Our Denver tax attorneys assist clients in resolving IRS debts, audits and other matters, as well as applying the tax laws to our client’s individual and business issues. If you or your business are experiencing difficulties with the IRS or any other taxing authority, or just need tax advice, contact Buckingham & McGuire law firm.

Deducting Business Expenses

Can I deduct my meals as a business expense?  Can I deduct this flight as a business expense?  Can I deduct the cost of my clothes or uniform as a business expense?  As a tax attorney, these are common questions I am asked, and rightfully so as everyone wants to take advantage of all potential deductions allowed by the Internal Revenue Code.  Not only is the deductibility of certain business expenses a hot topic with business owners, it is a hot topic and highly litigated topic with the Internal Revenue Service.  In fact, I recall reading a recent annual report to Congress by the Taxpayer Advocate Service whereby the deductibility of trade or business expenses he been one of the top ten most litigates issues for a very long time.  Furthermore, the same report stated that the courts affirmed the position taken by the Internal Revenue Service (the dissallowance 0f the deduction) in the vast majority of cases and that the taxpayer only prevailed (in full) about two-percent (2%) of the time.  The article below is not intended to be legal advice, but rather to provide general information regarding this issue.

First and foremost, we should start with the current law regarding deductions for business expenses.  Internal Revenue Code (the “Code”) Section 162 allows deductions for ordinary and necessary expenses incurred in a business or trade.  What actually constitutes ordinary and necessary may better be understood through an analysis of the case law, which is significant, surrounding the question.  Generally, the determination is made based upon a court’s full review of all facts and circumstances.

Based upon the black and white law under the Code, what constitutes a trade or business for purposes of Section 162.  Perhaps it is ironic that the term “trade or business” is so widely used in the Code, but yet, neither the Code nor the Treasury Regulations provide a definition for Trade or Business.  Personally, I think it would be quite hard to provide a definition for trade or business, especially under the auspices of income tax.  The concept of trade or business has been refined and defined by the courts more so than the Code.  The United States Supreme Court has held and stated that a trade or business is an activity conducted with continuity and regularity, and with the primary purpose of earning a profit.  Albeit broad, I would agree this definition would be sufficient for the majority of businesses I work and assist.

Now that we have an idea of what may constitute a trade or business, what is “ordinary and necessary?”  Again, the Supreme Court has helped provide definitions for these broad, but important terms.  Ordinary has been defined as customary or usual and of common or frequent occurrence in the trade or business.  Necessary has been defined as an expenses that is appropriate and helpful for the development of the business.  Further, it should be noted that some courts have also applied a level of reasonableness to each expense.

John McGuire is a tax attorney and business attorney at The McGuire Law Firm focusing his practice on issues before the IRS, tax planning & analysis and business transactions from formation to sale.

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Attempting to Avoid Shareholder Loan Reclassification

Many corporate shareholders may have taken a loan from their corporation.  In a prior article we discussed issues related to corporate loans and issues considered regarding the reclassification of a loan.  The article below discusses issues and actions a shareholder may consider taking to prevent the reclassification of a loan.  Please remember that this article is for informational purposes and it is recommended that you discuss any corporate loan issue directly with your tax attorney, business attorney or other advisors.

Proper recordkeeping and maintaining current promissory notes are of extreme importance regarding this issue.  The promissory notes must be kept current and reflect the payments that have actually been made by the shareholder to the corporation, the accrual of interest and other related issues in the previously executed notes.  Moreover, the approval of the loans should follow the proper approval and acceptance by the corporation’s board of directors and memorialized via the corporate minutes and other corporate memorandums.  The shareholder should also be able to verify that the interest has been paid on the note, the interest should be paid at regular intervals, and at least on an annual basis.  Contemporaneous evidence is always important when verifying loan payment and loan treatment to the Internal Revenue Service. From a tax return perspective, the corporate tax return should accurately reflect the loan on the balance sheet.

Because payment of the loan is such a vital factor, I often find it can be helpful to have multiple options or strategies for repayment.  Of course, the shareholder can make regular payments on a monthly, quarterly or yearly basis, but there are also other options for repayment.  If the corporation has strong earnings and profit, the shareholder could also use a distribution to pay make payment on the loan, perhaps even a lump sum payment to expedite payment on the note.  The shareholder may also be able to provide additional services to the corporation and receive bonuses for their work.  These bonuses could be paid to the shareholder and then paid to the corporation, or at least taxed to the shareholder as compensation and then reduce the amount of the note.

