Archive for Small Business
How to calculate stock and loan basis in an S Corp for tax purposes
If you are a shareholder of an S corporation you are responsible for keeping track of your own basis (investment value) in the S corporation of which you own shares. Tracking shareholder basis is usually not the S corporation’s responsibility.
You can have stock basis and loan basis, which are usually adjusted each year based on the S corporation’s operations.
It is important to annually calculate your shareholders basis in the S corporation stock you own for the following reasons:
• You can claim losses and deductions passed through on Schedule K-1 to the extent of their stock and loan basis [§1366(d)(1)].
• If you receive a non-dividend distribution from the S corporation, it’s nontaxable to the extent of you stock basis [§1368(b)(1)].
• When you disposes of the S corporation stock, gain or loss on the disposition is calculated using you stock basis.
Stock basis starts with your initial contribution of capital to the S corporation’s capital account or the price paid for the stock. This amount is adjusted annually, as of the last day of the S corporation year, in the following order [Reg. §1.1367-1(f)]:
(1) Increased by all income including tax-exempt income reported on Schedule K-1 and excess depletion.
(2) Decreased by property distributions including cash made by the S corporation that are reported on Schedule K-1 in Box 16 with code D.
(3) Decreased by nondeductible non capital expenses, such as illegal bribes, kickbacks, fines and penalties, expenses and interest related to tax-exempt income, and the nondeductible portion of meals and entertainment.
(4) Decreased by deductible losses and deductions reported on Schedule K-1.
Stock basis can never go below zero.
If non dividend distributions exceed stock basis, the excess is taxed as capital gain on your personal return [§1368(b)(2)].
If deductible losses and deductions exceed stock basis, they can be deducted to the extent you have loan basis and any amount in excess of loan basis is suspended and carried over to the succeeding tax year.
You can elect to reduce your stock basis by deductible losses and deductions before decreasing their basis by non deductible expenses [Reg. §1.1367-1(g)]. If this election is made and nondeductible expenses exceed your stock and loan basis, the excess retains its character and is carried over to the succeeding tax year. If the election is not made, any excess nondeductible expenses are lost, not suspended and not carried over.
Loan basis starts with a loan substantiated with loan documentation from you the shareholder of the S corporation to the S corporation. In other words, it includes a traditional, written note with a reasonable stated rate of interest. It does not include third party loans to the S corporation that you guarantee or co-signs.
Loan basis is adjusted as follows:
• Losses and deductions (deductible and nondeductible) passed through on Schedule K-1 reduce stock basis before they reduce loan basis.
• Loan basis can never go below zero. If deductible losses and deductions exceed your stock and loan basis, the excess is suspended and carried over.
• If there are different types of losses and deductions, the allowable loss and deduction items must be prorated.
• If loan basis has been reduced by pass-through losses and deductions, any net increase in a subsequent year restores the reduced loan basis before it increases your stock basis [Reg. §1.1367-2(c)].
A net increase is the amount by which the increases to stock basis exceed the decreases to stock basis including non dividend distributions.
• Non dividend distributions are not taxable if there is a “net increase” for the year, even if you have no stock basis.
• Reduced loan basis is restored by any “net increase” for the year before any loan repayments during the year are taken into account [Reg. §1.1367-2(d)(1)].
These loan repayments must be allocated in part to a return of your basis and in part to the receipt of income. If the loan is a written note, the note is a capital asset and the income will be capital gain.
As an S corporation shareholder you must establish that you have enough basis in the S corporation before you can claim any pass-through losses or deductions. Basically S corporation shareholders usually tend to get into trouble when they assume that non dividend distributions from an S corporation are entirely nontaxable. Be sure to verify that the distribution does not exceed your stock basis. Also be sure to be aware of the various ordering rules for adjusting stock and loan basis in an S corporation.
The New Home Office Deduction Safe Harbor – IRS Rev. Proc. 2013-13
The Internal Revenue Service announced a simplified option that many owners of home-based businesses and some home-based workers may use to figure their deductions for the business use of their homes. The new simplified option is available starting with the 2013 return most taxpayers file early in 2014. Further details on the new option can be found in
IRS Revenue Procedure 2013-13
This Rev. Proc. provides an optional safe harbor method that may be used to determine the amount of deductible expenses attributable to certain business use of a residence during the taxable year. This safe harbor method is an alternative to the calculation, allocation, and substantiation of actual expenses for purposes of satisfying the requirements of § 280A of the Internal Revenue Code.
The new optional deduction, capped at $1,500 per year based on $5 a square foot for up to 300 square feet, will reduce the paperwork and record keeping burden on small businesses by an estimated 1.6 million hours annually. It also provides eligible taxpayers an easier path to claiming the home office deduction. Currently, they are generally required to fill out a IRS Form 8829 calculating allocated expenses, depreciation and carryovers of unused deductions. Taxpayers claiming the optional deduction will complete a significantly simplified form.
