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topten June, 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 am in the process of getting a divorce; it should be final in the next month or so. As part of the divorce agreement I am to pay my wife for her 50% interest in our S corporation (which will leave me as the 100% owner). Is my basis in the S corporation increased by the amount I have to pay her, which is about double her basis?

A.1 From your description, your ex-wife will transfer the S corporation stock to you as a property settlement under the divorce decree. As such, the transaction is not taxable to or deductible by any party and the basis of the stock you receive will be equal to your ex-wife’s basis on the transfer.  
Q.2 I am the sole shareholder of an S corporation. I have a SEP-IRA established for the corporation.
On your advice, I extended the
tax return for the corporation, but filed a few days later (before the original due date) and made the SEP-IRA contribution using 15% of compensation. I have now decided that I want to increase the SEP-IRA contribution percentage for 2010 to the maximum amount of 25%. Since I filed the return is it too late?

A.2 Thanks to the extension filed for the S corporation, the answer is “No, it is not too late”. The corporation has until the extended due date to make the additional contribution. An amended return should be filed indicating the additional contribution.

Q.3 My rental property was foreclosed on at the end of 2010. I received a Form 1099 that says the fair market value of the house was $250,000, I have debt relief of $75,000 and I was not personally liable for the debt. No interest was included in the mortgage debt. Does this mean I have to recognize income?

A.3 It is possible. We need a few more facts. Because you were not personally liable for the debt, the full amount of the mortgage principal due at the time of the foreclosure is considered the sales price of the property. Depending on your basis in the property, you may either have a gain or loss on the deemed sale.

Q.4 I have established a 401k plan in my business and several employees are participating. I am the administrator of the plan, and I generally write checks at the end of the following month to move the employee deferrals into the plan. I have been told by a friend I should get the money to the plan faster. Is there a problem?

A.4 There is a potential problem. The Department of Labor oversees the deposit requirement for employee deferrals and has ruled that the deferral is to be deposited as soon as possible (the “safe harbor” time frame is seven business days), but no later than the 15th day of the month following the payday. Both IRS and the DOL may assess penalties related to failing to deposit the employee deferrals timely. The penalties may range from 15% up to 200%. Penalties are generally lower and may be forgiven if corrections are made to the deposit agenda before notice is sent by IRS or DOL.

Q.5 I am a retired minister. I do not perform services any more for the church. As part of my small pension, I also receive a housing allowance- the amount is determined each year by the Board. I was told by an acquaintance that the housing allowance is excluded from income tax but is subject to SE tax.
Is that true?

A.5 What you were told is not true. A retired minister may generally exclude from income for both income tax purposes and self-employment tax purposes an amount designated as a housing allowance by the employing body. If you were not retired, the full amount of the housing allowance is included in income for purposes of determining self employment tax (but excluded from income for income tax purposes). Perhaps the individual was not fully aware that you are retired.

Q.6 I am leaving the US to work in Bahrain for at least two years starting next month. I will only come back to the US for a week or two during that time. Can I get the full foreign earned income exclusion for 2011?

A.6 A6. No; but you likely will qualify for a pro-rated exclusion. Given that you are present in a foreign country for at least 330 out of any 365 day period you will qualify for the foreign earned income exclusion. However, as that 365 day period will overlap two years, the exclusion for 2011 will be pro-rated based on the number of days present in the foreign country during 2011 over 365. For 2011, the full foreign earned income exclusion is $92,900. For example, if you have 200 qualifying days for 2011, your foreign earned income exclusion for 2011 will be 200/365 x $92,900 = $50,904.

Q.7 I operate a small retail store as a sole proprietor. My wife and I employ a maid through a maid service who cleans our house once a week. We have heard from friends that we now need to pay payroll taxes and supply the maid with a W-2. Is that true?

A.7 Generally, if you employ maid or other household employee and pay more than $1,700 per year you are subject to paying FICA and if more than $1,000 a quarter, FUTA. However, if the maid is self-employed (provides their own tools and offers services to the general public) or is employed by an agency you
the service recipient but you are not the employer and you are not responsible for paying the maids payroll taxes- the employer is.

Q.8 Q8. I regularly volunteer to deliver “meals on wheels” for my church.
I bought coolers and insulated totes which I contributed to the church and I help prepare meals in the church kitchen and deliver them to ill, disabled or needy individuals.
Are my expenses deductible?

A.8 In general, you may deduct as a charitable contribution your contribution of the coolers and totes and any other out-of-pocket costs in preparing the meals and you may deduct 14 cents per mile for the miles driven in purchasing the food and delivering the meals.

Q.9 I acquired a house a little over a year ago using a Section 1031 tax-free exchange. I used a qualified intermediary and exchanged one rental property for another. The tenant has now moved out. I want to move in and convert my present home into a rental property. I may sell the former rental property later when I retire in five or six years. Is there anything I should be aware of before I make the change?

A.9 There is a provision in the Tax Code that if a rental property is converted to a personal residence, the ownership requirement to meet the demands of Section 121 (which provides for an exclusion of up to $250,000 of gain- $500,000 if married filing jointly) is increased from 2 years to 5 years. You need not occupy the residence for 5 years, but must occupy it for at least 2 years and own it for 5 years prior to its sale to be eligible for the maximum exclusion of gain. Depreciation taken after May 6, 1997 is subject to recapture under Section 1250 (subject to tax at a maximum rate of 25%) and is not excluded under Section 121. You should also be aware that IRS has provided a safe harbor whereby if property is rented to another person at a fair rental price for at least 14 days and the owner’s personal use does not exceed the greater of 14 days or 10% of the number of days it was rented during the 24 months following the exchange, the 1031 exchange falls into a safe harbor wherein IRS will not challenge the intent to hold the replacement property as rental property. If the safe harbor requirement is not met (i.e., you convert the house to your residence within 24 months of the exchange), you should be able to prove that your intent was to hold the property for rental and not to acquire it for personal use.



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