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topten November, 2010

This is a monthly reference source. By providing samples of questions and answers, we hope to help you understand that we provide a superior service in our ability to get answers to your questions. There are some general caveats that go along with this presentation. Understand that tax law is fluid and always changing; the answer that is correct today may be incorrect tomorrow. Also be aware that changing one small fact may change the entire answer. We are not trying to give a complete outline of any particular subject. We are attempting to give a general direction that can be taken to resolve a problem or obtain an answer. You should discuss your particular situation with your Fiducial Business Advisor to answer your specific problem or concerns. (You may not rely on any answer given to avoid a penalty.)


Q.1 My mother died several years ago and a trust was established through her will. I am the sole beneficiary of the trust; which was to stay in force until I reach age 25- which is this year. The trust will be terminated before the end of the year. May I have the trust pay taxes on the income earned this year?


In its final year, a trust is a pass through entity. All items of income, loss and deduction will pass out to the beneficiary (you). There is no “election” to have the trust pay tax on the income earned this year. This may be an advantage depending on your tax bracket however; the tax brackets for trusts increases quickly (the 35% bracket is reached for 2010 once taxable income exceeds $11,200).

Q.2 I was relieved of debt two years ago (2008) and due to insolvency I did not recognize income. I am just noticing now that when I filed my return for 2009 that I did not use my NOL that was carried over from 2008. Should I amend?

A.2 When you exclude income from debt relief due to insolvency, you are subject to having your tax attributes (including NOL carryovers) reduced by the amount of debt relief. A Form 982 should have been filed with your 2008 return outlining the tax attributes that were reduced. It is possible that the reason no NOL was claimed for 2009 is that particular tax attribute was exhausted when applied against the debt relief claimed through insolvency. If not, an amended return may be prepared.

Q.3 I was employed overseas for six months. I was hoping the position was going to last for at least twelve months. Given that I was hired to work overseas may I claim the foreign earned income exclusion?

A.3 To qualify for the foreign earned income exclusion, you must meet either the foreign physical presence test (out of the US for at least 330 days during a twelve month period) or the foreign residence test (resident in a foreign country for a period of at least one calendar year). Absent that, you will not qualify for the foreign earned income exclusion. If at the beginning of your employment it was reasonably anticipated you’re your employment would last less than twelve months, you should claim any temporary living expenses not reimbursed by the employer as an employee business expense (subject to the 2% of AGI limitation).

Q.4 I am opening a retail store before the end of this year. I have incurred about $25,000 of start up expenses. Assuming I do open the business before the end of the year, may I claim $5,000 as a deduction?

A.4 If the $25,000 of expenses consists of expenses that would otherwise be currently deductible business expenses (not for capital equipment or inventory) you may claim a deduction for up to $10,000 for 2010. The Small Business Jobs Act of 2010 increased the start up expenses deduction from $5,000 to $10,000 and increased the phase-out threshold from $50,000 to $60,000

Q.5 I have a self-directed IRA. I want to have the IRA purchase a resort condominium to hold as rental property until I retire- after which I will move into the unit. Is there any problem with my plan?

A.5 An IRA may hold real property. However, an IRA is prohibited from holding real property that is or will be used personally by the beneficiary of the IRA. A prohibited transaction may result in the IRA losing its exempt status with the IRA proceeds treated as distributed (taxable) on that day. In addition, if the time comes for the IRA to make required minimum distributions, those distributions must be in cash- if there is not enough cash the property will have to be sold. As the IRA owner you may not buy the property from the IRA as that is a prohibited transaction.

Q.6 I received Social Security benefits for the last four years due to a dispute that was resolved. Do I have to recognize all of the benefits received this year on my return for this year?

A.6 No, you do not. You should calculate your tax in two ways. First, use the regular method as if all the benefits were 2010 benefits. Second, use the Lump-sum method: use only the 2010 benefits to calculate taxable income for 2010 and recalculate tax in the prior years by adding the benefits for that year to the return. Whichever method results in the lowest tax; use that method.
Q.7 I am in a partnership with a close friend. We were several months late getting our partnership return filed for 2009 (no extension), but I got my individual return filed on time (my friend did not) and included all of my partnership information on my timely filed individual return. I am not the tax matters partner, but I got a notice assessing a penalty for late filing of $534.00. Do I have to pay?

A.7 The partner’s of a partnership that does not file on time is subject to a late filing penalty of $89.00 per partner per month for 2009. For tax years after 2009, the penalty increases to $195.00 per partner per month. The penalty may be assessed against any partner. While there is a safe-harbor reasonable cause exception for partnerships made up of 10 or fewer individuals that report all items of partnership income, loss, deduction and credit on their timely filed individual returns, ALL partners must report the information timely for that exception to apply. While you may have reason to hold your partner responsible, IRS may collect from either. To avoid the penalty you have to provide a reasonable cause to IRS as to why they should not hold you responsible for the penalty. If there are any specific facts or circumstances unique to your situation, you may request that IRS abate the penalty.

Q.8 I have a single member LLC. I want to elect to be taxed as an S corporation effective January 1 of next year. What do I need to do?

A.8 You need only file Form 2553 by March 15 of next year (I would suggest filing it earlier and filing the election certified with a return receipt). IRS issued regulations that eliminated the need to file both a Form 8832 and 2553 for an LLC to elect to be taxed as an S corporation- now only the Form 2553 is required. Something you should be aware of is that as with a regular incorporation if the net book value of assets is exceeded by liabilities transferred, you are subject to recognizing income. If that is the case, it is best to hold out sufficient liabilities personally so that the net book value of the assets transferred at least equals the liabilities.

Q.9 I am buying all of the assets of a corporation for over $400,000, rather than buying stock. In addition to doing this to have depreciable basis in the equipment and amortizable goodwill, I am doing this to avoid any potential liability for the debts of the corporation. Are there any tax problems I should be aware of?

A.9 Many states have a “bulk sale” provision. Under this provision, if substantially all of the assets of a business are purchased the new owner will be liable for any unpaid sales taxes (and many state laws also cover unpaid payroll taxes) of the business. Several states, including Michigan, Pennsylvania and Texas have allowed the provision to apply to unpaid corporate income tax (the Franchise Tax in Texas). With any purchase of a business, even with an asset purchase, it is a good idea to get a tax clearance letter. Insisting on a right of restitution is a good idea, too, but you are still liable and you must bear the burden of paying the amount due until (hopefully) restitution is obtained from the seller. Make sure your attorney goes over these issues in detail with you before you finalize the sale.

Q.10 I own my own business; a corporation. I just discovered last week that an employee has been embezzling from the corporation over several years. We reported all of our income, just some of the deposits never made it to the corporate bank account. The employee is promising to repay the stolen funds if criminal charges are not brought. I have grave doubts that anything will be paid as the employee is asking for time to get the funds and has no security to offer; but prefer being repaid rather than sending someone to jail. Can the corporation claim a deduction for the embezzlement loss?

A.10 As long as there is a reasonable expectation for repayment of the embezzled funds, a deduction cannot be claimed. Usually, in cases such as this the embezzled funds are long gone and the individual is judgment proof. If you can get the corporation’s attorney to confirm that repayment possibilities are so small that pursuing a judgment is not worth the legal expense, a loss can be claimed for the year that the embezzlement was discovered (the current year). The loss may be claimed even if criminal charges are not brought, but you should have a documented reasonable cause for not doing so. If repayment is made in the future, income will have to be recognized.



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