News On The Tax Front--The latest tax news.
Reasonable Compensation--If you do business as a C (regular) corporation, you don't want the IRS asserting your salary is excessive. The corporation could lose a deduction, but the payment would still be income.
Bad Debt Deduction Denied --Before loaning money to a friend, relative, or business associate, read this article.
Loans to Businesses--If you're loaning money to a business, there are a number of things you can do to protect yourself and make sure you can deduct the amount if you're not repaid.
Receipt of Profits Interest Not Taxable--If you're organizing a partnership or LLC, there's a big tax break available.
Hiring Executives--Hiring a displaced executive from a large company may be a mistake. Here are some questions you should ask yourself.
Postage Savings--Sounds like small potatoes, but they can add up quickly.
Tips When Negotiating a Loan--If you borrow money, the lender will have a say in your business. Here are some of the possible restrictions and what you can do about them.
In Brief:--Tax, business, and personal finance tips.
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
Here's another case of where a taxpayer was required to capitalize an expenditure. A car dealer paid and 'enrollment fee' to a financing company for the right to sell customer loans to the company. Since the benefits of the fee extended over a number of years, the IRS held that the company had to capitalize the fee. In the technical advice memorandum (TAM 199909002) the IRS said that the fee could be amortized according to the rules of Sec. 197, that is, it could be written off ratably over 15 years.
In Terry U. Neal (T.C. Memo. 1999-97) the Tax Court disallowed the taxpayer miscellaneous itemized deductions because he presented no independent evidence that he actually incurred the amounts. It also denied unsubstantiated expenses related to his computer service business.
When is income taxable? The question can be very important. The IRS usually tries to tax an amount as soon as possible. However, that's not always true. In this case (Roy V. Thomas, et ux.; 83 AFTR2d, Par. 99-685, U.S. District Court, So. Dist. Ohio) the District Court held that lottery prize winnings weren't taxable until the lottery commission performed their final verification. The taxpayer had argued that the amount was taxable because he won the amount in 1992, and provided all the required information to the commission before the end of the year. Keep that in mind in your tax planning.
The IRS has announced the release of updated Publication 954, Tax Incentives for Emplowerment Zones and Other Distressed Communities. The publication is primarily for business owners who want to find out whether they qualify for certain tax incentives created to increase business activity in distress communities.
Here's another case where the taxpayer tried to deduct employee business expenses personally rather than seek reimbursement from his employer. The rule is simple. If you can be reimbursed by your employer, you must try to recover from him first. Only if you are denied, or your employer has a policy of not reimbursing, can you deduct the expenses on your personal return. This rule is especially important for business owners. Thomas M. and Dolores F. Gomez; T.C. Memo. 1999-94.
And you thought you heard the end of the O.J. Simpson case. In Cann (99-1 USTC 50,349; U.S. District Court, Cent. Dist. Calif.) the taxpayer lived in the same neighborhood as O.J. Simpson at the time of the murders. He claimed that the publicity surrounding the case diminished the value of his home and took a casualty loss deduction to reflect the decline. The Court said that in order for a casualty loss to occur, there must be some physical damage to the property. The taxpayers cited a case (Finkbohner), but the Court did not agree that that case was relevant. Note, generally you can't take a deduction until there is a completed transaction that results in a loss.
If you're planning to promote your business you shouldn't go too far afield. In this case (Jim Wood Land Clearing Co., Inc.; T.C. Memo. 1999-90) the taxpayer claimed that the construction of two homes on the shareholder's property were valid business expenses. The company claimed the expenditures as advertising, arguing it was a way to meet local contractors and promote its business. The Court didn't see it that way. It noted that constructing the houses was neither customary nor usual method of advertising and the construction was not helpful or appropriate to its business. It disallowed the deductions.
This is another hobby loss case where the taxpayers kept good records. In denying the losses in this case (Louis A. Filios and Estate of Emma L. Filios; T.C. Memo. 1999-92) the Court cited the fact that the taxpayers did not prepare regular financial statements, did not change their business practices even in the face of continued losses and did not seek professional advice. The Court also noted that they hadn't turned a profit in 30 years.
