C. Memo. 1999-23) the Tax Court sided with the IRS in finding that distributions to such a shareholder were compensation for services, and not loans as the taxpayer claimed. Since the corporation was in bankruptcy the Court found that the shareholder could not reasonably anticipate that he would have received additional monies later for his services.
If you provide health coverage to employees, you either know about the COBRA rules, or you should. They require an employer to allow the employee to pay for coverage after separation from service. Small businesses are exempt from the rules, but if you're covered and you violate the rules, the penalties can be substantial. They generally start at $100 per day. The IRS has just issued new regulations with respect to COBRA coverage.
The IRS has announced that Publication 950, Estate and Gift Taxes is now available.
If you can be considered a responsible person for withheld taxes, you can be personally liable for the payment to the IRS. (State withholding and even sales tax rules are similar.) And the IRS will pursue officers, directors, shareholders in close corporations, and even bookkeepers that had authority to determine which vendors were to be paid. In In re Lou DeMarco, Jr. Debtor (99-1 USTC 50,213; U.S. Bankruptcy court, Mid. Dist. Fla., Tampa Div.) the Court found that, while the individual was a stockholder and an officer, he was not a responsible person. While could sign on the business bank accounts and did sign the quarterly employment tax returns, his duties were limited and, in actuality, he had little authority.
Get good advice before signing a closing agreement with the IRS. In William C. Kercheval, Nancy M. Kercheval (99-1 USTC 50,220; U.S. Court of Appeals, 4th Circuit) the Court affirmed a District Court decision could not seek recovery of the taxes he paid as a result of a closing agreement with the IRS. The rollover of his IRA was later determined to be tax free. The Court found that the fact that the IRS claimed it was taxable was not a misrepresentation of the facts. Moreover, the taxpayer was represented by counsel.
If you've got a net operating loss (NOL), whether business or personal, you've got to first carry the loss back. Only after you've offset all income in the earlier years (now 2 years back), can you carry the losses forward. But that can be disadvantegous. If you anticipate your tax rate to be higher in the future, you want to carry the losses forward. And you can do so. But you've got to make an election. In James F. McGuirl (T.C. Memo. 1999-21) the taxpayer failed to make the election. Thus, they had to be first carried back.
Here's another case where the taxpayer won a hobby loss issue. In Dana L. McNaught (T.C. Memo. 1999-25) the taxpayer had consistent losses from a horse breeding activity. The Court was swayed by the fact that she devoted nearly all her free time to the activity and successfully operated another business in the past. It allowed the losses.
No evidence, no deduction. That's what the Tax Court said to a taxpayer who claimed itemized deductions but was unable to substantiate any of the expenses with the exception of his medical and dental expenses which weren't enough to allow him to itemize. Charles Edward Shepherd, T.C. Memo. 1999- 19.
If you're going to claim a bad debt deduction you have to be able to show worthlessness. In Richard T. Stanley, Sr., and Miriam Stanley (T.C. Memo. 1999-20) the taxpayer was unable to point to an event that would show worthlessness. Moreover, the fact that the taxpayer was still in litigation in an attempt to collect the debt showed that there was still a possibility that it was not worthless.
While the tax shelter frenzy of the 80's is over, there are still some promoters trying to sell such investments. The investments may have changed, but the approaches are still the same. In Abraham and Dina Weiss (T.C. Memo. 1999-17) the Tax Court found that the taxpayers investment in a cable television business had no profit motive. It sided with the IRS in denying tax credits and losses.
In another issues in the same case Abraham and Dina Weiss (T.C. Memo. 1999-17)) the Tax Court found that the taxpayers still had the burden of proving the IRS wrong, despite the fact that the Service lost their records. CAUTION. Make copies of all records before submitting them to the IRS.
The IRS often wins regular cases in Tax Court, but, because of the extra burden of proof, it's track record with fraud cases is not nearly as good. In AJF Transportation Consultants, Inc., et al. (T.C. Memo. 1999-16) the IRS proved its point. The taxpayer had a cash hoard and did not keep adequate records. In addition, he provided his accountant with information he knew to be incomplete and far from accurate. Finally, since the IRS was able to show fraud, the statute of limitations was not applicable.