In short, generally the most important issues will be recordkeeping from corporate documents such as minutes, agreements and returns to the actual promissory note and making sure the shareholder is making payments with interest on the loan.

John McGuire is a tax attorney and business attorney at The McGuire Law Firm.  John assists clients with matters before the IRS, tax planning and advice, and business matters from contracts to the sale of business assets and interests.

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Rental Losses

Many individuals hold property for rent.  Rental properties can make good investment options as they diversify an individual’s overall portfolio, the mortgage can often be satisfied by the rental payments as equity grows in the property and with the allowable deductions, including depreciation, a loss may exists that allows the individual to lower their total income and thus taxable income.  In regards to the losses, it is important that those renting property understand rental losses and when they are allowed and when the rental loss is not allowed.  The article below has been prepared to provide general information regarding rental losses.

Rental income is generally considered a passive activity and thus is subject to the passive loss allowance rules under the Internal Revenue Code.  Under the code, a passive loss would generally not be allowed unless: 1) the taxpayer had passive income (passive losses can be allowed to the extent of passive income); 2) the taxpayer actively participated in the real estate activity and qualifies for the $25,000 rental real estate loss allowance; 3) there is a qualifying disposition under the Internal Revenue Code; or 4) the taxpayer meets the criteria to be considered a real estate professional.

It is likely the most common fact or circumstance that allows a taxpayer to take the passive loss is the $25,000 rental real estate exception. This exception allows a taxpayer with certain income to take the passive loss, up to $25,000 if the taxpayer actively participated in the rental.  Further, the taxpayer should know that the rental activity cannot be an equipment leases, but rather a real estate rental, they must have actively participated and their adjusted gross income needs to be within a certain amount or the allowance can be lessened or not allowed at all.

Thus, how does a taxpayer show active participation in a rental activity?  In general, if the taxpayer participates in the management of the rental activity they are likely to be considered to actively participate.  The taxpayer does not necessarily need to work a certain number of hours, but rather show they are exercising their own independent judgment and decisions regarding the rental, and not following the requests of another individual.  There are specific taxpayers that do not meet the active participation requirement, which are: 1) A limited partner; 2) A taxpayer with less than 10% ownership; and, 3) A trust or corporation, because the $25,000 allowance is only intended for a natural person.  It should be noted that a grantor trust could be an exception to number 3 above because a grantor trust is owned by a natural person because it is not deemed a separate entity.

The above article has been prepared by John McGuire, a tax attorney and business attorney at The McGuire Law Firm.  John’s practice focuses primarily on matters before the IRS, tax planning & analysis for individuals and businesses and business transactions from business formation to business contracts and the sale of business assets and interests.

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Loans to S Corporation Shareholder

Often times a payment or payments to S corporation shareholders will be booked or accounted for as a loan to shareholder.  Sometimes this is purposefully, other times, it may be due to lack of options.  These loans can be advantageous with the proper planning and/or under certain circumstances, but they can also create and lead to unintended and disadvantageous tax consequences.

If a loan is not being treated as a loan (documented, repayment with interest etc.) the loan can be reclassified as a distribution to the shareholder.  If the shareholder does not have enough tax basis in their stock, taxable gain will result when the loan is reclassified as a distribution.  Further, it is important to note that if a loan is reclassified as a distribution and there are multiple shareholders, the distribution could create disproportionate distributions amongst the shareholders.  Not only could the disproportionate distribution be a violation of certain law/business acts, the Internal Revenue Service could determine that the disproportionate distributions created or indicate a second class of stock.  As an S corporation, there can only be one class of stock, and thus, a second class of stock could/would result in the termination of the S corporation election, which could have ill intended tax consequences and other business consequences.

Given the above, what can be done in an attempt to prevent payments or disbursements to a shareholder from being treated as distribution, but rather a loan to the shareholder?  Generally speaking, the key is proving intent, that the disbursements were intended to be a loan or loans.  Below is a list of the issues and factors a court would likely consider when making a determination of whether or not a shareholder loan was in fact created.