Sustaining a hobby loss deduction is usually difficult. While most taxpayers hurt their chances by not keeping good records, that's not the only reason for losing out. In Courtney Lundquist and Brenda Lundquist (T.C. Memo. 1999-83) the taxpayers kept good records, but had no business plan or profit projections. It was also clear from the way the business was run and the investigations undertaken that the taxpayers were more interested in the sport than in turning a profit.
Making a charitable contribution of appreciated stock can provide significant tax savings. You get to deduct the full fair market value. If you sold the stock you'd get to keep less than 80% after federal and state taxes. However, you can't make the contribution just before the shares are expected to increase in value. In the case of Michael Ferguson, et ux. et al. (83 AFTR2d Par. 99-648) the taxpayers owned almost 20% of a corporation and held seats on the board of directors. The company was seeking to be acquired. A merger agreement was signed in early August. Before the end of the month, the taxpayers placed a significant amount of their stock in charitable foundations. The Court found the taxpayers were taxable on the stock's gain under the 'anticipatory assignment of income' doctrine.
Taking a Section 179 expense deduction (writing off up to $19,000 (in 1999) of equipment) generally makes sense. You've got to be careful, however. There are a number of restrictions on the deduction. One is that the entity must have enough taxable income. For example, if a partnership's income is only $15,000, that's the maximum Sec. 179 deduction. (The same is generally true for S corporations and sole proprietorships, but some special rules apply.) In Dennis L. Hayden and Sharon E. Hayden (112 TC--, No. 11) the taxpayers claimed a Section 179 expense deduction in a year when the partnership in which they were partners had no taxable income. They argued that the regulations were invalid. The Tax Court did not agree. Note, if the Sec. 179 expense is limited in that way, you can carry the amount forward to use in a later year. However, that's probably only a smart move if you're sure you can use it in the next year. Beyond that point, you're probably better off sticking with regular depreciation.
Sometimes the strangest things can be capital assets. In William T. Gladden, et ux. (112 TC--, No. 15) the taxpayers successfully argued that water rights (the right to use a specified amount of water from the Colorado River) they acquired along with farmland, were capital assets. Thus, the income received for the sale of the rights produced a long-term capital gain, not ordinary income as the IRS had asserted.
Both the House and Senate have passed the fiscal 2000 GOP budget blueprint. The measure includes $778 billion of tax cuts over a 10-year period. While it's too early to speculate on the final outcome, a good sign is that Chairman Archer has agreed to an early markup of any tax legislation. There's a good chance we'll have a look at the legislation before the summer recess.
Trying to get around the law by restructuring a transaction generally doesn't work. In Jacobs Engineering Group, Inc. (99-1 USTC 50,335; U.S. Court of Appeals, 9th Circuit) the taxpayer tried to avoid the consequences of a loan that would exceed the 1-year maximum term allowed to avoid tax on repatriated foreign income by structuring a series of 1-month loans. The Court found the loans interrelated and could find no valid business reason for a series of short loans. Thus, it held the loans were really one long-term one.
Generally, there's no gain or loss for tax purposes on property transferred between spouses in a divorce. In Linda Karen Brownlow Craven (99-1 USTC 50,336; U.S. District Court, No. Dist. Ga.) the issue wasn't the transfer of property, but interest on a note exchanged for stock redeemed. The Court found that the imputed interest on the note was taxable income.
If you're incorporating a sole proprietorship, or just starting a new corporation, you may be contributing property (equipment, supplies, inventory, etc.) to the new entity. A special section of the law (Sec. 351) allows you to transfer the property without having to report a gain or loss on the transaction. In Don Ballantyne and Susanne C. Ballantyne (99-1 USTC 50,322; U.S. Court of Appeals, 9th Circuit) the taxpayer tried to argue that, although the transaction was structured as a sale, the substance of the transfer was not a sale and the transaction should be tax free. The Court did not agree. Get good advice. The tax consequences can be significant. Moreover, any additional tax burden could come at a particularly bad time, just when the shareholders need the cash for the new business.