In another issues in the same case (AJF Transportation Consultants, Inc., et al. (T.C. Memo. 1999-16)) the Tax Court sided with the IRS in finding that reimbursements for fuel expenses received by the company were includible in the taxpayer's gross income.
You may be able to deduct certain unsubstantiated expenses if you can show that you did incur the expenses, that the expenses would be deductible if substantiated, and that there was a basis for estimating them. It's called the Cohan rule, after George M. Cohan. For example, you lose some of your rent bills for the year. You've got the bills for the first and last couple of months. The courts can allow the expenses for the missing months even without the bills since it's clear you had rent expense and the amount can be estimated. But consider this a last resort. And you can't use it for travel and entertainment expenses. In William Barry Blythe and Cheryl Lynn Blythe (T.C. Memo. 1999-11) the Tax Court did not allow the Cohan rule because the taxpayers did not show that they incurred the expenses.
LLCs--Selling, Buying, Accepting New Members Limited liability companies (LLCs) are all the rage. It almost seems that everyone starting a business is choosing to operate as an LLC. In many cases they have advantages over S corporations and they offer the limited liability protection that you can't get with a partnership or sole proprietorship. But two recent revenue rulings (Rev. Rul. 99-5 and 99-6) point out some problems you might encounter if you accept a new member, lose a member, sell out or buy into an LLC.
Keep in mind that a single-member LLC is taxed as a sole proprietorship. That is, for tax purposes the LLC is disregarded and the owner reports the income and expenses on a Schedule C. A multi-member LLC is taxed as a partnership and the income and expenses are reported on a partnership return.
Single member LLC takes on a new member. What are the tax consequences if you're doing business as a single member LLC and take on a member? Since the LLC form is essentially ignored, it's like doing business as a sole proprietor and then taking on a partner. Here are two possible situations.
Situation 1. Susan, who is not related to Fred, purchases 50% of Fred's ownership interest in the LLC for $5,000. Fred does not contribute any portion of the $5,000 to the LLC. Fred and Susan continue to operate the business of the LLC as co- owners.
Tax consequences. Susan's purchase of 50% of Fred's ownership interest in the LLC is treated as the purchase of a 50% interest in each of the LLC's assets, which are treated as held directly by Susan for tax purposes. That means than Susan will recognize gain or loss from the deemed sale of the 50% interest in each asset of the LLC.
Susan's basis in the LLC interest is equal to $5,000, the amount she paid to Fred for the assets which she is deemed to contribute to the newly created partnership. Fred's basis in the partnership interest is equal to his basis in his 50% share of the assets of the LLC.
That's a big difference from the consequences if Fred owned 100% of the stock of Madison Inc., an S corporation. If Fred sold 50% of his stock to Susan he'd still have a gain or loss on the transaction, but it would all be capital. Any gain would be taxed at no more than 20%. The sale of an interest in the LLC could generate capital gain taxes (at 20%) and/or ordinary income on the depreciation recapture. That could be taxed at up to 39.6%. Not only that, a gain or loss would have to be calculated on each asset.
Situation 2. Susan contributes $10,000 to the LLC in exchange for a 50% ownership interest. The LLC uses all of the contributed cash in its business and Fred and Susan continue to operate the business of the LLC as co-owners.
Tax consequences. In this situation, the contribution by Susan is treated as a contribution to a partnership in exchange for an ownership interest in the partnership. Fred is treated as contributing all of the assets of the LLC to the new LLC in exchange for a ownership interest.
In this case, Fred has no gain or loss on the conversion of the single-member LLC to a multiple owner LLC. His basis in the new LLC is the same as that in the old LLC.
Multi-member LLC becomes a single-member LLC. In these two situations, an LLC with two or more members becomes an LLC with just a single member.
Situation 1. Fred and Susan are equal partners in an LLC. Fred sells his interest to Susan for $10,000. After the sale, the business is continued by the LLC, which is now owned solely by Susan.
Tax consequences. The partnership (LLC) terminates when Susan purchases Fred's entire interest in the LLC. Fred must treat the transaction as the sale of a partnership interest, and must report the gain or loss resulting from the sale of his partnership interest.
