The advent of the Limited Liability Company, or LLC, is relatively new to the United States. Wyoming was the first state to offer an LLC business entity classification in 1977, and within 20 years, nearly every other state had followed suit. LLCs are a great option for businesses looking to obtain the liability protection of a corporation while maintaining the flexibility of a closely held business.
The IRS struggled mightily with how this new-fangled business entity should be taxed, with the ultimate decision being two-fold:
- If the LLC has only one owner, it will be disregarded for tax purposes (that is, placed on the owner’s individual return), and
- If it has multiple owners, it will default to a partnership (though an S-corporation or C-corporation can be elected, that’s a different article).
When setting up your LLC taxed as a partnership, there are a few considerations to keep in mind:
- An LLC should always have an operating agreement that outlines some key points. Without getting too technical, if this agreement does not contain certain provisions, special allocations mentioned in point 2 below may not be allowed. That being said, it almost always makes sense to go to a well-respected attorney when drafting your operating agreement to make sure it contains these key provisions. Note that an operating agreement and Articles of Organization are two different documents.
- Partnerships can allow for flexible allocations of income and losses, granted that the reason for the allocations is not simply tax avoidance. For example, if two partners form a partnership, one contributing cash and the other bringing nothing but business know-how, the agreement could state that the partner contributing cash receives his investment back first as the business generates income, before the other partner gets any allocated profits. Because the second partner is not trying principally to avoid taxes by not receiving income, the allocation is allowed. This flexibility is simply not an option with other entity types.
- When initially funding the partnership, contributing anything but cash can create an issue, as the partnership rules look at fair market values more closely than other business entities. The issue arises if the asset you are contributing has a higher or lower fair market value than what you paid for it.
A perfect example is a building. LLCs taxed as partnerships are a great vehicle for investment property as the rules allow for easy distributions of the property whenever needed. However, complex rules in the code dictate that if the market value is higher than your “tax basis”, there will be special allocations made to certain partners that are required and could leave one partner with much more income than he may have anticipated.
As a rule of thumb, if the property that will ultimately end up in the partnership has not been purchased, it is almost always advisable to contribute only cash to the partnership and have the entity buy the asset. Because cash has a market value that is always equal to tax basis, the above mentioned consequences will never happen.
The above points are only a fraction of the total consideration when starting or operating an LLC taxed as a partnership. Talk to a CPA who has experience with partnerships, as these rules are complex and can trip up even the most seasoned practitioner.
By Brock Yates, CPAPosted on April 27 2016 by admin
You promised yourself back in January that you wouldn’t procrastinate on your tax return this year. It would be finished and filed by the middle of March, at the latest. But, sure enough, you found yourself scrambling on April 14th to round up all of your tax forms and enter them into TurboTax. And, as usual, you succeed! You congratulate yourself on a job well done and bid the IRS farewell until next year.
Until a few days later, that is, when you come across what appears to be a tax form. Uh-oh, you say. I think I forgot that one. What do I do now? Your mind races… Is the IRS going to raid my house? Am I headed for a prison term? I wouldn’t last a day in there!
First of all, relax. While in a perfect world all tax returns would be right the first time, mistakes happen. Whether it’s a forgotten form, a typo, or a misunderstanding of tax law, the IRS knows that people make mistakes. In order to correct these mistakes, the IRS provides Form 1040X, specifically designed for amending individual tax returns that have already been filed.
If you realize that you made a material error on your return, your best bet is typically to file an amended return. Amended returns aren’t only for the benefit of Uncle Sam, either. If you forgot to include a deduction, double counted income, or otherwise calculated an overly large tax liability, you can amend to receive a refund of the incorrect additional tax.
Amended returns can be prepared using most of the big-name software programs such as TurboTax, by your friendly neighborhood CPA or other tax professional, or even the old fashioned way with paper and pencil for all of you DIY’ers out there. You can read up on all the details for filing an amended return on the IRS website. If you do choose to file a 1040X without the assistance of a tax professional, make sure you do your homework. You don’t want to be amending your amended return later!