Introduction
If you do business as a C (regular) corporation one of the disadvantages is that you have to worry about the IRS claiming that a portion of your compensation is unreasonable. If they do, the excess will be reclassified as a dividend. The dividend would be taxable income to you, but not deductible by the corporation. That would result in the dividend being taxed twice--once as income at the corporate level, and again as income to you personally.
Of course, if you keep your salary low you avoid this problem. But then the money is locked in the corporation. Eventually you'll pay tax twice on that amount. If you take the funds out as a dividend, you'll pay tax a second time. The result is the same if you leave the money in and sell the assets or liquidate the corporation. That's one of the reasons an S corporation, partnership, or LLC are so attractive.
There is some good news here. Taxpayers have been winning more cases in Tax Court. The Court has allowed salaries of $500,000, $1,000,000 and even higher amounts to even small companies if they can show the compensation is commensurate with the employee/stockholder's experience, performance, etc. The bad news is that you don't want to go to court to prove your point. That's expensive and time consuming. And, checking for unreasonable compensation is part of any field audit by an agent.
In this article we'll discuss the factors the IRS and courts look at in deciding whether or not the compensation is reasonable. This issue generally only applies to employees who are also stockholders, and generally only stockholders who have a controlling interest.
Factors the Courts Consider
In a recent case (Alpha Medical, Inc.; 99-1 USTC 50,461; U.S. Court of Appeals, 6th Circuit), the company took a deduction of $4,439,000 (for one year) as salary to its president, director, and sole shareholder. That amounted to about 65% of the corporation's taxable income for the year. The IRS argued that the maximum allowed deduction should have been $400,000. The taxpayer lost in Tax Court, but the Court of Appeals allowed the full deduction. Here are the factors the Court examined. Keep in mind that no one factor is determinative, and the courts can give different weights to the factors as they see fit.
Employee's Qualifications. The factors to be considered here include the employee's education, experience, ambition, energy, etc. The Court found that the success of the corporation was due mainly to the president's ambition, creativity, vision, and energy. Before founding Alpha he started and sold two other successful businesses in the same industry. He had 25 years experience in developing the company's products. His hard work, talent, and considerable experience were the linchpin of the corporation's success.
Nature, extent, and scope of employee's work. What are the employee's duties, how difficult is the work, how many hours a day or week does the employee put in, etc. Managing a company in a stable, nontechnical, industry is easier than having to spend 12 or more hours a day managing a fast growing company in a constantly changing industry, rescuing one for bankruptcy. The Court noted that at one time or another the president held most of the management positions at Alpha. He consistently worked 12 hours each day in the office and was on call around the clock. His responsibilities covered a wide range of activities, including sales, operations, planning, personnel, and finance. The record showed that no other officer of the company had the breadth of experience. He was the company's primary salesman and deal closer. He personally obtained each of Alpha's clients and negotiated each contract. The Court noted that in the 4 preceding years Alpha's gross receipts increased almost 12 times; taxable income increased 18 times; net worth showed an increase of over 35 times.
Size and complexity of the business. The Court noted the number of employees increased from 2 to 60 in 4 years and the number of locations grew from 1 to 43. The Court also noted that the operation of the company required considerable technical expertise and compliance with various insurance programs.
Comparison of salaries paid with gross and net income. How much of the gross and net income of the corporation is paid out in salary to employee/shareholders is indicative of a effort to avoid paying dividends. The higher the ratio of such salaries to net income, the more it weighs against the taxpayer. The Court noted that in this case the president's salary amounted to almost 65% of net income. It was also telling that the corporation paid only $1,500 in dividends to the president. The fact that the president was the sole shareholder only compounded the case against him.
Prevailing general economic conditions. Examining general economic conditions during the tax years in question helps to determine whether the success of a business is attributable to general economic conditions as opposed to the efforts and business acumen of the employees. In this case the economy was actually slowing as the company underwent a rapid increase in sales and income.
Comparison of salaries paid with distributions of retained earnings. The failure to pay more than nominal dividends may suggest that some of the amounts paid as compensation to a shareholder/employee is really a dividend. The absence of a consistent, developed dividend history may raise a red flag that invites special scrutiny.
There's nothing wrong with paying no dividends if the company needs the retained earnings for growth. However, large salaries paid to employee/shareholders tend to contradict the need to retain earnings.