The LLC is deemed to make a liquidating distribution of all of its assets to Fred and Susan, and then Susan is treated as acquiring the assets deemed to have been distributed to Fred in liquidation of his interest.
Upon the termination of the LLC, Susan is considered to receive a distribution of those assets attributable to her former interest in the LLC. She must recognize gain or loss on the deemed distribution of the assets.
If the business were operated as an S corporation, the purchase of Fred's interest by Susan would have been much simpler. Again, Fred would have a capital gain or loss, probably taxable at 20% on the transaction.
Situation 2. Fred and Susan are equal partners in an LLC. They sell their entire interests to Mike, an unrelated person, for $10,000 each. After the sale, the business is continued by the LLC, which is now owned solely by Mike.
Tax consequences. The LLC terminates when Mike purchases the entire interest of Fred and Susan. They must report gain or loss from the sale of their partnership interests.
The LLC is deemed to make a liquidating distribution of its assets to Fred and Susan. Immediately thereafter, Mike is deemed to acquire, by purchase, all of the former partnership assets.
Pluses and minuses. There are advantages and disadvantages to each form of doing business. Even though the sale of an interest in an LLC can be more complicated than the sale of shares in an S corporation, there can be some tax advantages.
Here are some rough rules of thumb.
In our November 15th issue we reported on the new Roth rules for conversions (going from a traditional IRA to a Roth) and recharacterizations (going back to a traditional IRA from a Roth) and recoversions (converting a traditional IRA that had been a Roth to a Roth). At that time the rule was that you could go through a full cycle (from a traditional to a Roth back to a traditional and then a second conversion to a Roth) only once in 1999. We also indicated that the IRS was working on new rules for 2000 and later years. The Service has now issued those new rules.
Effective January 1, 2000 an IRA owner who converts an amount from a traditional IRA to a Roth IRA during any taxable year and then transfers that amount back to a traditional IRA by means of a recharacterizaton may not reconvert that amount from the traditional IRA to a Roth before the beginning of the taxable year following the taxable year in which the amount was converted to a Roth IRA, or, if later, the end of the 30-day period beginning on the day on which the IRA owner transfers the amount from the Roth IRA back to a traditional IRA.
Example 1--On January 15, 2000 you convert $50,000 from a traditional IRA to a Roth. In mid-March you decide to undo the transaction. You recharacterize it, taking the money out of the Roth and putting it back in the traditional IRA. You must wait until January 1, 2001 (the next taxable year) to reconvert funds from a traditional IRA to a Roth.
Example 2--On December 15, 2000 you convert $50,000 from a traditional IRA to a Roth. On December 20, you decide to undo the transaction. You recharacterize it, putting the money back in the traditional IRA. You must wait until January 19, 2001 (the later of the next taxable year or 30 days) to reconvert the funds to a Roth IRA.
Tax Tip--While you can still take advantage of dips in the market to convert a traditional IRA into a Roth to save taxes, and you can still undo the transaction, you won't be able to reconvert as easily if you found the market dropping further. You'll have to wait for a time. How long depends on the when the transactions occur. For a number of reasons, unless you're timing the market you should probably wait until the end of the year to convert a traditional IRA to a Roth. That way you can reduce to a minimum any waiting time before reconverting.
A reconversion made before the later of the beginning of the next taxable year or the end of the 30-day period that begins on the day of the recharacterization is treated as a 'failed conversion (a distribution from the traditional IRA and a regular contribution to the Roth IRA), subject to a correction through a recharacterziation back to a traditional IRA. For these purposes only a failed conversion resulting from a failure to satisfy the statutory requirements for a conversion (e.g., the $100,000 modified adjusted gross income (AGI) limit) is treated as a conversion in determining when an IRA owner may make a reconversion. Thus, an IRA owner whose taxable year is the calendar year and who converts an amount to a Roth IRA in 2000 and then transfers that amount back to a traditional IRA on January 18, 2001 because his or her AGI for 2000 exceeds the $100,000 cannot reconvert that amount until February 17, 2001 (the first day after the end of the 30-day period beginning on the day of the recharacterization transfer) because the failed conversion made in 2000 is treated as a conversion for purposes of the reconversion rules. However, if the IRA owner inadvertently attempts to reconvert that amount before February 17, 2001, the attempted conversion is not treated as a conversion for purposes of the reconversion rules (although it is otherwise treated as a failed conversion). Therefore, the IRA owner could transfer the amount back to a traditional IRA in a recharacterization and reconvert it at any time on or after February 17, 2001. If the IRA owner does reconvert the amount on or after February 17, 2001, he or she cannot reconvert that amount again until 2002.
