Reasons for S corp switch
Changing from a C corporation setup to the S corporation setup can be beneficial, but there are numerous factors to consider. With the March 15, 2011 deadline for 2011 fast approaching, you should seek guidance for your situation.
Basic benefits of a switch: If a C Corporation owner elects S corp status, the corporation’s income and deduction items are passed through to the owner, reported on his or her 1040 and taxed at personal rates. Significantly, switching to S status would avoid any threat of double taxation on: (1) future corporate operating profits and (2) future appreciation in corporate assets that occurs after the switch.
As you may know, double taxation occurs when a C corporation pays corporate-level tax on its income and gains. Then the owner pays tax again at the shareholder level when those income and gains are distributed as taxable dividends.
In contrast, a business owner is only taxed once under the S corp form of doing business, while retaining other benefits such as corporate protection from personal liability.
Basic drawbacks to a switch: The decision to switch isn’t always a slam-dunk. If the owner has substantial income from other sources or if the company is quite profitable, he or she may be forced to pay the 35% maximum rate on most or all of the incremental income passed through. Rule of thumb: With the current tax brackets in effect, the owner often fares better if the company generates annual profits of less than $100,000.
In addition, beware of the onerous “built-in gains” (BIG) tax. It comes into play if the corporation owns appreciated assets when it switches from C to S status. When this corporate-level tax applies, the rate is 35%.
We can help you with this determination. Contact us at 562-868-6333 to discuss your situation.
Appeals… Resolving Tax Disputes
Is Appeals right for you?
The Appeals mission is to settle tax disagreements without having to go to Court and a formal trial. Appeals is here to assist you if you don’t agree with a tax decision. The Office of Appeals is independent of any other IRS office and provides a venue where disagreements concerning the application of tax law can be resolved on a fair and impartial basis.
Our office represented hundreds of clients on their appeals with the IRS. Please contact us at 562-868-6333 to see if Appeals would be the best approach for you.
Many of the different departments within IRS are responsible for making decisions concerning the application of tax law to various taxpayer issues. In some cases, agreement on these decisions, or determinations, cannot be reached. In other words, the taxpayer does not agree with the determination.
This is where Appeals comes in. Appeals is independent of any other IRS office and serves as an informal administrative forum for any taxpayer who disagrees with an IRS determination. Appeals provides a venue where disagreements concerning the application of tax law can be resolved on a fair and impartial basis for both the taxpayer and the government. The mission of Appeals is to settle tax disagreements without having to go to the Courts and a formal trial. Make sure you discuss this appeal process with a tax professional.
What Can Appeals do for you?
Appeals is the place for you if:
- You received an IRS correspondence explaining you have the right to come to Appeals to dispute an IRS decision.
AND - You do not agree and are not signing an agreement form sent to you.
If you meet the above qualifiers listed above then you may be ready to request an Appeals conference or hearing.
Appeals is not for you if:
- Your only concern is that you cannot afford to pay the amount you owe.
- The correspondence you received from the IRS was a bill and there was no mention of Appeals.
If you cannot identify the requirements, or if you do not meet the conditions for coming to Appeals as explained above, please contact us at 562-868-6333 to discuss whether an Appeals is the place for you or not and how we can assist you specific situation.
Are You Ready to Request an Appeals Conference or Hearing?
Consider the following:
- If you need help in deciding whether the IRS made an incorrect decision due to misinterpreting the law, check the publications discussing your issue(s) for additional information, or refer to Tax Topics.
- If you believe the IRS did not properly apply the law due to a misunderstanding of the facts, be prepared to clarify and support your position refer to the Examination page.
- If you believe the IRS is taking an inappropriate collection action against you, or you do not agree with Collection’s denial of your offer in compromise, refer to the Collections page.
If you believe the facts used by the IRS are incorrect, then you should have records or other support available to back up your position.
Preparing a Request for Appeals
Review the letter and publication(s) that were sent to you by the IRS department making the decision. These will tell you:
- How to prepare a request for an appeal (protest)
- Where to mail the request
- When the request must be received
- What information you need to include in the request for an appeal
For specific information appealing Examination issues, refer to the Examination page.
For specific information appealing Collection issues, refer to the Collection page.