But there's an additional issue. The IRS and the courts examine the return a shareholder would receive. That is, would an independent shareholder be satisfied with the return on his investment even with the large salaries paid? The Court noted that the president was the lone shareholder and that his equity grew from $97,000 to $1.7 million in 4 years. His total return on equity was over 98%. That should be sufficient to satisfy any investor.
Prevailing compensation for comparable positions in comparable businesses. This can be the most important factor. This concept here is straightforward. How does the salary of the shareholder/employee compare to other salaries in similar businesses? Unfortunately, making such a comparison is not easy. You've got to find a number of similar businesses. Not only do the businesses have to be in the same industry, they should be similar in size and complexity, and maybe even in the same life stage. If you're going to court, you'll need to hire expert witnesses and significant research may be needed.
One of the facts considered here was that just before starting the company the president turned down a job offer at a similar company for $1 million.
Compensation paid in previous years. It's not unusual for an employee/shareholder to take only a nominal salary in the early years of the business when cash flow is critical, and then make up for lost wages when the company prospers.
In fact, the president took only a $67,000 salary the first year of operation; $76,000 the second; $431,000 the third; $928,000 the fourth and $4.4 million the fifth year. He was clearly undercompensated the first two or three years the business was in operation.
The Court sided with the taxpayer here, finding he was undercompensated in the early years.
Salary policy as to all employees. The IRS and courts compare the salaries paid to other employees to determine whether employee/shareholders are compensated differently than the corporation's other employees just because of their status as shareholders.
The Court noted that the compensation of the next highest paid nonshareholder was only 5.1% of the president's salary. That, coupled with the fact that the president's salary increased dramatically in one year (from $928,000 to $4.4 million), weighed against the taxpayer.
The Court offset these negatives by the fact that the president had, almost entirely on his own, taken the company from nothing to nearly $7 million in profits within 5 years.
The Court also noted that contingent compensation formulas, typically tied to gross revenue or profits, are often used to inspire productivity. When such compensation is paid under a long-standing arm's length agreement, it will usually be upheld, even if an incentive formula results in greater compensation than the parties anticipated at the time they entered into the contract.
The president's bonus formula was established in the corporate minutes about a year before it was paid. The Court found that wasn't long enough. Moreover, the president was not only the chief executive officer, he was also the only shareholder and only director and determined the bonus formula. The formula couldn't be considered an arm's length transaction.
Protecting Yourself
While at some salary level no amount of effort will prevent the IRS from winning an unreasonable compensation case, there are some steps you can take to protect yourself. We've also included some other points to keep in mind.
You may be able to protect yourself with a repayment agreement. Basically, the agreement states that, should the IRS disallow a portion of an officer's salary as unreasonable, the officer must repay that amount to the company. The employee is allowed to take a business deduction for the amount in the year repaid. This only works if the agreement is in effect before the payments are made.
The disadvantage is that the existence of such an agreement may be a tip-off to the IRS that the company is aware that the compensation could be considered excessive. A better approach is to include such an agreement in the bylaws and make it applicable to all employees.
For a sample resolution, see our Excessive Compensation Repayment Agreement in our Forms page.
Finally, if in doubt, your CPA or tax advisor should be able to help.
On more than one occasion we've discussed the difference between a business and a nonbusiness bad debt. A business bad debt (account receivable or a loan with a business rather than investment motive, for example, loaning money to a supplier so that he can complete your contract) is generally fully deductible against income. A nonbusiness bad debt is deductible only as a capital loss, and subject to the capital loss restrictions (the loss can be used to offset capital gains or up to $3,000 in ordinary income for an individual, or carried forward).
But even before you can consider the business versus nonbusiness argument, you have to have a valid bad debt. In Arthur Mayhew and Estate of Dorothy Mayhew, Deceased (T.C. Memo. 1994-310) the taxpayer was a CPA, who, in addition to his accounting practice, purchased loan contracts from used car dealers who loaned money to individuals for auto purchases. The loans were secured by the autos. One of the auto loans purchased was a debt owed by an individual we'll call Fred Flood. We won't go into the details. Suffice it to say that Flood ended up borrowing significant sums from the taxpayer, first for a bus to operate a tour bus business, then to open a restaurant, in addition to borrowings for personal purposes. At one point the taxpayer was paying for the storage of the restaurant equipment following the closing of that business. Flood performed some services for the taxpayer, including the delivery of tax returns.