  • Was the shareholder paying interest? It is also important to note, the IRS can impute interest under the Internal Revenue Code.
  • Is the amount/loan being repaid by the shareholder?
  • Is the debt evidenced by a written instrument such as a promissory note, with stated interest, payment terms & conditions and a maturity date?
  • How has the disbursement to the shareholder been recorded and reflected within the S corporation’s books
  • If the shareholder was in arrears of any payment, did the corporation attempt to enforce or require payment
  • Did the shareholder have the financial wherewithal to repay the note when the loan was provided by the corporation

Of all the above issues & factors, perhaps the most important is whether or not the shareholder was actually repaying the loan.  Courts have determined a loan existed even without documentation and promissory notes given the shareholder was making payments.

The above article has been prepared by John McGuire of The McGuire Law Firm for informational purposes.  John focuses his practice on tax matters before the IRS, advising individual & business clients on tax planning and tax related issues and business transactions from business formation and contracts to the sale of a business or business interest.

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Embezzlement or Fraud Involved With 941 Taxes

Embezzlement or theft may be a more frequent issue faced by small and medium sized businesses than many people think.  Often office managers or employees will improperly take money or assets from a business.  Although, perhaps not as common as an employee misappropriating monies or assets, I have seen professionals, such as the businesses CPA embezzle or steal money, which when done is typically a much higher dollar amount and more damaging to the company.  One means by which I have witnessed a CPA or professional embezzle monies from a business is through the employment tax (941 tax) process whereby federal tax deposits are paid to the IRS on a weekly or monthly basis.  Below I have provided examples of this embezzlement or fraud scheme, which hopefully can prevent some business owners from falling victim.

One situation whereby I have witnessed a CPA or office manager involved with theft or embezzlement from a company was when the CPA or office manager was preparing the 941 employment tax returns and in charge of making the federal tax deposits.  The scheme was conducted under the following facts & circumstances.  The corporation would run payroll and net payroll checks would be paid to all employees and officers.  A payroll report was provided to the corporation stating gross payroll, net payroll and the total employment tax liabilities.  The correct amount(s) were withdrawn from the corporation’s bank account to pay the tax deposits, but the deposits were not paid to the federal government or state agencies.  The deposits went to another account, usually an account under the control of the third party responsible for the embezzlement or fraud.

Thus, when looking at the bank statements, payroll records and 941 tax returns, everything would appear ok.  The net payroll was paid to employees and the appropriate amount was being withdrawn for tax deposits.  The internal books of the business would be in line.  When preparing the 941 returns, the correct return was provided to the necessary parties or officers for review and signature, but then a zero ($0) 941 was filed or no 941 was ever filed at all.  The business owners can be personally responsible for the trust fund portion of the 941 tax!

You may be asking yourself, how does the IRS catch on, or why did the IRS not catch on?  The IRS will catch on, because in all likelihood the business must issue correct W-2s to employees so employees can file their individual returns.  Eventually, the IRS will see that the W-2s are not matching up with the 941s and the federal ta deposits, but this could easily occur 12-24 months after the fact and thus the fraud could have been ongoing for 24-36 months.  Furthermore, if the individual responsible for the fraud also receives the IRS notices and is responsible for IRS contacts, knowledge to the business owners could be further delayed.

As a business owner, what can you?

  • Making the actual federal tax deposits yourself is the safest manner to prevent this fraud or embezzlement
  • If you do not make the deposits, make sure you obtain receipts of the deposits paid through eftps.gov and check these deposits against the bank withdrawals and applicable documents
  • Make sure the 941s are accurate based upon payroll and ensure they are filed. If filed and a balance is due, you would receive a notice within 15-60 days.
  • Make sure you are receiving all IRS and tax notices.

If you or your business have been the victim of theft or fraud through a similar 941 scheme, please feel free to contact The McGuire Law Firm to discuss your options with the IRS.

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Residency and Estate Taxes

What is the effect of an individual’s residency and the application of estate taxes?  This may be an issue that does not apply to you or your clients because you or your client is a citizen of the United States and thus the law is relatively clear that tax on the individual’s estate is subject to world-wide reach.  Once it is clear that your or your client is not a United Stated citizen a determination must be made upon residency, which will impact the reach of the Internal Revenue Code in regards to estate tax.

If based upon the facts and circumstances an individual is a resident of the United States for transfer tax purposes then the Internal Revenue Code will reach the world-wide assets of such individual’s assets regarding the transfer of such property regardless of where the property, properties or assets are located.  Furthermore, the individual will want to consider the application of the transfer tax laws of the state they are a resident in, or own property.

If the facts and circumstances show that the individual is a non-citizen and non-resident of the United States for estate tax purposes, the Internal Revenue Code would hold that transfer taxes should only apply to the individuals assets and property located within the United States, which may be referred to as United States situs property.