The final regulations clarify that a nonqualified distribution from a Roth IRA is taxed only to the extent that the amount of the distribution, when added to all previous distributions (whether or not they were qualified distributions) and reduced by the taxable amount of such previous distributions, exceed the owner's contributions to all his or her Roth IRAs.
Example 1--Over the years you've made a total of $20,000 in contributions to your Roth IRA. Earnings have increased so that the total in the account to $80,000. Only qualified distributions completely escape taxes and the early withdrawal penalties. A qualified distribution is one made at least 5 years after the initial contribution to the Roth and after reaching age 59-1/2 (certain other exceptions also apply). You've held the account for more than 5 years but you're only age 45 and none of the other exceptions apply. You withdraw $15,000 from the account. Distributions are deemed to first be out of contributions and, if you've held the account for at least 5 years such distributions aren't taxed.
Example 2--The year following the distribution in the example above you withdraw $8,000 more. The first $5,000 of this distribution isn't taxed. However, this $5,000 when added to the $15,000 distributed in prior years equals your contribution (cost basis) to the account of $20,000. Thus, the additional distribution of $3,000 is not only taxable, it is also subject to the 10% penalty on early withdrawals.
Introduction. What's a net operating loss? For a regular corporation, it's when you compute your taxable taxable income and the result is a loss. S corporations, partnerships, etc. don't have net operating losses because their income or loss is passed through to the shareholders to be reported on their personal return. But, an individual can have a net operating loss. For an individual, there are a number of adjustments that must be made (we won't cover them in this article). The important thing to keep in mind is, if your taxable income is negative, you should determine if you have a net operating loss. And that can happen if you do business as a sole proprietorship or through an S corporation, partnership, LLC, etc.
How do you handle a net operating loss (NOL)? The loss can generally be carried back 2 years and forward 20. By offsetting the income in the earlier year, you can get a refund for part or all of the taxes paid in that year. Unless you make a special election (see below), you must carry the loss back to the earliest of the 2 years to offset income in that year. Any loss that's not utilized is carried to the first year before the NOL. Then any remaining loss can be carried forward.
Example--Madison Inc. has a $100,000 NOL for 1998. It carries the loss back to 1996 when it had $20,000 of income. The $100,000 NOL reduces Madison's income for that year to $0. Using Form 1139 Madison claims a refund of the $3,000 in taxes it originally paid on the $20,000.
Madison has used only $20,000 of the $100,000 NOL. It's got $80,000 left. Madison had taxable income of $35,000 in 1997. Using the same procedure, it uses part of the NOL to offset that $35,000, claiming a refund for the taxes paid of $6,250.
Madison has now used up $55,000 of the $100,000 NOL. The remaining $45,000 can be carried forward to offset income in future years. For example, if Madison had a profit of $25,000 in 1999, it would use the NOL to reduce the profit to $0 and still have a $20,000 NOL to offset income in 2000. But the company must can't choose when to use it. As much of the NOL must be applied each year as the company has income.
Things get trickier if you've got intervening NOLs, tax credits, etc. For example, if Madison had a loss in 1997 instead of a profit, none of the $80,000 unused NOL could have been used in 1997. Instead, that amount would have been carried forward to 1999.
In the opening paragraph, we prefaced our discussion by indicating this was the general rule. Unfortunately, there are a number of exceptions. Fortunately, the rules in those cases are actually more liberal.
Losses for earlier tax years. For losses incurred in tax years beginning on or before August 5, 1997, NOLs are carried back to the earliest of 3 years and carried forward for 15 years.
Small business exception. Small businesses (those with average annual gross receipts of no more than $5,000,000 for the prior three years) can use a 3-year carryback period for the portion of an NOL attributable to a Presidentially declared disaster.