The taxpayer filed a Schedule C, claiming to be in the financing business. He reported gross receipts of $2,357 and claimed a bad debt deduction of $36,140 for amounts advanced to Flood.
The Court disallowed the deduction in its entirety, and added a negligence penalty. It found that no bona fide debtor- creditor relationship existed. When looking at the validity of a debt, the IRS and courts generally look at 7 factors:
In this case the taxpayer, a CPA, apparently realized documentation was going to be important if he was to secure a deduction. The Court breezed through that issue. (Note, most taxpayers are out of the game at this point. Most don't have anything resembling the necessary paperwork.) Instead it noted that there were discrepancies between the testimony of the taxpayer and Flood regarding repayments of the loans and even the existence of some of the loans. The Court then focused on the last factor in the list above, i.e., was the borrower solvent at the time of the loan?
The Court looked at the facts and concluded that the taxpayer could not have had a reasonable expectation of being repaid. Flood had no assets, was unable to pay the rent on his home or to make personal loan payments, nor expenses associated with his business. Even the taxpayer's records showed that Flood could not make payments as they came due. Flood's own testimony indicated he could not obtain a loan from a bank. The Court also noted that Flood had a history of being a poor businessman.
While the fact that the taxpayer did not have collateral from Flood nor did he take legal action to demand payment further damaged his position, the poor financial status of Flood certainly seemed to be the crucial factor. Don't forget, while the courts may look at a number of factors when evaluating whether a bona fide debt exists, they rarely weigh the factors equally. Thus, 5 of the 7 factors can be in your favor, but the two going against you could be weighted more heavily by the court.
While this situation involved loans to an individual, making loans to a fried or relative's business can have similar consequences. See the article below for a discussion of some important issues.
In the article above the taxpayer did not have a bona fide debt. Thus, he could not take a bad debt deduction. If you're loaning money to friends or relatives for their business, here are some points to keep in mind to protect your tax benefits (and rights as a creditor!).
Fully document the loan. A standard promissory note with a fixed interest rate (or one pegged to an objective standard, such as the prime rate), and a repayment schedule with a fixed maturity date is the minimum requirement. For a starter, see our sample Promissory Note in our Forms section. Try to get collateral if at all possible. A demand note can work for small amounts, but both the IRS and the courts realize that you're unlikely to demand repayment from your son when his business turns sour.
Make the loan to the business. But make it with recourse to the individual. That protects your interests since you will first try to collect from the business, but, should that fail, you have the individual as a guarantor. It also protects you from a tax standpoint. Should the IRS contend the loan is really equity capital, you'd be entitled to a capital loss.
Lease equipment to business. Instead of making a direct loan or taking an equity interest, consider purchasing equipment and leasing it to the business. That could improve the company's balance sheet while avoiding the bad debt/equity issue entirely. Moreover, your interest may be protected if the equipment is readily salable, e.g., a truck, construction equipment, etc. There are tax consequences associated with this action (e.g., passive losses), so check with your tax advisor first.
Analyze and evaluate. It's not uncommon for a friend or relative with deeper pockets to get drawn into an investment far beyond the point originally contemplated. Making management decisions, equity investments, etc. can make you liable for unpaid withholding taxes and could even create personal liability for other company actions. Keep your distance. If you can't, get sound legal advice.
Partnerships. If the business is organized as a partnership or limited liability company (LLC), there are other tax and legal implications. These can be more complex. Check the partnership papers and get legal advice before investing.
Receipt of Profits Interest Not Taxable
There are a great many considerations when starting a business. Raising and conserving capital is one of the biggest. It's not unusual for a newly formed partnership to give an interest in the partnership in exchange for services performed by a person or other entity. In Rev. Proc. 93-27 the IRS explained the tax treatment of such a transaction.
