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topten August, 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 contracted to purchase a new home on April 24th, 2010. The house I am buying is being purchased through a short sale and is taking longer to close than I anticipated. I will not close by the end of June, but should close by the end of July. Otherwise, I would qualify for the first time homebuyer tax credit. Do I lose the credit due to the late closing?

A.1 For purchases of a principal residence where the contract was ratified (signed) by April 30, 2010, the law provided that the closing date deadline was June 30, 2010. However, the Homebuyer Tax Credit Relief Act was signed July 2, 2010 and it provides an extended closing deadline to September 30, 2010 for homebuyers that had ratified sales contracts prior to May 1, 2010.

Q.2 My mother and I are purchasing a new residence. I will be the only resident (my mother will continue to live with my father). We are both contributing some funds, but I will be paying the mortgage entirely by myself. I will qualify for the first time homebuyer credit, but she will not. May all of the credit be allocated to me?

A.2 Yes. IRS published guidance for unmarried co-purchasers of property that covers your situation. You and your mother may agree to allocate the first time homebuyer credit in any reasonable manner. As she does not qualify for the credit and you do, it is reasonable to allocate it entirely to you.

Q.3 I elected S corporation status effective January 1, 2010. My C corporation reports using the cash method of accounting. There was $25,000 of accounts receivable and $20,000 of accounts payable when the S corporation became effective. Do I have a built-in gains tax to pay on $25,000 even though I used the collections to cover the payables?

A.3 Built in gains are computed based the corporation’s property present as of the effective date of the S corporation election. The tax is 35% of the net recognized built-in gain limited to taxable income computed as if the corporation were a regular corporation. The accounts payable are taken into account in determining the corporation’s income and will be taken into account in determining the net recognized built-in gain.

Q.4 I have a medical plan in my S corporation. I am the 100% shareholder and my wife and I both work in the business. If I am covered through my spouse, do we still have to report the premiums paid on her W-2 to claim the self-employed health insurance deduction even though she is not a shareholder?

A.4 Your spouse is deemed to be a 100% shareholder through attribution. She is deemed to own the same shares you own. As such, to be able to claim the Self Employed health insurance deduction, the premiums paid must be included as compensation on the Form W-2 (not subject to FICA or FUTA as long as the plan is not discriminatory).

Q.5 I am the owner of a rental property. I am planning on a tax-free exchange of the property for a 15% membership interest from a departing member in an LLC that holds an apartment building. Will this work?

A.5 To qualify as a tax free exchange under Section 1031, the property received must be like kind property. A membership interest in a multi-member LLC will not qualify as like kind property when it is received in exchange for real property. The latitude allowed exchanges of real property is wide - improved property may be exchanged for unimproved, rural for urban and vice-versa. If you can persuade the LLC to dissolve and exchange your property for a tenant-in-common interest, the property would be considered like-kind. The LLC may then be re-formed. Otherwise, we recommend you pursue another property.
Q.6 I am the only shareholder of an S corporation. The corporation has a medical reimbursement plan in place that allows for reimbursement of medical insurance premiums. Will the reimbursement qualify to be claimed as self-employed health insurance?

A.6 The IRS has ruled that the reimbursement of medical insurance under a non-discriminatory medical reimbursement plan will qualify for the self-employed health insurance deduction. The amount of the reimbursement must be included on your Form W-2 as compensation; but it is not subject to FICA or FUTA.

Q.7 My children, ages 10 and 12, have worked with me for the past year doing light filing, restocking shelves, etc. for my retail store. I am forming a single member LLC for liability protection. Does this mean I will have to pay FICA and FUTA on the salary paid my kids?

A.7 The exemption from FICA and FUTA for the children of a sole proprietor will continue to apply if no election is made to be taxed as a corporation. The exemption from FICA applies until the child is 18 while the exemption from FUTA applies until age 21. For tax purposes, a single-member LLC is a disregarded entity unless an election is made to be taxed as a corporation. As a disregarded entity, the LLC continues to be reported on Schedule C and the business is treated for tax purposes as a sole proprietorship. If an election is made to tax the business as a corporation the wages paid to the children will be treated as any other employees and will be subject to all payroll taxes.

Q.8 I have a rental property that I plan to sell in the future, but it is not on the market yet. I am going to refinance the property now to take advantage of lower interest rates and I may get some cash from the refinance. Will this endanger my chances of exchanging the property tax -free?

A.8 No. As long as the refinance is not related to the exchange (e.g.., it is not done to equalize debt given up and debt received on an exchange) it should not impact the exchange directly. Given that you do not receive cash (or have access to cash) and the replacement property costs as much as the sales price of the property given up, the exchange should be tax-free. You should understand that if you take on less debt than you give up on the exchange, it is considered the same as receiving cash. You should also note that if you take cash on the refinance and use the proceeds for personal purposes, the interest attributed to the cash taken will not be deductible.

Q.9 I am the sole shareholder of an S corporation. The corporation sold all of its assets six years ago on an installment basis. The corporation did not liquidate. The installment note is scheduled to be paid off over the next three years, but I would like to liquidate the corporation now. Is there any reason to keep the corporation going?

A.9 If the corporation is liquidated at this point, the installment note will “collapse” at the corporate level and the remaining gain will be recognized. If an S corporation liquidates within 12 months of entering into an installment sale, installment reporting is preserved at both the corporate and shareholder level. As more than 12 months have passed since the sale, a distribution of the note will cause the all the remaining deferred gain on the note to be recognized by the S corporation (and pass it through to you, the shareholder).

Q.10 I have 2 C corporations, both in the same line of business, but located in different cities. One is profitable, but the other is not. Is there any way the losses in the second corporation can offset the income of the first corporation.

A.10 You may consider merging the two corporations using a tax-free, statutory merger (Type A). Such a merger requires complying with certain legal requirements which include filing articles of merger with the State. While the losses in the second corporation cannot be carried back against the income of the first corporation, the losses can be used to offset the income of the combined corporations after the merger.

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