Farming losses. Net operating losses attributable to the income and deductions of a farming business can be carried back 5 years and forward 20.
Product liability losses. The portion of a net operating loss attributable to a product liability loss, the dismantlement of a drilling platform, the remediation of environmental contamination, or a payment under any workers compensation act can be carried back 10 years.
Change of ownership. Some years ago corporations would 'traffic' in NOLs. That is, a profitable corporation would buy a corporation with a big NOL. It would use the losses to offset its profits. When the law put a stop to it, it did so in a way that could trap unwary small business owners.
Under the rules, if there is percentage ownership change of more than 50 percentage points over a 3-year testing period, the net operating loss carryback or carryforward will be limited by some complex rules. That can easily happen in a small corporation.
Example--Fred owns 50% of Madison Inc.; Sharon owns 20% and Linda owns 30%. Fred and Linda decide to sell out to Sharon during 1998. Sharon's ownership position has increased by more than 50 percentage points. Thus, Madison's NOL deductions are limited.
Corporate equity reduction transaction. If a corporation buys another corporation, a portion of the interest deduction can be disallowed if there is an NOL and the interest for any taxable year is $1,000,000 or more. A portion of an NOL can also be disallowed if there is a excess distribution (i.e., an abnormally large dividend) by the corporation.
Claiming the NOL. You must carry the loss to the earliest year prescribed by law first. If you don't, the loss is permanently lost. Thus, if you had a loss that you didn't carry back, you should file an amended return, if you still can.
You can make an election to forgo the carryback period. If you do, the losses will only be carried forward.
Tax Tip--Why would you elect to forgo the carryback? After all, why give up a sure thing for the chance to offset future profits? The election makes sense if your tax rate was low for the years to which the loss would be carried and you anticipate being in a higher bracket in the future.
Capital losses. While not an NOL, a capital loss can be particularly frustrating for a regular corporation. A capital loss can only be used to offset capital gains. If you can't use it in the current year, the loss can be carried back 3 years or forward 5. But many corporations can go for years without having a capital gain.
Tax Tip--If you fall into such a situation, it might make sense to sell an asset that would generate a capital gain. For a corporation, that might be real estate, goodwill, etc. Fixed assets such as equipment often don't create capital gains. If you sell the asset so that the gain offsets the losses you'll have no additional taxes and have eliminated property that could result in substantial taxes in the future.
Bad debt losses. Again, not a true NOL. Bad debts or worthless security losses can only be deducted in the year they occur. There can be significant uncertainty as to when that happens. For example, your business loaned Madison Inc. $50,000. In 1998 Madison goes bankrupt. Can you take the loss this year? Probably not. Many courts have held there's a possibility of recovery until there's a final resolution. That can be a problem since the time limit for filing an amended return is 3 years from the date of the original return. However, in the case of a bad debt or worthless security loss, that 3 year limit is extended to 7 years.
Summary. An NOL can generate some significant tax savings. If you can carry it back to an earlier year that can mean extra cash when you need it most. However, there are some strict rules to keep in mind. And, if you do business as a C corporation, you want to be particularly careful to avoid any transactions that can result in the loss of some of those benefits. Watch out for sales of stock by shareholders who own more than a 5% interest in the company; avoid any large, excess distributions, and don't think you can buy a company with losses and use them to offset your profits. And the reverse, buying a profitable company to use up your losses, won't work either.
Computing Your Basis in S Corporation
Why is your basis important? If you take a distribution that exceeds your basis, the distribution will be taxable. Repayments of loans from shareholders can result in income. Things could be even worse if the business was once a regular corporation.
On more than one occasion we've said that your basis in the stock of an S corporation is equal to your original investment plus any income and additional capital contributions less any losses and distributions. Thus, if your invest $5,000 in the stock, have a profit of $20,000 and take $3,000 in distributions from the business, your basis would be $22,000. Unfortunately, it's not that simple. The rules for computing the income of and your basis in an S corporation are more complicated. Many income items and deductions not included in the income of the corporation. Instead, they're passed through separately to the shareholders and reported on their tax return in the appropriate spot. The same is true for certain deductions.