Some definitions are in order. An interest in a partnership can be split into two parts--a capital interest and a profits interest. The IRS defines a capital interest as an interest that would give the holder a share of the proceeds if the partnership's assets were sold at fair market value and then the proceeds were distributed in a complete liquidation of the partnership. This determination is generally made at the time of receipt of the partnership interest. On the other hand, a profits interest is any partnership interest other than a capital interest.
Example--Madison Co., a partnership, has two partners. Fred has a 75% interest in the capital and a 25% interest in the profits and losses. Sue has a 25% interest in the capital and a 75% interest in the profits and losses.
There can be all sorts of reasons for partners having unequal interests in the capital and the profits and losses. It can be used to provide more financing options, to create incentives to owner/managers, for tax benefits, etc. There are limits to having unequal allocations. Check with your tax advisor.
For some time the IRS regulations have held that the receipt of a partnership capital interest for services provided to the partnership results in taxable compensation. However, the issue of the receipt of a profits interest was the subject of considerable litigation.
In a revenue procedure (Rev. Proc. 93-27) the IRS held that if a person receives a profits interest for providing services to or for the benefit of a partnership in a partner capacity or in anticipation of being a partner, the Service will not treat the receipt of such an interest as a taxable event, either for the partnership or the partner.
However, this revenue procedure does not apply if (1) the profits interest relates to a substantially certain and predictable stream of income (e.g., income from high-quality debt securities), (2) within two years of receipt, the partner disposes of the profits interest; or (3) the interest is a limited partnership interest in a publicly traded partnership.
Thus, you have a choice on how to compensate someone for services to the partnership. If you give them a capital interest it will be taxable to them as compensation. The partnership should be able to deduct the payments as expenses. On the other hand, if you give them a profits interest, the person does not have taxable income, nor does the partnership get a deduction. That may work out just fine for a startup. The business doesn't need the deduction and the partner probably doesn't want taxable income. Another advantage to giving a profits interest is that there can be no valuation questions as are almost sure to occur with a capital interest.
Downsizing by large companies has created a supply of executives, many of which are actively searching for positions outside the old corporate environment. You may get resumes from some of these displaced executives. Can they benefit your operation?
It depends on several factors. Many have considerable and varied experience. However, just as many have spent a good portion of their working life in a small niche, and they may not be able to provide the range a smaller business needs. Here are some things to consider when interviewing an executive from a big company:
Most small businesses are not just scaled down big businesses. There are fundamental differences in the method of operation, supporting staff, etc. Many executives can't adjust to that difference. Of course, the larger the former employer, the greater the change and the less likely the applicant will be able to adapt.
The interview process is critical here. The applicant is almost sure to claim he can handle the switch. You've got to read between the lines. The best approach may be to have a professional personnel manager assist you on the interview. Making a bad decision here could be costly.
On an annual basis, postage can add up to a significant dollar amount, even for a small business. Saving just 10% can result in a big payback. Here are some thoughts:
Pledging stock. You may be asked to pledge the stock in your company as collateral. Depending on your ownership position, that may give the bank or other lender control of the company should you default. Try to avoid pledging stock. You'll probably have to personally guarantee the loan anyway. There's little reason you should also have to pledge the stock.
Transfer restrictions. You may be prohibited from any transfer of an interest by the present stockholders or partners. That could be a big restriction if you want to gift stock to children or relatives, or sell a portion of your interest. The longer the term of the loan, the more this type of clause can hurt. A restriction on transfer could even impact your ability to acquire another business.
Dividend and salary restrictions. More than likely the bank will try to insert a covenant preventing you from increasing the salaries of owner/employees or paying dividends. This may not be too onerous, but you should be allowed modest salary increases each year. You may have to agree to forego dividends, but that's usually not a problem for most smaller businesses. However, it could be an issue if you've been taking money out of an S corporation as distributions rather than as a salary that's subject to employment taxes. Make sure you can live on the combination of salary and distributions before signing.
Loan prepayment. Make sure you have the ability to prepay the loan without a substantial penalty. You may be locked into a penalty in the first year, but fight for no or only a nominal penalty in future years. That will allow you to pay down the loan if your cash flow is better than anticipated or to refinance if rates drop.