By Austin Bradley, CPAPosted on April 26 2016 by admin
The United States Department of Labor is proposing to update its regulations governing which executive, administrative, and professional employees (white collar workers) are entitled to the Fair Labor Standards Act’s minimum wage and overtime pay protections. These regulations were last updated in 2004 and new rules may be published as early as April 2016, though no effective date is known yet.
A key provision in the proposed regs is to raise the salary level for the “white collar” exemption from the current minimum of $455 per week, or $23,660 a year, to $970 per week, or $50,440 a year. In other words, it could mean that employees paid below the $50,440 threshold could be entitled to overtime pay on any work over 40 hours per week. The Department of Labor estimates that 5 million currently exempt workers would become eligible for overtime pay unless their salary is raised.
The D.O.L. wishes to set the standard salary level at the 40th percentile of weekly earnings for full-time salaried workers and to have a mechanism to automatically update the wage amounts to this standard going forward.
Business will want to check their individual State verses Federal Regulations as each state may enact regulations that differ from federal regulations. However businesses will be bound by whichever set of regulations is more generous to employees. To deal with this, businesses may want to consider changes to salaries at an amount determined to be the most cost effective when taking overtime into consideration. The new rules should also be taken into consideration when looking at the cost-effectiveness of additional hiring vs utilization of employee overtime.
By Dale F. Jensen, CPAPosted on April 21 2016 by admin
Recently, a client contacted me looking for some advice on an issue with his former employer. The client had been a shareholder in a C-Corp and received W-2 wages from the C-Corp partially based on the performance of the company. After my client and several other shareholders left the company a few years ago, the company realized that, due to a host of accounting errors, the shareholders had received more compensation than they should have under their shareholder agreement.
After some legal wrangling, the taxpayer and his former company agreed to settle for about one-third of the amount the company was claiming he owed in clawback compensation. The company assured him this would be fully deductible by the taxpayer since he’d already been taxed on those wages in prior years. My client wanted to know what that meant for their tax return this year, the year in which they would make the settlement payment.
Most accounting is based on the “matching principle,” meaning revenue is recognized in the year it is earned and expenses should be recognized in the same period as the related revenue. Based on the matching principle, you would think the client would be able to go back and amend his tax returns for the years in which he had to repay the compensation he’d previously reported as income. Unfortunately, income taxes are not always so simple.
IRS Publication 525 makes it clear that if you have to repay an amount that was included in income in an earlier year, you can deduct the amount you repaid in the year you repaid it, and generally you’ll deduct the income on the same form or schedule on which you previously reported it as income (Schedule C for business income, Schedule D for capital gain income, etc.). However, when the income being repaid is wages, it can only be deducted as a miscellaneous itemized deduction on Schedule A. This treatment virtually guarantees that the tax benefit received from the deduction will not yield the benefit that would have been obtained had the income reported in a prior year been reduced. As a miscellaneous itemized deduction, the amount repaid is deductible only to the extent that it exceeds 2% of the taxpayer’s adjusted gross income and may be subject to phase-out depending on the taxpayer’s income level. It gets even worse if the taxpayer is subject to the alternative minimum tax. In fact, a significant level of miscellaneous itemized deductions could actually trigger application of the AMT.
There is one other option available to the taxpayer, subject to certain rules. If the repayment is greater than $3,000, we can instead take a Section 1341 tax credit in the year of repayment if the taxpayer included the income under a claim of right. Claim of right means that at the time the taxpayer reported the income, it appeared that he had an unrestricted right to it. Since the taxpayer qualifies for this choice, we’ll have to calculate tax under both methods (deduction and credit) and use whichever method yields the better tax result.
The issue for my client is that, according to the claim made by his former employer, his compensation had been overpaid stretching back over a period of seven years. That means that the taxpayer’s repayment will have to be allocated and tax recalculated for each of the years in question.
Making matters worse, the taxpayer not only paid income taxes on the wages that he’s now required to pay back, those wages were also subject to social security and Medicare taxes. Neither the deduction nor the tax credit take those overpayments into account. The taxpayer will have to ask his former employer to refund those taxes. If the employer refuses to refund the taxes, he’ll have to ask for a statement indicating the amount of the over collection and file a claim for refund using Form 843, Claim for Refund and Request for Abatement. Again, since the clawback involves compensation over a period of seven years, a separate Form 843 will have to be filed for each of the years at issue.
