Tax Tips 8-29-02-Who Gets the Deduction
RICHARD M. COLOMBIK, JD, CPA
WHO GETS THE DEDUCTION?
Many closely held business owners, particularly of S corporation, sometimes forget that their S corporation is a separate tax paying entity. This can potentially lead to problems not only in the ability of a plaintiff to ?pierce the corporate veil?, seek the owner?s personal assets, but can also lead to denial of otherwise legitimate tax deductions!
In a recent tax case, the taxpayer had guaranteed over $6.7 million of real estate loans for their closely held corporation. The corporation was building a shopping center. The shopping center was not progressing well and had delinquent real estate taxes for 1995 and 1996. The taxpayer had paid over $426,000 in one year and over $501,000 in a second year to pay the delinquent real estate taxes. The taxpayer then took the real estate tax deduction, within IRC §164 on their personal tax return. After all the taxpayer contended, they not only guaranteed the loans and would have to pay them, but if the taxes were not paid, they would lose $7 million!
The IRS protested their deduction based upon the issue that the real property taxes were not imposed upon the taxpayers, but against their corporation, even though the deduction by the corporation would have resulted in the taxpayer being able to deduct the taxes on their personal return.
The taxpayer then argued that if not deductible within IRC §162, then obviously the taxes should be deductible under IRC §162 as an ordinary and necessary business expense. Again, the IRS countered that a taxpayer may not deduct a payment made on another?s behalf unless it is made as an expense of the taxpayer?s own business which is not the business of a third party. Since the taxpayer was a shareholder, a shareholder is not entitled to a deduction from his individual income tax return for a corporate expense.
Therefore, even though if the taxpayer sought advice from competent tax counsel, they could have made their expenses deductible instead they not only could not, but also were liable for interest and penalties as well.
The moral of the story: Call your tax lawyer; that?s the way to save money.
DIVORCE LAWYER SHOULD HAVE GOTTEN TAX HELP
All divorce lawyers are aware that certain requirements within IRC §71 must be met in order to have one spouse take a deduction for payments made to another. This treatment generally is accorded to ?alimony?.
In a recent case, two taypayers had their marriage dissolved. Part of their settlement agreement required the husband to make a series of monthly payments to his former wife in exchange for the wife transferring her interest in a farm to him. The husband made all the payments and the wife received the payments. This was not in dispute.
The husband?s tax counsel reviewed the payments and the settlement document and noted that there was no mention of the tax consequence in the payment within the divorce decree. Tax counsel further analyzed the payments and determined that the strict letter of the law was followed by the payments to be deemed ?alimony or separate maintenance payment?. IRC §71(b). Since all factors were present within IRC §71(b), the payments to purchase the property technically qualified as alimony! The husband was entitled to a tax deduction for each and every payment made to purchase the farm and the former wife was required to include these in income.
Maybe they should have had a tax lawyer review the settlement agreement before they signed it, not after.
Another reason why tax counsel is indispensable to any business transaction, or personal transaction involving tax affected property.
NEW RETIREMENT PLAN OPTIONS
Defined contribution plans can now accept contributions of up to $40,000 per year per recipient. Only two years ago this amount was $30,000 which increased to $35,000 in 2001. This is an alternative that one needs to review.
Self employed plans have also been modified so that loans are now available.
Further, prior law required a taxpayer to set up two retirement plans in order to make a 25% of compensation contribution. Normally, a profit sharing plan was set up to receive 15% of compensation and a money purchase plan would typically receive 10%. Under current law, the full 25% can be contributed to a profit sharing plan. This eliminates the cost of setting up two plans and provides for more financial flexibility.
Clients that have more than one plan may wish to consider consolidating their plans so that expenses and fees are only charged for one plan instead of two.
This is an area that our expertise can be utilized and help you make a decision on which plan to retain and which plan to terminate.
A further benefit from qualified plans is they are exempt from creditor attachment. Non-qualified plans which are not ERISA qualified are only protected on a state by state basis, whereas qualified plans are protected nationally. This is another area which you should review with tax counsel.
Private foundations are an often overlooked estate planning and income tax planning device. The general structure is that a private foundation is set up today and you can begin making contributions to it today as well. The transfers that you make today provide a current income tax deduction, limited only by 30% of your adjusted gross income.
As an annual contribution can add up and deplete your estate, the general strategy is to take the income tax savings and purchase life insurance in an irrevocable life insurance trust. This way, the life insurance passes estate tax free, you get a current income tax deduction, and the property in your foundation passes estate tax free.
One of the best assets in which to fund a foundation is a retirement plan. For example, when one passes on, a retirement plan is subject to both income tax and estate tax. Instead, if a retirement plan is left to a private foundation, then no income tax or estate tax is due. As in a large estate, approximately 70% in the value would be paid between federal and state income tax as well as estate tax, a $1 million bequest to a family would only leave approximately $300,000 for the family and $700,000 would go to taxes. Therefore, a $300,000 life insurance policy would actually provide the family the same amount of money while leaving $1 million that the family could continue to manage and provide for the public good. This way, you can have things work to not only benefit you after life, but you could also have the part of the bequest made during life to provide you an income as well.
The laws are quite complicated, but can provide savings.
Remember to contact us to discuss how this may impact and benefit you and your family.
ABOUT RICHARD M. COLOMBIK
Richard M. Colombik is a tax partner in the Itasca headquartered firm of Richard M. Colombik & Associates, P.C. Mr. Colombik concentrates his practice in Federal Taxation, Estate Planning and Asset Protection Plans for individuals as well as corporate clients. He received his B.S. Degree in Business from the University of Colorado his J.D., Cum Laude, from the John Marshall Law School and his Certified Public Accountant certificate from the University of Illinois. Mr. Colombik has spoken at numerous engagements, radio television and is a well-publicized author regarding Income Tax, Estate Tax and Asset Protection Planning. His work, Business Entity Selection Within Illinois, has been published by the Illinois Institute of Continuing Legal Education. He is the former chair of the Illinois State Bar?s Federal Taxation Committee, Northwest Suburban Bar?s Estate Planning and Taxation Committee, Vice Chair of the American Bar Association?s Taxation Sub-Committee of the General Practice Council, a former officer of both the Northwest Suburban Bar Association, the American Association of Attorney CPAs, and is currently a member in the Offshore Institute. Mr. Colombik is also the current liaison to the Washington National office of the Internal Revenue Service for the American Association of Attorney-CPA?s, Inc.