Additional financing. You may need additional financings in the future. Be sure the loan agreement allows you to do so. In the case of debt financing, fight for a provision that allows you to borrow 50 cents for every $1 increase in your net worth. Of course, when deciding on the amount of funds you need, be sure you don't have to go back to the well too quickly. Unless you're profitable and growing rapidly, you'll have a hard time getting funds. Moreover, lenders will question your planning and forecasting abilities.
Capital expenditures. The lender will probably want to restrict your capital expenditures. Lenders know it's hard to get their money back if it's in equipment. You'll probably have to agree to some restrictions, but make sure any amount is cumulative. That is, if an amount isn't used in one year it can be carried forward and used in a later year.
Asset transfers. You may be restricted from pleging any assets for additional financing, or from the sale of a substantial portion of your assets, even if they are not used to secure the loan in question.
Tradeoffs. Read the loan agreement carefully. While you may not be in the best of bargaining positions, you should be able to make some tradeoffs. Check the restrictions in the note and identify the most onerous ones. Talk to the bank or other lender to see what he would require in a new restriction to reduce one of the existing ones in the agreement.
Previously Reported In Daily Update
Travel insurance . . . Life insurance for airline trips has been a money maker for years. While a $10 or $15 premium may give you $1,000,000 of protection, there's very little chance your spouse or other family members will collect. Flying is one of the safest modes of transportation. You may be able to purchase the insurance if you purchase your tickets on a certain credit card. The credit card issuer isn't doing you a favor. The rates are high. And the issuer is winning two ways. First, he's collecting a fee from the airline for the ticket, and, second, he's overcharging for the insurance. Another point. Some credit card companies automatically provide you with $500,000 or some other substantial amount of insurance if you purchase your ticket with their card.
Estate planning . . . You may have an up-to-date will, but do you have an estate attorney lined up? While your heirs won't need one immediately, you can make things easier for them and protect your estate by evaluating attorneys ahead of time. Administering your estate can be more complicated that drafting a will, particularly if you own your own business. Make sure your choice is up to the task. In addition, consider negotiating the fee in advance. That doesn't mean a fixed dollar amount, but a percentage of the estate that's lower than the standard.
Asset sale planning . . . The sale of a large asset or a group of smaller assets can really mess up your tax planning. Why? That same depreciation that saved taxes for several years will now come back to haunt you. For example, consider a machine you bought for $60,000 5 years ago. It's now fully depreciated but you manage to sell it for $25,000. Result? You have an additional $25,000 more income for the year. That might not be a disaster if your S corporation (LLC, etc.) is having a bad year and the extra income is taxed at 28%. On the other hand, if the last few years have been less than outstanding, you may have gotten a tax benefit for the depreciation at rates of 15% or 28% and now have to pay it back at 39.6%. Before selling the equipment, talk to your accountant. It may make more sense to hold it for another year when you might be in a lower bracket. Weigh that against the net cash inflow ($25,000 less the taxes to be paid) and the benefits it could produce (lower your debt and interest costs, provide expansion capital, etc.), and the fact that you may not be able to get that price next year. If you have other equipment that would sell for a loss, it might make sense to do so to offset the gain. Another point. If you know the asset is to be sold within a year or two after purchase, you may not want to take the Sec. 179 election.
Partnership or cost sharing venture? . . . You and a business associate agree to cut some timber on land owned by a third party. Is it a simple cost-sharing arrangement or a partnership? The difference is important. If it's a partnership you must file a partnership return and the associated K-1s. If a cost-sharing arrangement, you just report the expenses on your own return. If you agree to share both the income and expenses, you've probably got a partnership, even if there's no formal agreement. On the other hand, if you are just sharing costs (e.g., splitting the rental of a skidder, portable sawmill, the cost of making roads, etc.) chances are no partnership exists.
Forms on demand . . . You may use a number of forms in your office. Years ago you went to a printer and ordered 1,000 copies for maybe a 6 months' supply. Some of the forms were probably tossed because they became obsolete, were damaged, etc. or they were lost. It may make more sense to set up the form in a word processing, desktop publishing or forms program, they printing it only when needed. This approach makes sense if you use a laser printer where operational costs are cheap and the monthly duty cycle is high. Printing forms on an ink jet printer only makes sense for very low volume.