By Janet Berry-Johnson, CPAPosted on April 20 2016 by admin
Did you file your tax return electronically this year? If so, you are in with a pack of your closest friends – over 100 million tax returns are expected to have been completed by e-file for 2015. That is a large number – but it looks bigger when it is written out as 100,000,000.
But if you were with the very first group of electronically filed returns for 1986 – there were only 25,000 that year.
The 1986 program was a pilot program to try and gauge acceptance on both the part of preparers and taxpayers. A whopping five preparers participated, in three metropolitan areas – Cincinnati, Raleigh-Durham and Phoenix (Henry & Horne was not the firm in Phoenix!).
Only returns that were due refunds could be electronically filed. The tax preparer would call the IRS in Cincinnati and the IRS employee would plug the phone line into what amounted to a big modem with some sort of a tape drive. The tape would then be moved to a different system, where the IRS computer would massage the data on the tape drive into a format that could be read by the IRS computers.
That is not the way it works now – we electronically file through our tax software provider. For federal transmittals, even at the end with the big crush, we are getting acknowledgement back within 24 hours – sometimes sooner. Many of the states, including Arizona, are taking a bit longer – 48 hours.
And the computers just talk – I believe – there is no transferring of data from one computer system to another computer system.
By Donna H. Laubscher, CPAPosted on April 19 2016 by admin
So as another tax season comes to an end, I am going to share some memories of conversations overheard in the hallway, just as I was walking by. Obviously, these are just snippets of conversations, but show how patient we try to be with our clients.
- “No, you cannot just put the same numbers on your 2015 return that were on your 2014 return.”
- “There is not an option to deduct on your tax return all of the items you purchased during the year for your personal use.”
- This one is great – it is from Friday, April 15th – CPA: “So, I have this piece of paper with your deductions on it – did you bring me any of the income items?” Client: “No, I left those at home.” CPA: “You will probably need to make another trip to our office”
- This one we always get every year – by a variety of clients – usually those that get their information in late. Client: “When will it be ready? You know – the deadline is Monday.” CPA (in our head and not out of our mouths): “We are quite aware of when the deadline is. Thank you!” What we actually say: “We will call you when it is ready.”
- In the lobby, as the client is picking up the return – “I just received this in the mail – is it included in this return?”
- Client: “Emancipation Day – what is that?” CPA: “It is the reason that tax season can never end on a Friday.”
Thank you to all of our team members and our clients for your patience and your understanding and your hard work. We have survived another tax season. But, then, we always do.
By Donna H. Laubscher, CPAPosted on April 14 2016 by admin
A recent UK high court decision provides insight and HMRC may grant flow through treatment status for certain qualified United States LLCs. Prior to this decision, HMRC has denied UK investors relief from double taxation in the UK.
On July 1, 2015 the Supreme Court reached a decision in the case, known as Anson v Commissioners for Her Majesty’s Revenue and Customs (2015) UKSC 44, to allow a US LLC formed in Delaware to be treated as a partnership for UK tax purposes. Therefore, the LLC was considered to be taxed on the same income in both the U.S. and UK and the taxpayer were able to take a credit in the UK for the taxes paid in the U.S.
Although this ground-breaking decision may pave the way for more taxpayers to take the same position, the HMRC has indicated it will review such positions on a case by case basis. U.S. LLCs that want to claim similar treatment and relief from double-tax should be careful to review the state’s law where the LLC was formed and also the details of the operating agreement to determine if the facts are similar to that in the Anson case.
Please note this information is general in nature and should not be relied upon. Again, as we understand that at this time, this recent court victory is applicable only to the named taxpayer. Please consult with your tax adviser in the UK and U.S. for specific advice.
By Jill A. Helm, CPAPosted on April 13 2016 by admin
Unless you received a letter from the Bureau of Economic Analysis (BEA) requesting you complete a survey, you may not have been aware of the existence of these surveys. Although BEA surveys have been around for a number of years, it wasn’t until 2015 that it seems word of the possible need to complete a survey was spreading through professional newsletters and other announcements. The BEA is part of the U.S. Department of Commerce that gathers statistical data on the economic performance of U.S. investments in foreign affiliates and foreign investments in the United States.