Example--For 1999 Madison Inc. has a 'profit' from operations of $50,000. Included that amount is a deduction for the Section 179 expense deduction of $5,000 and interest income of $2,000. On Madison's tax return, it reports a profit of $53,000. The $5,000 Section 179 deduction is added back for tax purposes. It's reported on the shareholders' K-1 and deducted by the shareholder's on their personal returns. The $2,000 of interest income is not included in the corporation's profit. It too is reported on the K-1 and the shareholders report their share of the amount on Schedule B (Interest and Dividend Income) of their personal tax return.
There are a number of other items that are treated in similar fashion. They most frequently encountered ones include:
All this increases the complexity of the return. And it makes computing your basis more difficult. You've got to adjust for these and a number of other items.
Why the concern over your basis? First, your basis will determine your gain or loss when you sell or liquidate the business. Second, and usually more importantly, if you make distributions (and that can include the payment of personal expenses by the corporation) that would drop your basis in the stock below zero, a number of adverse tax consequences can take place. For one, any repayments of loans by the corporation to you can be fully taxable. If there are no loans outstanding, the distributions will be taxable as a sale of the corporation's stock. Both situations can generate a migraine headache.
Fortunately, calculating your basis isn't all that difficult. Your accountant or tax adviser may do it automatically. If not, you can use the numbers from your tax return (you may have to do some additional research). You should do it every year, right after your tax return is done. If you keep the schedule up to date, you won't have to go digging in old files and you'll stay out of trouble. The form below is pretty much self-explanatory, but we've annotated it with footnotes where appropriate. You can find most of the information on Schedule K of Form 1120S or on your K-1.
Stock basis at start of year _________
Excess deductions/losses from prior years _________
Net _________
Plus--Increases:
Ordinary business income _________
Net income from rental activities _________
Interest income _________
Dividend income _________
Royalty income _________
Net short-term capital gain _________
Net long-term capital gain _________
Net gain under Section 1231 _________
Tax-exempt interest income _________
Other income _________
Section 179 recapture on disposition of assets _________
Depletion (but not oil and gas) in excess of basis _________
Life insurance proceeds _________
Other increases _________
Contributions to capital _________
Less--Decreases:
Ordinary loss _________
50% of meals and entertainment (1) _________
Section 179 expense deduction _________
Charitable contributions _________
Deductions related to interest, dividends, etc. _________
Interest expense on investment debt _________
Other nondeductible expenses (2) _________
Net loss from rental activities _________
Net short-term capital loss _________
Net long-term capital loss _________
Net loss under Section 1231 _________
Foreign taxes _________
Oil and gas depletion _________
Other decreases _________
Distributions (not in excess of stock basis) (3) _________
Basis _________
Notes:
Basis is computed separately for each shareholder.
(1) The 50% of meals and entertainment expenses that are not deductible still reduce your basis.
(2) Other nondeductible expenses can include fines and penalties.
(3) Distributions can include actual cash or property payments to shareholders or the payment of a shareholder's personal expenses.
Debt basis at start of year _________
Plus:
Loans made during the year _________
Less:
Loan repayments _________
Excess losses/deductions from prior years _________
Losses/deductions in excess of stock basis _________
Distributions (not in excess of debt basis) _________
Basis in debt _________
Normally, only 50% of meals are deductible. That rule applies whether you're taking a client to lunch, or if you're out of town on a job. And, while the 50% rule applies most of the time, there are some exceptions.
You can deduct the full cost of meals in the following situations:
Meals furnished on company premises
If you furnish meals to employees on company premises you might be able to exclude the value of the fringe benefit from the employee's income and deduct the full cost of the meal. There are two possible situations when you can qualify for this exception.
The first is if the meals qualify as a de minimis fringe benefit. This is a benefit of any property or service you provide to an employee that has so little value (taking into account how frequently you provide similar benefits to your employees) that accounting for it would be unreasonable or administratively impracticable. Cash, no matter how little, is never excludable as a de minimis fringe benefit, except for occasional meal money.
