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topten February, 2011

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 read that the credit for energy saving improvements to your principal residence has been extended through 2011. Does that mean that I can claim another $1,500 credit for new windows I install in my home for 2011 like I received for the windows I put in during 2009?

A.1 Under the provisions of the 2010 Tax Relief Act, the residential energy credit was extended through 2011. However, the maximum amount of credit available under the extended provision is $500 and it is not available to the extent the credit has been claimed in prior years. As you claimed the full credit in a prior year, no further credit is available.  
Q.2 I am the sole member of an LLC that elected S corporation status effective January 1, 2011. I am also the sole employee. I plan on paying a “reasonable” salary and taking distributions of profit. I anticipate my salary will be about $20,000 per year and my distributions should be about $80,000. Is there a problem with my plan?

A.2 If IRS determines that your compensation is not commensurate with the services you provide the corporation, IRS does have the regulatory authority to re-characterize the distributions to compensation which would result in payroll taxes, penalties and interest being assessed. In establishing a reasonable salary, we suggest that you determine what an individual rendering the same services to an unrelated employer would be paid in your area and use that as the basis for establishing your salary. IRS has been particularly active recently in the area of compensation paid S corporation shareholders, and to insulate as much as possible against an IRS challenge it is best to have some rationale documented as to how the determination of a reasonable salary was made.

Q.3 I formed an LLC early in 2010 and intended to elect S corporation status. I thought the provider that helped me form my LLC was going to oversee the entity election and the S corporation election. I just found out that neither the entity election nor the election to S corporation status was filed. Am I out of luck?

A.3 Fortunately, Rev Proc 2007-62 provides a potential solution to your issue. Given that the LLC otherwise qualified to file an S corporation election and it fails to qualify as an S corporation solely because the form was not filed, the entity has not filed a tax return for the first taxable year the election was intended, the request for relief is made no later than six months after the due date of the tax return (excluding extensions), and no taxpayer whose tax liability would be affected by the S corporation election has reported inconsistently with that election, you may request relief by attaching a Form 2553 to the initial S corporation return. The Form 2553 should have “Filed under Rev Proc 2007-62” at the top and must include a reasonable cause explanation for the late filing. Confusion between you and your provider as to what party was going to make the elections has generally been accepted by IRS as a reasonable cause. Under this revenue procedure, you do not have to make the entity election- it is deemed made by filing the Form 2553.

Q.4 My wife and I formed a partnership to run our store. I heard that we can avoid filing a partnership return and just report the partnership on our Form 1040. Is that correct?

A.4 A change in filing instructions allows a husband-wife partnership that is operating a trade or business that if income is generated would be self-employment income to elect to report that partnership on two Schedule Cs (or Schedule Fs) rather than filing a partnership return. To make the election, all items of income, gain, credit, loss and deduction are divided according to each spouse’s interest in the venture and reported on a separate Schedule C. Once made, the election is irrevocable without IRS consent.

Q.5 I sold a piece of equipment I had in my proprietorship before I retired for cash a few years ago and reported a $30,000 gain. The buyer had problems with it and there was a lawsuit. We settled after I agreed to return $15,000 to him. Can I deduct the repayment? the retirement accounts right away?

A.5 You may either claim a credit for the repaid amount or claim the amount repaid as an itemized deduction (not subject to the 2% of AGI limitation). The credit is determined by calculating the difference between the tax you paid in the year of the sale and the tax that would have been paid if sold for the original sales price less the amount you repaid.

Q.6 I have a rental property and I am paying the quarterly condo fees. Is the payment of that fee a deductible rental expense?

A.6 Yes, the payment of the condominium fee is a deductible expense for rental property.

Q.7 I am renting room in our house to an unrelated party. How do I calculate the depreciable portion of the house? The tenant has a bedroom and private bathroom and has free use of the rest of the house except my bedroom/bathroom.

A.7 If a portion of a home is rented and portion is used personally, any reasonable method of allocating the space may be used. The allocation to rental property is limited, however, to that property which is used exclusively by the tenant (the bedroom and bathroom). Generally, a determination of square footage can be used to determine the relationship of the tenant’s exclusive space relative to the rest of the living space in the house.

Q.8 I am the principal member of a two member LLC that is taxed as a partnership. I am buying out my partner. May I still file a Form 1065 and take guaranteed payments after the buyout?

A.8 A multi member LLC that has elected to be taxed as a partnership changes its status by becoming a single member LLC. The LLC is taxed as a sole proprietorship as a single member LLC is a disregarded entity for tax purposes and is reported on Schedule C unless you elect to have the LLC taxed as a corporation. You may not pay yourself wages from the proprietorship. You may elect to have the LLC taxed as an S corporation (file Form 1120S). This would allow you to be paid a reasonable salary and would allow pass-through profit to be received without being subject to self-employment tax.

Q.9 May an S corporation have an LLC as a shareholder?

A.9 If the LLC is a single member LLC that is taxed as a disregarded entity and that member is a qualified individual, the LLC may be a shareholder of the S corporation. Alternatively, if the LLC has elected to be taxed as an S corporation and is the 100% shareholder of the second S corporation, the second S corporation may be a Qualified Sub S Subsidiary (QSSS).

Q.10 I currently am the sole shareholder of a regular corporation. The corporation currently has a net operating loss carryover, but I think the business has turned the corner and will be profitable for the foreseeable future. I am considering an election to S corporation status. Can the S corporation make use of the NOL?

A.10 Generally the answer is “No”. The net operating loss may not be used against operating income generated by the S corporation. If you are subject to built-in gain, the net operating loss may be applied against that built-in gain. Otherwise, it is not available but the time limitation continues to run. A suggestion to consider is to defer electing S corporation status until the beginning of the year after the year the NOL is used up.

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