FILING A REQUEST FOR APPEALS DOES NOT STOP INTEREST AND PENALTIES FROM ACCRUING
Interest and certain penalties will continue to accrue during the Appeals process and during any subsequent Appeals to the Courts on any amount not paid. In order to stop the accrual of interest and penalties on proposed adjustments, refer to Notice 1016, How to Stop Interest. For an explanation on how to stop interest from accruing on an unpaid balance, refer to Publication 594, What You Should Know About the IRS Collection Process.
What Can You Expect from Appeals?
Appeals is independent of any other IRS office and provides a venue where disagreements concerning the application of tax law can be resolved on a fair and impartial basis for both the taxpayer and the government.
An Appeals or Settlement Officer will review the strengths and weaknesses of the issues in your case and give them a fresh look. Appeals conferences are conducted in an informal manner, by correspondence, telephone or in person. Most differences are settled in these appeals without expensive and time-consuming court trials. Appeals will consider any reason you have for disagreeing, except for moral, religious, political, constitutional, conscientious objection, or similar grounds. Our goal is to provide a forum for us to work together to resolve the tax dispute.
Our Commitments
- Explain your appeal rights and the Appeals process
- Listen to your concerns, be courteous and professional
- Be timely and responsive
- Be fair and impartial
Your Responsibilities
- Listen to our explanation of your appeal rights and the Appeals process
- Give us a statement as to how you understand the facts and the law, listing all issues with which you disagree and why.
- Give us any additional information or documentation that will be helpful to your case within a reasonable time.
- Tell us when and how you think your case should be resolved.
- Let us know the best time to contact you.
Frequently Asked Questions
Q. I sent in my appeal request/protest. How long will it be before I hear from the Appeals office?
A. This varies, depending on the type of case you are appealing and the time needed to review the file before sending your case to Appeals. Normally, you can expect to hear from an Appeals employee within 90 days after you file your appeal request.
If more than 90 days have gone by and you still haven’t heard from Appeals, you should contact the office where you sent your appeal request. They can tell you when they forwarded your case to Appeals. If they were delayed in sending your case, you would not expect to hear from Appeals until at least 90 days from that date. If more than 90 days has gone by and there is no known delay, ask that office to contact Appeals to get a time frame for when Appeals will contact you. You can also contact an Appeals Account Resolution Specialist (AARS) in Fresno Appeals at 559-456-5931. After researching the Appeals data base, they can tell you if your case has been assigned to an Appeals employee, their name and number and you can contact that employee directly.
Q. How long will it take to resolve my case once it is received in Appeals?
A. It depends on the facts and circumstances. It could take anywhere from 90 days to a year. Appeals continues to work towards reducing the time to resolve cases. Your Appeals Officer or Settlement Officer can provide you with a more specific time frame.
Learn more about what to expect of the Appeals process in these online videos.
Alternative Motor Vehicle Credit
The Alternative Fuel Motor Vehicle Credit was enacted by the Energy Policy Act of 2005 and includes separate credits for four distinct categories of vehicles:
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Qualified Hybrid Vehicles,
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Qualified Fuel Cell Vehicles,
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Qualified Alternative Fuel Motor Vehicles (QAFMV) and Heavy Hybrids, and
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Advanced Lean-Burn Technology Vehicles.
The amount of the potential credit varies by type of vehicle and which of the four credits applies.
Internal Revenue Code Section 30B provides for the Alternative Motor Vehicle Credit. Notice 2006-9 provides procedures for manufacturers to certify passenger auto and light trucks as Qualified Hybrid Vehicles and Advance Lean Burn Vehicles and Notice 2007-46 provides procedures for heavy hybrid vehicles. Notice 2006-54 provides procedures for manufacturers to certify vehicles as Qualified Alternative Fuel Motor Vehicles (QAFMV). Notice 2008-33 provides procedures for manufacturers to certify Fuel Cell Vehicles.
Each of the four credits under the Alternative Motor Vehicle Credit is addressed individually below.
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Qualified Hybrid Vehicles
Hybrid vehicles are a combination of gasoline and electric engines. These vehicles have drive trains powered by both internal combustion engine and a rechargeable battery.