Though homeowners using the new option cannot depreciate the portion of their home used in a trade or business, they can claim allowable mortgage interest, real estate taxes and casualty losses on the home as itemized deductions on Schedule A. These deductions need not be allocated between personal and business use, as is required under the regular method.
Business expenses unrelated to the home, such as advertising, supplies and wages paid to employees are still fully deductible.
Current restrictions on the home office deduction, such as the requirement that a home office must be used regularly and exclusively for business and the limit tied to the income derived from the particular business, still apply under the new option.
This new option is available starting with the 2013 return most taxpayers file early in 2014.
S Corp Late Filing Penalty Excused IRC 6699 Ensyc Technologies v. Commissioner
Considering the scope of the reasonable cause language to the Code Sec. 6699 penalty for late filing of an S corporation return, the Tax Court determined that the failure to timely file a 2008 2008 1120-S tax return was due to reasonable cause not subject to penalty in Ensyc Technologies v. Comm’r, T.C. Summary 2012-55 (6/14/12). The following are the facts as I understand:
1. Ensyc Technologies, an S corporation operated entirely by its president who works from his home in Idaho with the assistance of subcontractors, had its tax returns prepared by an accountant in Nevada.
2. Ensyc’s annual tax return for 2008 was due March 16, 2009.
3. On March 10, 2009, Ensyc’s accountant sent Ensyc IRS Form 1120S, U.S. Income Tax Return for an S Corporation, to file with the IRS. The accountant also sent copies of Schedules K-1, Shareholder’s Share of Income, Deductions, Credits.
4. Ensyc’s files contained a copy of a Form 1120S bearing the President’s signature dated March 16, 2009.
5. The IRS has record receiving a Form 1120S from Ensyc on September 11, 2009 postmarked September 8, 2009.
6. The 1120-S form itself was dated February 24, 2009.
7. Code Sec. 6699 basically states that an S corporation not timely filing its annual tax return is liable for a per-shareholder penalty for every month the tax return is late up to 12 months. However the penalty is not imposed if the failure to timely file the return is due to reasonable cause.
8. On the theory that the Form 1120S it received on September 11, 2009, was the only Form 1120S Ensyc had filed for tax year 2008, the IRS assessed a $6,408 late-filing penalty.
9. On February 1, 2010, Ensyc requested a collection-review hearing with the Office of Appeals regarding levy action.
10. The IRS Office of Appeals determined that Ensyc did not timely file a Form 1120S nor did it have reasonable cause for failing to timely file the form and sustained the levy.
11. Ensyc took the case to the Tax Court, arguing that it was not liable for the late-filing penalty because it mailed a Form 1120S on March 16, 2009.
12. The Tax Court examined the possible explanations for why the IRS had no record of receiving the Form 1120S and essentially determined that the tax return was not timely mailed.
13. The Tax Court then considered whether there was reasonable cause for not filing the form on time noting that no judicial opinion had yet considered the scope of the reasonable cause exception to the Code Sec. 6699 penalty.
14. The court applied the ordinary-business-care-and-prudence test from IRC 6651 concluding that Ensyc exercised ordinary business care and prudence in its efforts to timely file its Form 1120S for 2008.
15. The Tax Court specifically noted that the President routinely mailed Ensyc’s tax returns on time. Further he mailed the Schedules K-1 to Ensyc’s shareholders and that an Ensyc shareholder filed an annual individual income-tax return on April 15, 2009 reflecting the shareholder’s pass through loss.
16. The court believed the President’s testimony that he thought he had mailed the 2008 Form 1120S on March 16, 2009. As a result, the court found that Ensyc’s failure to timely file a Form 1120S for the 2008 tax year was due to reasonable cause and, thus, Ensyc was not liable for the Code Sec. 6699 penalty.
17. It was also noted that pursuant to INTERNAL REVENUE CODE SECTION 7463(b), this opinion may not be treated as precedent for any other case.
I think the lesson learned here is to file on time and avoid the penalty.
IRS Form 1040 Line 21 and Subsequent CP2000 Notices
IRS CP2000 notices are annoying for a wide variety of reasons but mostly because the IRS assumes that most all items reported on line 21 of IRS From 1040 are subject to self-employment (SE) tax.
Much of what goes on line 21 (trustee fees for executors, prizes and awards, gambling winnings, cancellation of debt income, foreign pensions) is NOT subject to SE tax. What is driving this CP 2000 project inside the IRS causing all these no-change audit determinations?
First I learned the notices are reviewed inside the IRS prior to issuance, but it appears that the old e-file system did not provide the “dotted line” between the explanation provided on the return and the amount reported on line 21. Second and more importantly even though most of what goes on line 21 is not subject to Self Employment tax, the IRS finds that many taxpayers (and preparers) routinely include items subject to SE tax on line 21. Or in the opinion of the IRS many preparers and taxpayers prepare the form incorrectly without fully recognizing the implications of their entries on line 21. The result is that in many cases IRS’ proposed assessments are correct. The bottom line is to really understand the items being reported on line 21 of IRS Form 1040 and do not report any items here that may be subject to SE tax.