Summarized below are some of the surveys and who may be required to file.
PLEASE NOTE – THIS IS A GENERAL OUTLINE ONLY AND DOES NOT COVER ALL SITUATIONS. YOU SHOULD NOT RELY ON THIS OUTLINE TO DETERMINE YOUR OWN REQUIREMENTS. WE STRONGLY ENCOURAGE READERS TO REACH OUT TO THEIR LEGAL ADVISERS FOR SPECIFIC GUIDANCE.
FAILURE TO FILE MAY RESULT IN LARGE PENALTIES AND/OR IMPRISONMENT.
U.S. Direct Investment Abroad
- BE-10 Benchmark Survey: U.S. person (U.S. reporter) that has direct or indirect ownership of at least 10% voting stock of A foreign affiliate
- Filed once every five years (most recent was 2014 BE-10 Benchmark Survey filed in 2015)
- Must file if requirement is met, even if not contacted by the BEA
- BE-10A: filed for each U.S. investor to report domestic information
- BE-10B, BE-10C, and BE-10D: filed for each foreign affiliate
- Filed in lieu of the BE-11 annual survey
- If you were required to file and did not, contact your adviser to address the issue
- BE-11 Annual Survey:
- Filed each of the four years between benchmark surveys
- Data collected for larger foreign affiliates
- Only required to file if contacted by the BEA
- Generally required to file if contacted by the BEA and:
- U.S. reporter with majority or minority ownership of a foreign affiliate with more than $60 million (positive or negative) in assets, sales, or net income; or
- U.S. reporter establishes or acquires a foreign affiliate with assets, sales, or net income between $25 million and $60 million (positive or negative)
Foreign Direct Investment in the U.S.
- BE-12 Benchmark Survey: At least 10% voting interest is directly or indirectly owned by a foreign person
- Filed once every five years (most recent was 2012 BE-10 Benchmark Survey filed in 2013)
- Forms BE-12A, BE-12B, or BE-12C
- If you were required to file and did not, contact your adviser to address the issue
- BE-15 Annual Survey:
- Filed each of the four years between benchmark surveys
- Only required if contacted by the BEA
- Generally required if contacted by the BEA and total assets, sales, gross operating revenues, or net income are at least $40 million (positive or negative)
New Foreign Direct Investment in the U.S.
- Form BE-13: New Survey in 2014
- For retroactive data back to 1/1/2014. Moving forward, reports are due no later than 45 days after a transaction occurs.
- Acquisitions, establishments, expansions
- Required of all new investments that meet the requirements, even if BEA does not contact you
- Transaction resulting in at least 10% voting interest in a U.S. business enterprise now being held by a foreign affiliate
- Expansion of operations to include a new facility
The above list is not an exhaustive list of required BEA surveys. This information is general in nature. Please consult with your legal adviser for specific advice and potential reporting requirements.
By Jill A. Helm, CPAPosted on April 12 2016 by admin
In IR-2016-56, the IRS announced a new tax payment option for individual taxpayers who need to pay their taxes with cash. In partnership with ACI Worldwide’s OfficialPayments.com and the PayNearMe Company, individuals can now make a payment without the need of a bank account or credit card at over 7,000 7-Eleven stores nationwide.
Individuals wishing to take advantage of this payment option should visit the IRS.gov payments page, select the cash option in the other ways you can pay section and follow the instructions:
- Taxpayers will receive an email from OfficialPayments.com confirming their information.
- Once the IRS has verified the information, PayNearMe sends the taxpayer an email with a link to the payment code and instructions.
- Individuals may print the payment code provided or send it to their smart phone, along with a list of the closest 7-Eleven stores.
- The retail store provides a receipt after accepting the cash and the payment usually posts to the taxpayer’s account within two business days.
- There is a $1,000 payment limit per day and a $3.99 fee per payment.
Because PayNearMe involves a three-step process, the IRS urges taxpayers choosing this option to start the process well ahead of the tax deadline to avoid interest and penalty charges.
In this new option, PayNearMe is currently available at participating 7-Eleven stores in 34 states. Most stores are open 24 hours a day, seven days a week. For details about PayNearMe, the IRS offers a list of frequently asked questions on IRS.gov.
