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topten September, 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 am one of two S 50% corporation shareholders (unrelated to the other 50% shareholder). I loaned $20,000 to the S corporation some time ago. I have used $10,000 of the loan basis to claim losses and there has not been any repayment of the loan in the past. If the S corporation repays $5,000 of the loan, do I have to recognize the entire repayment as income?

A.1 When basis in loans has been used to claim losses from an S corporation and the loan is repaid before basis is fully restored, a pro-rata portion of every dollar repaid is taxable. If the loan is evidenced by a note, the gain is capital gain. If the loan is an open account, the gain is ordinary income. With 50% of the loan basis used to take losses, 50% of the repayment ($2,500) will be taxable gain. The other 50% of the repayment will reduce basis in the loan (leaving you with a loan balance of $15,000 and a loan basis of $7,500).

Q.2 I claim my daughter as a dependent (She lives at our home, I provide more than ½ of her support and she is under age 24 and a full time college student). She does work during the summer to save money to use at college and has paid some of her tuition. Do I have to subtract the payments she made in calculating the amount eligible for the American Opportunity Credit?

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 grantor trust I established several years ago to hold my property (to avoid probate). I have never filed a Form 1041 for the trust. I just sold a rental property. Do I have to file a Form 1041?

A.4 No, you report the sale on your Form 1040. Even though you established a trust, a grantor-type trust is considered a disregarded entity for tax purposes. If the trust received a Form 1099 with regard to the house sale, you should include a statement with your individual return noting that the sale of the property was made by a grantor-type trust held for your benefit and all items of income, loss and deduction associated with the trust (indicate the name and federal EIN) are reported on your individual return.

Q.5 I am a US citizen, but I own a rental property in Greece. I report and pay tax in Greece. Do I really have to report the rental in the US, too?

A.5 As a US citizen you are responsible for reporting worldwide income. The rental of the property in Greece is subject to US reporting. As the real property is located outside the US, it is depreciated for US tax purposes over 45 years. The tax paid to Greece may be claimed as a deduction or foreign tax credit may be taken on your US income tax return.
Q.6 I married last year. My new husband has some prior federal tax debts that resulted from a failed business. Those debts arose several years before we met. I expect a refund of my taxes. Is there anything we can do to protect my refund from being taken by IRS?

A.6 Yes, in preparing your return we can do an injured spouse allocation on Form 8379. It may be filed with your tax return and allows for a calculation of the tax that applies to your income and given your withholding provides for a refund, a recovery of that refund free from IRS seizure due to the tax debt of your new husband.

Q.7 I have just received a proposal to put my business in a trust. The intent is to reduce or eliminate the tax that is paid relative to the business. There is also some mention of putting my personal residence in a trust to allow more deductions. Is there anything to these offers?

A.7 IRS has issued warnings with regard to abusive trusts. The proposals you outline would appear to fall in the “abusive” category, especially where a promise is made to allow deductions for personal expenses not otherwise deductible. I would suggest that you request to see any IRS Private Letter Rulings obtained for the trusts and you let our Tax Department review the trust document for tax issues.

Q.8 I am the sole shareholder of an S corporation that operates a retail store. I am negotiating the sale of the corporation. The corporation will sell all of its assets, including goodwill. I started from scratch as an S corporation. Since the goodwill is being sold by a corporation, is any gain ordinary income?

A.8 The general answer to your question is “No”. The sale of goodwill that has not been amortized will generate capital gain. Given the business has been operated for more than 12 months, the gain on the sale of the goodwill will be long term capital gain and will pass through to you as such.

Q.9 I am the sole shareholder of an S corporation that operates a retail store. I am negotiating the sale of the corporation. The corporation will sell all of its assets, including goodwill. I started from scratch as an S corporation. Since the goodwill is being sold by a corporation, is any gain ordinary income?

A.9 If there is a non-compete agreement with the corporation, courts have held that the corporation owns the goodwill. If there is NOT a non-compete agreement, courts have held that the goodwill associated with a patient list abides with the employee and the goodwill associated with that list belongs to the employee and may be sold by the employee (separate from the corporation). As long as you do not have a non-compete in place with the corporation you may sell your client list (goodwill) yourself. The sale will generate capital gain to you (as you did not amortize the goodwill) and will not be taxed to the corporation. You should make sure the sales agreement specifically notes that the sale of the patient list (goodwill) is being made by you, personally
and you sign that part of the agreement individually.

Q.10 My father passed away early this year. He put his income producing assets (several investment accounts and a rental property) in a revocable trust. It converted to a complex trust on his death. Once the attorney’s fees, appraisal fees and other trust administrative expenses are tallied, the trust will likely have a net loss for the year even though dividend and interest income will likely be about $800. Do I still have to file Form 1041?

A.10 If the trust has more than $600 of gross income for the year or has
any taxable income, a trust
return is required.

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