Generally for qualified hybrids, a taxpayer may rely on the manufacturer’s certification that a specific make, model and model year vehicle qualifies for the credit and the amount of the credit for which it qualifies. Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th hybrid passenger automobile or light truck or advance lean burn technology motor vehicle. For the second and third calendar quarters after the quarter in which the 60,000th vehicle is sold, taxpayers may claim 50 percent of the credit. For the fourth and fifth calendar quarters, taxpayers may claim 25 percent of the credit. No credit is allowed after the fifth quarter.
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A qualified fuel cell motor vehicle is a vehicle that is propelled by power derived from one or more cells which convert chemical energy directly into electricity.
The base amount of the new qualified fuel cell motor vehicle credit varies with the gross vehicle weight rating of the vehicle. Passenger automobiles and light trucks are eligible for an additional fuel economy amount that varies with the rated fuel economy of a qualifying vehicle. A list of qualifying cell vehicles is available.
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Qualified Alternative Fuel Motor Vehicles (QAFMV) and Heavy Hybrids
For alternative fueled light and heavy duty vehicles to meet the requirements of QAFMV, the vehicles may be either new, original equipment installation vehicles or prior use vehicles that are converted to use an alternative fuel by an aftermarket installer. Qualified alternative fuel includes compressed natural gas, liquefied natural gas, liquefied petroleum gas (propane) and hydrogen. The vehicles may also operate on certain mixed fuels such as liquefied propane gas or liquefied natural gas and gasoline.
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Advanced Lean-Burn Technology Vehicles
Advanced Lean-Burn Vehicles are passenger cars or light trucks with an internal combustion engine designed to operate primarily using more air than is necessary for complete combustion of the fuel. The vehicles must also incorporate direct fuel injection technology and achieve at least 125 percent of the 2002 model year city fuel economy rating.
Available credit amounts may vary and include a base credit amount based on fuel economy compared to the 2002 model year city fuel economy rating and an additional amount based on the vehicle’s lifetime fuel savings.
Closing a Business
There are t
ypical actions that are taken when closing a business. You must file an annual return for the year you go out of business. If you have employees, you must file the final employment tax returns, in addition to making final federal tax deposits of these taxes. Also attach a statement to your return showing the name of the person keeping the payroll records and the address where those records will be kept.
The annual tax return for a partnership, corporation, S corporation, limited liability company or trust includes check boxes near the top front page just below the entity information. For the tax year in which your business ceases to exist, check the box that indicates this tax return is a final return. If there are Schedule K-1s, repeat the same procedure on the Schedule K-1.
You will also need to file returns to report disposing of business property, reporting the exchange of like-kind property, and/or changing the form of your business. If you do not have a pre-printed envelope in which to send your taxes, refer to the Where To File page for a list of addresses. Below is a list of typical actions to take when closing a business, depending on your type of business structure:
Checklist
- Make final federal tax deposits
- Electronic Federal Tax Paying System (EFTPS)
OR - Form 8109-B
- Electronic Federal Tax Paying System (EFTPS)
- File final quarterly or annual employment tax form.
- Issue final wage and withholding information to employees
- Report information from W-2s issued.
- File final tip income and allocated tips information return.
- Report capital gains or losses.
- Report partner’s/shareholder’s shares.
- File final employee pension/benefit plan.
- Issue payment information to sub-contractors.
- Report information from 1099s issued.
- Report corporate dissolution or liquidation.
- Consider allowing S corporation election to terminate.
- Form 1120S, Instructions (PDF)
- Report business asset sales.
- Report the sale or exchange of property used in your trade or business.
Tax angles on donated ‘clunkers’
The hugely 
popular cash-for-clunkers program ended Aug. 25, 2009. This new program enabled vehicle owners to realize a tax-free discount of up to $4,500 on a trade-in. But you can still qualify for big tax benefits if you donate your “clunker” to charity.
Instead of trading in your vehicle, simply give it away to a qualified charitable organization. This entitles you to a deduction on your ’09 return.
The rules for charitable donations of vehicles were recently tightened by the American Jobs Creation Act of 2004. However, you may be able to qualify under a special exception.
Prior to 2004, you could generally deduct the fair market value (FMV) of a vehicle you donated to charity. But Congress became concerned about some over-aggressive valuations for beat-up jalopies. Under the 2004 law, the charitable deduction for a vehicle valued above $500 is generally limited to the amount the charity receives from a resale of the vehicle. The crackdown also applies to donations of boats and aircraft.