The IRS reminds individuals without the need to pay in cash that IRS Direct Pay offers the fastest and easiest way to pay the taxes they owe. Available at IRS.gov/Payments/Direct-Pay, this free, secure online tool allows taxpayers to pay their income tax directly from a checking or savings account without any fees or pre-registration.
Check IRS.gov/payments for the most current information about making a tax payment.
The IRS reminds taxpayers to watch out for email schemes. Taxpayers will only receive an email from OfficialPayments.com or PayNearMe if they have initiated the payment process.
By Melinda Nelson, CPAPosted on April 7 2016 by admin
Driving to work this morning, I happened to hear a commercial for one of the new Flat Fee rental agencies popping up across the Valley. They claim to be able to rent your home to quality tenants who will pay your mortgage, while you reap the benefits of cash flow and (the kicker for me) tax savings, all for a low monthly fee.
“Whoa”, you may think. “I can save on taxes just by renting out my house that I was going to sell anyway?” Real estate markets can be complex and intimidating, and the idea of holding onto your home and receiving a monthly check for doing almost nothing can be enticing. However, the tax consequences of rentals need to be discussed before your ultimate decision can be made.
Your individual tax return will now contain a new Form (Schedule E) to show rental income and expenses. Accurate books and records of the time you spend related to the rental (presumably minimal if you are hiring a management company), rental and other income, and related expenses should be maintained. Also, it would be prudent to get a fair market value appraisal of the property before renting. Once the property is placed for rent, you are eligible to take depreciation deductions. The basis from which you can depreciate the building (the value of the land is non-depreciable) is the lower of what you initially paid for the property plus any improvements made or the fair market value.
To generate the aforementioned tax savings from a rental property, though, it must generate tax losses that can offset up to $25,000 if a taxpayer actively participated in the rental. There are two issues here: active participation and tax losses versus negative cash flow.
You are deemed to actively participate in the rental if you make management decisions, approve tenants, decide on rental terms, etc. By hiring the management company, you may have these duties stripped from you, which per the tax rules, disallows any losses from being taken at all. Consult your CPA to see if you meet the active participation requirements before making the decision to bring on a management company.
Tax losses do not necessarily mean you lost money on the activity – depreciation deductions are not an “expense” to you, such as an HOA payment or repairman bill, where you pay actual cash. However, they do bring down the overall income of the rental, which is where people can reap “tax savings”. Unless the depreciable basis of the rental is very high, though, it is possible that depreciation deductions will not totally wipe out rental income, thus sticking you with a higher tax expense than if you had not rented the property in the first place. If you end up with a negative cash flow (i.e., more cash paid than received, regardless of depreciation), you will reduce your tax bill if you actively participate, but only by a percentage of what you actually lost – which is not worth the hassle of losing cash money.
As you can see, the headaches of renting one’s home can be numerous. Given that selling your primary residence could result in no tax due assuming certain requirements are met, it is worth at least a conversation to determine if renting your old home is worth the tax struggles presented above. Let us know if we can ever assist you in making these decisions.
By Brock Yates, CPA-- Older Entries »
There is nothing more complex than the world of taxes. We know this and yet we chose careers where we face these issues everyday. We get questions day in and day out about new tax laws, forms and news items and how they affect everyday people and businesses. Well, here at Henry & Horne we have set out to do what we do best; help everyday people understand what is going on in the world of state, local, federal, estate and international taxation. We will provide these weekly posts and we encourage you to give us feedback on those posts as well as letting us know what else you would like to know more about. Welcome to "Tax Insights." We hope you find this blog informative and worthy of your time.
Before posting a comment on a blog post please be aware that we do not give free tax advice to non-clients by email, comment response, or phone. Thank you!
- Forming a Partnership – Considerations When Creating an LLC as a Partnership
- You Need to File an Amended Return: Now What?
- HR May Need to Work Overtime for New Overtime Rule
- Clawback Compensation and Section 1341
- History of E-File
- Tax Season: Overheard in the Hallways
- UK Double Taxation Relief for the U.S. LLC
- BEA Survey Requirements
- Need to Make a Tax Payment? Go to Your Local 7-Eleven
- Flat Fee Rental Agencies – Are They Worth It?