Archive for June, 2012
While we have a number of expiring tax provisions, we also have a few new ones. This one is courtesy of the 2010 Health Care bill (Obamacare) and it puts into place a medicare tax on unearned income which starts 1/1/2013. The tax rate is 3.8% and it’s on the lower of the persons’ net investment income or their modified adjusted gross income over a certain limit. Investment income includes interest, dividends, capital gains, annuities, royalties, rents and pass through income like income from K-1’s from S-Corporations and partnerships.
The modified AGI limits are $250,000 for married filing jointly and qualified widows or widowers, $200,000 for head of household and single tax payers and $125,000 if you file married filing separately. Finally, if you’re an employee and your salary is over those threshold amounts, you get hit with an additional medicare tax of 0.9% which brings it up to the tax on unearned income of 3.8%.
What’s interesting is they’re creeping into making S-Corporation income subject to payroll taxes. You have to be over the threshold but once you’re over, it makes the difference between a salary and a distribution a little bit less enticing.
Many people feel that the two absolutes in life are death and taxes. In my experience, if there’s something that comes to close to a third absolute it’s that you should never hold real estate within a structure that’s taxed as a corporation. I can give you some examples of where it works out okay but still not as well as under a structure taxed as a partnership but I can give you a few different examples of where you can have some disastrous tax circumstances when holding real estate in a corporation. The primary pair of reasons are basis rules and distribution rules. As always, I’m keeping this simple so if you have a specific situation that applies to you, be sure to contact a professional.
Let’s say you get a great deal on a property. You’re able to buy a $1 million piece of property for $500,000 and because of the great purchase price, you’re able to finance the entire $500,000 with a bank loan. Let’s take a look at what happens in two years when you try to distribute this piece of property out of your legal entity.
If you bought the property under an LLC that’s taxed as a partnership, you’d be in pretty good shape. You’d probably (it would depend on the bank note) be able to pass through any losses from the partnership because your debt has given you basis. In two years, if you distribute the property out of the LLC, it’s a tax free transaction and the property would come through with its basis and carrying period intact.
If you bought the property under a C-Corporation, you’d have a mess. When you distribute property, it’s the same as if you sold it then distributed the proceeds so you’d have about a $500,000 gain that the C-Corporation would have to pay (plus any depreciation that you took in those two years). On top of that, the distribution would be taxable to the shareholder at the value of the property or in this case, $1,000,000. Those two layers of tax that will chew into that $500,000 in savings you picked up when you bought the property pretty quickly.
While not as bad as the C-Corporation example, if you had put it under a corporation that had made a Subchapter S election, you’d still have some tax to pay. You wouldn’t have any basis in the corporation because the debt from the bank note isn’t eligible as basis. You’d have the capital gains hit that would occur at the S-Corporation level (which would ultimately flow through to the owner’s personal return) but not the second layer of tax because the dividend would come through half tax free and half as a taxable S-Corp distribution because you’ve established some basis when the capital gain was taxed but not enough to cover the entire $1 million.
In short, putting into an LLC is pretty much a no lose situation. Putting into a corporate structure, you could have a tax mess on your hands. Be sure to discuss your personal situation with you tax adviser.
Enacted in 2011, employees and self-employed people alike received a temporary 2% cut in their payroll taxes. Mired in Congress, the extension of this tax cut was given some odd treatment because the two sides of the aisle couldn’t agree on how to pay for it so for a while, there was just a two month extension. At the end of February, a full year extension was finally passed but as we get closer to the end of the year, it’s unclear what the fate of this tax cut is going to be.
If you’re an employee (of a company you don’t own), there’s not a lot you can do to plan. Either the cut will be extended and you’ll get or it won’t and you’ll see your pay check take a hair cut. For the self-employed who pay SE tax, you fate is about the same. If you’re an employee of your S-Corporation, there is a little bit you can do. In December, if the political winds are telling you that an extension isn’t going to pass, it might be a good time to push some salary (maybe a one time bonus or an advance) from 2013 into 2012. Other than that, this one is a big “wait and see.”
Buying a business presents a host of both tax challenges and tax options. Knowing how you buy a business and how it’s going to be presented on a tax return can be just as important as the actual purchase price. As usual, I’m going to talk about things in a general sense. If you’re buying or selling a business, be sure to consult with a professional.
Alright, let’s start with the two types of sales. There are asset sales and stock sales (stock being the shares of a company, if it’s an LLC, it’s not stock it’s partnership units). An asset sale is where the assets of the company are sold where as a stock sale is where the stock or interest in the company is sold. Usually, if you’re the purchaser, you want an asset sale. If you’re the seller, usually a stock sale is the more beneficial. The primary reason an asset sale is better for the buyer (talking strictly from a tax perspective) is that the difference between the value of the assets and the purchase price of the transaction is amortizable goodwill while under a stock sale, that difference isn’t an amortizable expense. Of course a stock sale is usually an easier transaction administratively.
Let’s look at an example. You decide to buy a tanning salon for $30,000. It’s in a good location, it has below market rents for the next few years and the current owner has done a horrible job marketing the company so even though the assets of the company are only worth $20,000, you feel the $30,000 purchase price is a bargain based on the profit you’re going to bring in. Both sides agree on the value of the assets and both sides fill out and agree on a $20,000 allocation to tanning equipment and $10,000 of goodwill on Form 8883 (Asset Allocation Statement). Assuming you’re using a business structure, your business buys the “assets,” begins operating it and come tax time, the $20,000 in equipment is depreciated over a five or seven year life while the goodwill of $10,000 is amortized for tax purposes over 15 years.
Under a stock sale, let’s assume the tanning salon is owned by a company called Tanning Salon, Inc. and it’s taxed as a C-Corporation. For the same reasons above, you decide to buy the company for $30,000. The equipment has a value of $20,000 but it’s depreciable basis is $10,000 because the current owner has taken advantage of some of the more recent bonus depreciation provisions. Your “outside” basis in the stock is $30,000 so if you ever sold the stock in the company, this is what you’d use to compute your gain on the sale. Like in the asset sale example, you’d then start operating the business but now your depreciable value in the equipment is only $10,000 because you stepped into the shoes of the previous owner. There’s no goodwill to amortize under this type of transaction.
The final example has the tanning salon being owned by Tanning Salon, LLC and there are two owners who own a 50% piece of the LLC each. You’re buying out one of the 50% owners for $15,000 and you’re doing it by buying his interest in the LLC. The depreciable basis of the assets is $10,000. Since this company is a partnership for tax purposes and there’s a change in ownership of 50% or more, you’d have what’s called a technical termination. Under a technical termination, the LLC would file a “final” tax return on the date of the purchase (usually a short period return unless the sale happened at the company’s year end) and then there would be a second short period return that would take place from the date of the sale to the LLC’s normal year end date. In the “new” company, all of the depreciable assets would then restart. So you’d have a “new” basis in the asset that consists of the “old” companies purchase price in the asset less any depreciation and you’d depreciate them as if they were just purchased. This one can get messy so if you’re buying out an LLC member, like any of these situations, be sure you’re talking to an expert.
I really didn’t cover “everything” here (there’s entire books on the subject) so if you have a question on an issue I didn’t touch on, just leave me a comment and we can make this a living thread.