Example 1--At the end of each month, for 3 or 4 days, several employees stay late to close the books, make sure all customer statements are mailed, etc. While there's no written rule, supervisors will either order take-out food from a local restaurant or, sometimes, give the employees $10 as meal money. The amount of the fringe benefit is not based on the number of hours worked. That is, employees receive the same benefit whether they stay for 2 hours or 6 hours. The meals are not taxable to the employee, and are fully deductible by the company.
Example 2--Because of layoffs, the accounting department is understaffed and several employees are required to work late 4 nights per week, every week. In this case meals or meal money provided to the employees working later would not be a de minimis fringe.
The second situation is a little more complicated. And it generally applies to tax years beginning after 1997. You can exclude the meals from an employee's wages and fully deduct the cost of the meals, if you meet both of the following tests:
However, if an employee can choose to receive additional pay instead of meals, you must include the value of the meals in his wages, even if he chose a meal instead of cash.
The first test here is that the meals are furnished on your business premises. Business premises can mean your office or factory, or it could be a remote job site.
The second test is that the meals be furnished for your convenience. That depends on all the facts and circumstances. However, providing the employee with additional pay is not a valid reason. And a written statement that the meals are for your convenience isn't sufficient.
Here are some examples of meals furnished for a substantial nonpay business reason.
Meals you provide employees to promote goodwill, boost morale, or attract prospective employees are generally considered provided for pay reasons. Thus, they don't meet the exception above. Likewise, meals furnished on nonworkdays don't qualify.
Example 1--Sue is a customer telephone support person. She and a number of other employees troubleshoot customer problems. Support can be particularly heavy during the lunch hour. In order to limit Sue's (and the other support personnel) to 30 minutes, you provide lunch free in the employee cafeteria (or, if you have no cafeteria, you order take-out brought in. If Sue and the other employees were allowed to go out for lunch, they would take a full hour to eat and return.
Example 2--A hospital maintains a cafeteria on its premises where all of its 230 employees may get meals at no charge during their working hours. The hospital furnishes the meals in order to have 120 employees available for emergencies. Each of these employees is at times called upon to perform services during the meal period. Although the hospital does not require these employees to remain on the premises, they rarely leave the hospital during their meal period. Since the hospital provides meals to its employees to have more than half (120 out of 230) of them available for emergency calls during the meal periods, the hospital does not include the value of these meals in the wages of any of its employees and can take a full deduction for the expense.
This can be a tricky area. However, if you meet the requirements, providing free meals to employees can produce beneficial results. You can give the employees something for which they will not be taxed. And, there are other benefits. By keeping the employees on site, productivity might improve.
Picking an Investment Advisor?
Selecting an investment advisor could be more important than choosing a CPA for your business, picking an attorney, etc. While the specialities of CPAs vary, they all have to meet certain minimum standards. Moreover, CPAs rarely make major business decisions, at least not on their own.
It's different with an investment advisor. You may have a portfolio of $500,000. A few wrong decisions can prove very costly indeed. Here's a list of possible questions.
Obviously, your prospective advisor could answer the questions in a way to make himself look most favorable. Don't hesitate to verify whatever information you can. However, even that may not be enough. Ask for references of clients or professionals (CPAs, attorneys, etc.) with whom he's worked.
You can take some other steps to protect yourself.
While most investment advisors are both competent and honest, most victims are victims because they haven't taken the right precautions. Finally, there's no reason to relax your guard after a year or two.
Previously Reported In Daily Update
Retired and need cash? . . . While it may hurt, hit those savings and brokerage accounts first. Money in a regular (deductible) IRA, 401(k) plan, etc. is fully taxable at ordinary income rates. Since you have no 'basis' in the plan, the entire amount withdrawn is subject to tax. On the other hand, any money in a savings account, CD, etc. has already been fully taxed. There's no additional tax on a withdrawal. If you cash in stocks or bonds held in your personal brokerage account, you'll pay tax only on the amount of the gain, and then at no more than 20% if the gains are long-term (10% if you're in the 15% bracket). The tax savings can be substantial. Assume you put $7,500 in a brokerage account 8 years ago. The account has now grown to $20,000. The tax on the gain of $12,500 ($20,000 less $7,500) is $2,500. If you cash in the whole account, you'll be left with $17,500. Take $20,000 out of a deductible IRA or 401(k) plan and, assuming your combined federal and state rate is 33%, you'll pay $6,600 in taxes and be left with only $13,400, $4,100 less. Moreover, if you take the money out of a brokerage account, you may be able to use offsetting losses to reduce your taxes to zero. That may prove particularly advantageous because you'll avoid increasing your adjusted gross income (AGI) and the adverse tax consequences (e.g., tax on your social security payments) that come from doing so. Another option. Take some money out of each type of account. Work through the numbers with your tax or financial advisor.