On the other hand, if (1) the charity “materially improves” the vehicle (e.g., it repairs dents or installs new features like a nav system) or (2) it “significantly uses” the vehicle for its tax-exempt purpose and properly certifies its use, you can still deduct the full FMV.
In addition, the regular limit on the donation value doesn’t apply if the charity sells the vehicle after 2004 at a price significantly below FMV, or gives it away, to a “needy individual.” To qualify under this exception, the charity must be dedicated to relieving the poor and distressed or the underprivileged that are in need of transportation.
Don’t miss out on this tax-saving opportunity. We can help you maximize the tax benefits for charitable donations of vehicles. Before you give away a clunker, call our office and we will provide guidance.
Can you reconvert an IRA?
Suppose you converted your IRA to a Roth IRA just before the bottom fell out of the stock market last year. Because the tax liability for the conversion is based on the value of the account on the last day of the prior year – Dec. 31, 2007 — you would have paid tax on an inflated value. So you may have opted to recharacterize your Roth into a traditional IRA.
But now you see signs of a market rebound. And you’d like to take advantage of the Roth IRA setup for all the same reasons that attracted you to it in the first place.
In this case, you might “reconvert” your IRA. In other words, you can convert your recharacterized traditional IRA back into a Roth IRA. This is essentially treated as a new conversion for tax purposes.
With a Roth IRA in existence at least five years, qualified distributions are completely exempt from federal income tax. A qualified distribution is one that is paid after reaching age 59 1/2, received on account of death or disability or used for first-time homebuyer expenses (up to a lifetime limit of $10,000). In contrast, traditional IRA distributions are taxed at ordinary income rates as high as 35% — probably even higher in future years.
However, the IRS doesn’t allow you to keep flip-flopping back and forth between the two types of IRAs. You must meet specific time restrictions for a reconversion. Specifically, a traditional IRA can’t be reconverted to a Roth before the later of:
1. The beginning of the tax year following the tax year of the conversion
2. The end of the 30-day period beginning on the day of the recharacterization.
This rule applies regardless of whether the recharacterization falls into the year of the conversion or the following year.
This is an important decision for taxpayers rapidly approaching retirement. We can help you analyze your personal needs. Call us to arrange a consultation.
Donate IRA funds to charity
Time is running out on a unique tax break for older taxpayers with charitable intentions. If you donate funds directly from your IRA to a qualified charity of your choice, you can avoid tax on the distribution.
The 2006 pension law created a two-year window for these tax-free distributions. This provision was extended through 2009 by last year’s bailout law, so there are just a few months left to cash in on this tax break.
Here are more details: If you are age 70 1/2 or older, you can exclude from tax “qualified charitable distributions” of up to $100,000 that would otherwise be taxable as IRA distributions. A qualified charitable distribution isn’t reported as taxable income or claimed as a charitable deduction. The distribution also will not increase your adjusted gross income (AGI) for other tax purposes.
For example, if you have unreimbursed medical expenses this year, the IRA distribution to charity may help you qualify for a medical expense deduction. Similarly, you might be able to reduce the tax due on Social Security benefits through such a gift.
Note that your contribution must otherwise qualify as a charitable donation. Also, contributions must be made directly by an IRA trustee to the charitable organization.
Remember this tax break expires on Dec 31. Set up a meeting to determine if this technique is appropriate for your particular circumstances. Call our office to arrange a one-on-one consultation.
Medicare Tax: Start Planning Ahead
The significant new health care legislation imposes a unique “payroll tax” on investment income. At least the new tax doesn’t kick in until 2013 providing an opportunity for advance planning.
To recap, an individual must pay a 3.8% Medicare tax on the lesser of net investment or the excess of modified adjusted gross income (MAGI) over a $250,000 threshold ($200,000 for single filers), for tax years beginning after 2012. “Net investment income” includes interest, dividends, royalties, rents, gains from dispositions of property and income from passive activities.
If you expect to clear the threshold in 2013, here are four long-term ideas to consider.
1. Think about selling your principal residence. You can exclude tax on the first $250,000 of gain from a home sale — $500,000 for joint filers — if you have owned and used the place as a principal residence for at least two of the five years prior to the sale. But the 3.8% Medicare tax applies to any portion of the proceeds that doesn’t qualify for the exclusion.