Self Employed Health Insurance Insurance Deduction: Worksheet v. IRS Publication 535
If you qualify to take the deduction, use the Self-Employed Health Insurance Deduction Worksheet to figure the amount you can deduct. However use IRS Publication 535 instead if any of the following applies.
You had more than one source of income subject to self-employment tax.
You file Form 2555 or 2555-EZ.
You are using amounts paid for qualified long-term care insurance to figure the deduction.
According to IRS INSTRUCTIONS you may be able to deduct the amount you paid for health insurance for yourself, your spouse, and your dependents. The insurance can also cover your child who was under age 27 at the end of 2011, even if the child was not your dependent. A child includes your son, daughter, stepchild, adopted child, or foster child.
|
1. | Enter the total amount paid in 2011 for health insurance coverage established under your business | |||
(or the S corporation in which you were a more-than-2% shareholder) for 2011 for you, your spouse, and your dependents. Your insurance can also cover your child who was under age 27 at the end of 2011, even if the child was not your dependent. But do not include amounts for any month you were eligible to participate in an employer-sponsored health plan or amounts paid from retirement plan distributions that were nontaxable because you are a retired public safety officer | 1. | |||
2. | Enter your net profit* and any other earned income** from the business under which the insurance plan is established, minus any deductions on Form 1040, lines 27 and 28. Do not include Conservation Reserve Program payments exempt from self-employment tax | 2. | ||
3. | Self-employed health insurance deduction. Enter the smaller of line 1 or line 2 here and onForm 1040, line 29. Do not include this amount in figuring any medical expense deduction on Schedule A | 3. | ||
*If you used either optional method to figure your net earnings from self-employment, do not enter your net profit. Instead, enter the amount from Schedule SE, Section B, line 4b. | ||||
**Earned income includes net earnings and gains from the sale, transfer, or licensing of property you created. However, it does not include capital gain income. If you were a more-than-2% shareholder in the S corporation under which the insurance plan is established, earned income is your Medicare wages (box 5 of Form W-2) from that corporation. | ||||
One of the following statements must be true.
You were self-employed and had a net profit for the year.
You were a partner with net earnings from self-employment.
You used one of the optional methods to figure your net earnings from self-employment on Schedule SE.
You received wages in 2011 from an S corporation in which you were a more-than-2% shareholder. Health insurance premiums paid or reimbursed by the S corporation are shown as wages on Form W-2.
The insurance plan must be established under your business. Your personal services must have been a material income-producing factor in the business. If you are filing Schedule C, C-EZ, or F, the policy can be either in your name or in the name of the business.
If you are a partner, the policy can be either in your name or in the name of the partnership. You can either pay the premiums yourself or your partnership can pay them and report them as guaranteed payments. If the policy is in your name and you pay the premiums yourself, the partnership must reimburse you and report the premiums as guaranteed payments.
If you are a more-than-2% shareholder in an S corporation, the policy can be either in your name or in the name of the S corporation. You can either pay the premiums yourself or the S corporation can pay them and report them as wages. If the policy is in your name and you pay the premiums yourself, the S corporation must reimburse you. You can deduct the premiums only if the S corporation reports the premiums paid or reimbursed as wages in box 1 of your Form W-2 in 2011 and you also report the premium payments or reimbursements as wages on Form 1040, line 7.
But if you were also eligible to participate in any subsidized health plan maintained by your or your spouse’s employer for any month or part of a month in 2011, amounts paid for health insurance coverage for that month cannot be used to figure the deduction. Also, if you were eligible for any month or part of a month to participate in any subsidized health plan maintained by the employer of either your dependent or your child who was under age 27 at the end of 2011, do not use amounts paid for coverage for that month to figure the deduction.
If you were eligible to participate in a subsidized health plan maintained by your spouse’s employer from September 30 through December 31, you cannot use amounts paid for health insurance coverage for September through December to figure your deduction.
Medicare premiums you voluntarily pay to obtain insurance that is similar to qualifying private health insurance can be used to figure the deduction. Amounts paid for health insurance coverage from retirement plan distributions that were nontaxable because you are a retired public safety officer cannot be used to figure the deduction.
If you qualify to take the deduction, use the Self-Employed Health Insurance Deduction Worksheet to figure the amount you can deduct. However use IRS Publication 535 instead of the Self-Employed Health Insurance Deduction Worksheet in these instructions to figure your deduction if any of the following applies.
You had more than one source of income subject to self-employment tax.
You file Form 2555 or 2555-EZ.
You are using amounts paid for qualified long-term care insurance to figure the deduction.