Sunk costs . . . You probably heard about this in college or sometime during your business career. They're costs or investments that you can't recover so you shouldn't factor them into your decisions. But what does that really mean? Here's an example. You rent space in a location that's a bomb. Your store traffic never breaks 10 prospects a day. There's no way you can survive with those numbers. Space has just opened up 3 blocks away. The strip center gets 10 times the traffic of the one you're in and there's a complimentary store. But you've got 1- 1/2 years to run on your lease. There's little hope of subletting so you'll be out of pocket $15,000. You've got to ignore that $15,000 outlay when deciding whether or not to move. It shouldn't affect your decision. All you should be concerned about is whether the new location will allow you to turn a profit.
Pre-leased cars may be a good deal . . . Leasing has become increasingly popular in recent years. For auto companies one of the problems is that these cars come off lease on schedule. Good market or bad, when the lease is up the car is turned in. Many of the vehicles have low mileage because of the extra mileage charges built into leases. And a number of manufacturers will warranty the cars, often for an extended period. That's because they check the cars over carefully when they're returned and perform any necessary maintenance. Low finance rates are not unheard of. Your best deal may be on a luxury vehicle. After the first few years they tend to hold their value. There are potential pitfalls. Some leased vehicles have been abused. Stick to a reputable dealer.
Attending a convention of a charitable organization? . . . If you are a chosen representative attending a convention of a qualified charitable organization, you can deduct actual unreimbursed expenses for travel and transportation, including a reasonable amount for meals and lodging, while away from home overnight in connection with the convention. But you can't deduct personal expenses for sightseeing, theater tickets, etc. You cannot deduct travel, meals, lodging, etc. and other expenses for your spouse or children. And you can't deduct expenses in attending a convention if you go only as a member of the organization rather than as a chosen representative.
Warranties . . . Are they worth paying for? If there are options, what type should you buy? It depends. The warranty on your fax machine may be pretty much standard. For the first year the company will repair or replace the unit. You have to send it back to the company, and you pay shipping. No guarantees on when you'll get the unit back. In fact, extended warranties on items you can purchase at the local electronics chain (e.g., fax machine, inkjet printer, telephone, etc.) probably aren't worthwhile. Comparing the cost of the warranty and the price of the product, you're probably better off taking a chance. The story is different when it comes to a $50,000 computer that's has critical applications in your business. Moreover, the warranty that comes with the unit will probably include on-site service for the first year, with a 8-hour response time, 5 days a week. You may be able to upgrade that service to various levels, all the way up to a 3-hour response time, 24 hours a day, 7 days a week. That's likely to be very expensive. Is it worth it? If you've got a web site and that's your only computer, or its controlling an assembly line, the warranty could be critical. If you've got options (e.g., response time, availability, loaner, etc.) evaluate them carefully. For example, if you've got more than one unit, they're interchangeable, and only one unit is critical, you can get away with a lower level warranty. If you've got a number of units and they're relatively inexpensive, you might want to choose the lowest level of service and simply keep an extra unit on hand. It might be cheaper than paying for a higher level warranty on a number of units.
Inventory tracking . . . If you sell goods from inventory you should have a computerized method of tracking your stock. For office supplies, spare parts, you may not need as sophisticated system. But start a list and keep it updated. How closely you should track items and how much you should keep on hand will depend on the nature of the item. If you've got one laser printer and the cartridge runs out, you could be in trouble. How much? If you're got an office supply store a block away, not much. If the store's an hour drive, you should keep an extra cartridge on hand. If the cartridge can only be gotten from the manufacturer, you'd better have one in stock. Consider the cost of the item, the damage incurred if you're out of stock, and the ease of getting the item. For example, even if an item isn't that critical to your operation, or can be bought locally, if it's very cheap and your holding cost is low, there's no reason not to keep an adequate supply on hand. If you need more than one machine, try to stick to the same make an model, or one that uses the same parts. That'll reduce the cost of stocking spares considerably.