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topten December, 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 I just got socked with some credit card bills that I am having a hard time paying off. Can I use those bills as an “unforeseeable emergency” to make a hardship distribution from my 457 (government deferred compensation) plan so I can pay these high-interest cards off?

A.1 IRS just issued guidance on what constitutes an “unforeseeable emergency” so as to allow a hardship distribution from a 457 plan. If the circumstances that led to the credit card debt were themselves unforeseeable and extraordinary; for example, you had to charge some emergency home repairs after a pipe burst, the distribution should qualify as a hardship distribution. If the circumstances that led to the credit card debt were not unusual (e.g., use of the card to pay for normal purchases made over time), it would not allow for a hardship distribution. Remember that the distribution is still subject to income tax and unless one of the Section 72 exceptions applies (e.g., over age 59½) the distribution is also subject to a 10% early distribution penalty.  
Q.2 My daughter, who still lives at home but is not my dependent as she is working, had some medical expenses this year that I paid for. May I claim them?

A.2 If your daughter is eligible to be claimed as your dependent but for the gross income test, the medical expenses you pay for her may be claimed by you on your income tax return as an itemized deduction (subject to the 7.5% of AGI limitation that applies to medical expenses).

Q.3 I am the trustee of a trust established by my deceased parents that has my son as the sole beneficiary. The trust calls for the distribution of half its current value on my child reaching age 25, with the rest being distributed when he reaches age 30. He is going to turn 25 next month. Do I have to sell assets and distribute cash?

A.3 You should consult the trust document. It outlines your powers as trustee. You may have the option of distributing cash or property. If you distribute property from the trust as a distribution of corpus your son takes the property with a basis equal to its basis in the trust. If you distribute cash and the trust has distributable income, that income will pass through to your son and he will be subject to tax. Unless the trust specifically provides for the distribution of capital gain, such gain will be taxed to the trust in all but the trusts final year.

Q.4 I am planning on forming a separate LLC for every rental property I own. I will be the single member of most of the LLCs, but my wife and I will both be members of one as we own that property jointly. May we report our jointly owned property on our Schedule E like the rest of the rental properties?

A.4 As you have formed a multi-member LLC for one of the properties, the activity of that rental property should be reported on Form 1065 as a partnership. Given the increase in potential penalties for failure to file a partnership return ($195 per month per partner for up to twelve months), we suggest that the Form 1065 requirement be complied with. The K-1s for the partnership will be reported on your Schedule E, page 2.

Q.5 I forgot to send in my third quarter estimated payment. We are having a good year and I anticipate my income will be the same as last year. Should I just wait until I make the fourth quarter payment or should I make it now?

A.5 You should make the payment as soon as possible to minimize the potential penalty for late payment of the estimated tax. That penalty is based on the number of days late for the payment. The sooner you make the payment, the lower the potential penalty will be.

Q.6 My parents want to pay my son’s first year tuition at college. He is attending an out-of-state school and the tuition will be about $30,000. Is there a gift issue?

A.6 Not if your parents pay the school directly. Generally, for any year gifts may be given to an individual with a value of up to $13,000. However, the direct payment of qualified education expenses (or qualified medical expenses) is specifically excluded from the definition of a “gift”. It is important that the payment be made directly to the school. Payments must be for tuition only- books, room and board are not qualified education expenses for this purpose. Payments made indirectly, such as through a trust, do not qualify.
Q.7 My mother gave a check to her church the day before she passed and the check did not clear until after her death. May the contribution be deducted on her final Form 1040?

A.7 Generally, gifts by check are complete when the check is processed by the bank. However, gifts to qualified 501(c)(3) organizations are complete when the check is presented unconditionally to the organization. Therefore even though the check did not clear until after her passing given the check was presented to the church before that date and the position may be taken that the check was presented unconditionally to the church and the church timely presented the check to the bank, the contribution is complete on presenting the check. A check to a qualified charitable organization is generally complete when the check is unconditionally presented to the organization.

Q.8 I understand the penalty for failing to file a partnership return timely is going up for 2010 returns. Is that true?

A.8 All of the partners of a partnership that does not file on time are 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. 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. If any one partner files their individual return late or does not account for all of the partnership items, all of the partners are liable for the penalty regardless of whether they included the partnership items on their timely returns. The increased penalty for failure to file timely also applies to S corporation shareholders. The safe harbor does not apply to S corporations, however. To avoid the penalty S corporation shareholders must have a reasonable cause based on facts and circumstances to show why the return was late.

Q.9 I am the principal member of a three- member LLC that is taxed as a corporation (a regular corporation). The LLC operates a restaurant. I am buying out my 2 partners. For legal reasons I am maintaining the LLC. As the LLC will now be a single-member LLC, must I report the activity as a sole proprietorship?

A.9 A multi member LLC that has elected to be taxed as a corporation does not change its status by becoming a single member LLC. The election to be taxed as a corporation continues. Form 1120 is filed to report the activity unless it is decided to liquidate for tax purposes. You may confer with your attorney regarding the continuation of your LLC for legal purposes and any possible changes that may be required or recommended for the LLC operating agreement.

Q.10 I gave my house to my two kids last year, but retained a life estate - the right to live in the house for the rest of my life (which I will do) rent-free. I pay the property taxes (there is no mortgage) and upkeep. A friend recommended this method to exclude the house from my estate. Will the value of the house be excluded from my estate for estate tax purposes?

A.10 It appears that you may have confused estate tax with probate issues. As the property passes by operation of law to your children on your death given the life estate you have retained, the house is not included in your probate estate. However, the value of the house is included in your estate for estate tax purposes as you are occupying the house as your principal residence. Depending on the size of your estate, this may be a good thing as the children may receive the house on your death with a basis equal to its fair market value on the date of death. Even though there is no estate tax for 2010, the basis of assets with a value of up to $1.3 million ($4.3million of assets if passing to a surviving spouse) may be increased.



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