Got a dog? . . . He (or she) could affect your homeowners insurance. Some insurance companies are getting fussier about dogs after paying larger amounts each year for dog bites. You could find yourself paying a higher premium or being denied coverage from some companies if you have a German shepherd, rottweiler, pit bull, huskie, Alaskan malamute, Doberman, Akita or Great Dane. There's no universal rule and some any discrimination against dog owners may not be allowed by state law. It's something to check before deciding on a breed.
IRA accounts for children? . . . There's no lower age limit on contributions to any IRA account. If you 3-year old makes $2,000 doing modeling work, he or she can make a $2,000 IRA contribution. But do they make sense? If you can spare the cash, definitely. As little as $2,000 invested at age 14, growing at 10% per year (slightly less than the historical return on stocks), would grow to $258,260 by the time he or she reached 65. No one knows what that will buy 51 years from now, but, unless inflation increases significantly, it will still be considerable. If you or your child can't afford to spare the cash (because of college), maybe a grandparent will help.
State rules can differ on employee status . . . Generally, most states follow the federal rules when defining a worker as an employee or independent contractor. Similarly, most states follow federal rules when it comes to determining on which employees you must pay unemployment insurance. But that rule doesn't always hold. The more unusual the situation, the more it pays to check.
Buy business or parts? . . . You may want to buy a business to expand your own operations, but do you really need to buy the entire business? Consider what you really want. Is it only the customer list you want? Or just the business name? Why buy assets you will just have to dispose of? Or, worse, become saddled with liabilities. The seller will probably want to sell the business as a going concern. But, for many smaller businesses, or those in financial distress, you may have the upper hand. Offer to purchase just the customer list or name. You can afford to pay somewhat more than what the asset would be worth as part of a group since you won't be purchasing equipment, etc. that you may have to pay sales tax on, move, and then sell.
Vanishing premium life insurance policies . . . Life insurance has become a harder sell and agents have to sell to earn a living. To a customer vanishing premium insurance sounds interesting. The pitch is convert to this type of policy and within some limited number of years you'll be all paid up. The concept sounds good. And it works, but only if your premiums earn enough income. That's were the sell comes in. The earnings assumptions used in the projections are often unrealistically high. Should earnings fall short, your premiums could go up instead of vanishing. Considering checking with your accountant or an independent financial advisor before switching policies.
Worker's compensation . . . For many businesses it can be a significant percentage of your overall costs. Moreover, it can be a touchy area. You don't want an employee at home without a good reason, but you also don't want a disabled worker on the job. Some companies are requiring a doctor to complete a detailed questionnaire to determine the type and amount of work the employee can do. The employee may be able to perform the same work, but at a slower pace, or may be able to handle a desk job. Getting the employee back to the job can have two benefits. First, the employee is doing some productive work for the business. Second, if an employee knows he may be back at work even if injured, there may be no reason for feigning a claim. Check with your insurance company, they may have other suggestions.
Concentrate on your bread and butter . . . Too many entrepreneurs lose track of the part of the business that generates the most profit. You may be distracted by a new product or market, problems in products that produce only a small profit, nonbusiness problems, etc. If you don't have the time to manage the entire business efficiently, step back and concentrate on your most important product lines. We know of one business owner that put off a switch to a Windows version of their program because the consulting side of the business was generating big profits. That proved fatal. First, software sales plummeted. Then the consulting side of the business weakened. That left no core business. Worse yet, the consulting business weakened even further when potential consulting customers learned there was no Windows version of the software forthcoming. Make sure your main business is in good shape before expanding into other areas. That's even more important if cash from your main business is financing growth in the new markets.