2. Increase participation in “passive” activities. Net investment income includes amounts generated by passive activities such as rental real estate. Therefore, if you own a business interest where you don’t take an active role, you might get socked with the extra tax liability, starting in 2013. However, if you “materially participate” in the business, the income generally will not count as net investment income.
3. Add munis to your portfolio. The income from municipal bonds is exempt from federal income tax. So buying munis won’t result in the extra 3.8% Medicare tax on net investment income. However, projected higher tax rates after 2010 are expected to further increase demand.
4. Build up your 401(k) account. Distributions from a qualified retirement plan, like a 401(k), or an IRA don’t count as net investment income. Therefore, the more you can put away in a 401(k) plan (within the tax law limits), the more you can shelter from the extra Medicare tax.
These are just four potential strategies that might work. Everyone’s situation is different and the Tax and Accounting office of Certified Public Accountant, Emil Estafanous can develop an in-depth plan tailored to your particular circumstances. To address your particular problems, contact our tax and accounting office and we will gladly schedule a planning session.
New tax breakthrough for LLCs
An important new Tax Court case could provide valuable tax savings for owners of limited liability corporations (LLCs) and partners in limited liability partnerships (LLPs). The decision permits a couple to use a loss from an LLC or LLP to offset highly taxed income. Previously, it was presumed that such losses could only be used to offset income from other “passive” activities.
Background: New forms of business ownership featuring limited liability are growing in popularity. In particular, the LLC setup is advantageous for its owners (called “members”). As with other pass-through entities, like S corporations and partnerships, items of income and loss of an LLC are passed through to the members. There’s only one level of tax as opposed to double taxation for C corporations.
However, the IRS has long presumed that the passive activity loss (PAL) rules automatically apply to LLCs. If a business activity is characterized as a passive activity, the loss may only be used to offset income from other passive activities. Therefore, you can’t use a PAL to offset income from wages or other highly taxed income. Any excess loss is suspended and is carried forward to future years.
A passive activity is defined as a trade or business in which you do not “materially participate.” The IRS has established several tests for determining material participation. But certain activities, such as rental real estate and limited partnership interests, are treated as passive activities right from the start.
In the new case, a couple’s losses from several LLCs and LLPS were disallowed by the IRS. But the Tax Court disagreed with the IRS’ presumption. Unlike a limited partner in a limited partnership, LLC and LLP owners do not compromise their limited liability under state law by participating in management. Therefore, the taxpayers should not automatically be treated as passive investors. If they qualify as material participants, they can deduct the losses against other income.
Based on the new Tax Court case, some LLC members may be entitled to refunds for prior years. This new decision may have particular significance for many LLC members. If you have any questions about the potential tax benefits, call our office and we would be glad to assist you.
Produce big manufacturing deductions
The so-called “manufacturing deduction” isn’t just limited to companies that manufacture products in the traditional sense of the word. It’s available to a wider range of business operations than you might think.
What’s more, the maximum deduction is increasing to 9% of qualified production activity income (QPAI) in 2010. If your company is in the top 34% tax bracket, this effectively amounts to a 3.15% tax cut.
Here’s some background information. Under Section 199 of the tax code, a qualified domestic producer can currently deduct 6% of the lesser of its QPAI or its taxable income. The maximum deduction was initially doubled from 3% after 2006.
Production activities must be performed in whole, or in significant part, on U.S. soil. The annual deduction is limited to 50% of the W-2 wages.
Obviously, the deduction is fair game for traditional manufacturers of goods, but it also applies to farmers, fishermen, miners and a variety of businesses in the construction field. In fact, IRS regulations single out construction activities for special treatment. For instance, a qualified company doesn’t actually have to construct buildings. The deduction may be extended to certain taxpayers in the business of painting, drywalling and landscaping.
Similarly, the deduction is generally available to engineers and architects. As long as the services are related to construction, the costs qualify for the deduction, even if no actual construction takes place. The deduction may also be claimed by businesses conducting feasibility and environmental impact studies.
Depending on your situation, you may want to modify your business operation to qualify for the increased deduction in 2010. Don’t make any snap judgments if your business operation appears to fall outside the scope of a traditional manufacturing activity. We can make a definitive assessment of your situation. Please do not hesitate to call us and schedule a meeting for this purpose.