With the above being said, how does one determine residency for transfer tax purposes?  Believe it or not, Congress has not provided a specific definition for resident or non-resident.  The regulations provide somewhat of a definition using domicile as a concept.  The regulations state that a resident decedent is a decedent who at the time of his death was domiciled in the United States, and a non-resident decedent is a decedent who at the time of his death was domiciled outside of the United States.  See Regulations section 20.0-1(b)(1) and (b)(2).

Thus, we have narrowed (somewhat) our issue to defining what is domicile?  Generally, a person will acquire domicile in a place they are living (even for a brief period of time) given there is no present intention of leaving or removing themselves from the present location.  Thus, you could say domicile (at least for adults) could be established by physical presence in a place or location that is connected with the individual’s intent to remain in that location.  Generally, a child will take the domicile of their parent(s).  An individual will initially be considered domiciled where they are born and this domicile will continue until it is show to change.  Thus domicile may boil down to presence and intent.  Presence may be easier to prove and demonstrate than intent, as intent is inherently more subjective or likely to be so.

The above article was drafted by John McGuire.  John is a tax attorney and business attorney at The McGuire Law Firm focusing his practice on matters before the IRS, individual & business income tax matters and business transactions from formation and contracts to negotiations and the sale of business assets or interests.

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Passive Activities Discussed by Denver Tax Attorney

Many individuals do not understand passive activities & passive losses and the Internal Revenue Code Sections and Treasury Regulations that provide the tax law surrounding passive activities.  Further, you may not be aware that losses from passive activities may be disallowed or “suspended” so to speak.  John McGuire, is a tax attorney at The McGuire Law Firm and has prepared the article below to provide information regarding passive activities.

Passive activities would be considered business activities or other trade activities whereby you do not materially participate in the business.  Material participation involves regular, continuous and substantial involvement in the operation of the business or trade.  A common passive activity could be your involvement with rental properties and real estate.  Generally, rental properties and real estate activity is considered passive even if you are materially participating in the activity.  It is important to note that you may be considered a real estate professional and with such designation your rental activities may not be considered a passive activity. Below are some common questions and issues related to passive activities.

Who do the passive activity rules apply to?  The rules will apply to the following:

  • Individuals
  • Trusts (other than grantor trusts)
  • Estates
  • Closely held corporations
  • Personal Service Corporations

Although, the passive activity rules do not apply directly to a partnership, S corporation or grantor trust, it should be noted and understood how the passive activity rules can apply to the owners of these entities.

In general, a passive activity loss will be disallowed.  Your passive loss would be the excess of your passive deductions over the gross income from your passive activities.  Certain passive losses may be allowed, which are issues for a separate article.  So, if a passive loss is disallowed, what happens to the loss or do you ever get to use or take advantage of the loss.  In general, you may be able to take the disallowed loss or losses when you dispose of your entire and total interest in the property.  For example, assume you could not take certain losses from real estate due to your adjusted gross income or other issues.  When you do sell the property and dispose of your entire interest in that real estate whereby the loss has been disallowed, you may be able to claim the previously disallowed passive activity losses.  This is different from unused passive activity credits.  You cannot claim unused passive activity credits when you dispose of property with the unused credits.

You can contact The McGuire Law Firm to speak with a tax attorney regarding your individual and/or business tax matters.  In addition to his law degree, John McGuire holds an LL.M., which is an advanced degree in taxation. Mr. McGuire’s practice focuses primarily on tax issues before the IRS, individual & business income tax matters & law and business transactions.

Denver Tax Attorney

Contact The McGuire Law Firm at 720-833-7705 or http://jmtaxlaw.com/ to speak with a tax attorney in Denver, Colorado or Golden, Colorado.

 

 

IRS Audit Tip On Mileage Deduction

If you take mileage as a deduction on your income tax return, the IRS audit tip below may help you.  Many individuals will claim mileage as a non-reimbursed employee expense on Form 2106, or if self-employed, on a Schedule C, or the deduction may even be stated on another business income tax return.  Most individuals know that to substantiate the mileage deduction they need to keep a mileage log stating where they drove, the total mileage and other information such as the business purpose for the travel.  What many individuals may not be aware of is that the IRS may also request them to verify the total mileage driven on their vehicle with third party records.  This issue is discussed below in greater detail.

Recently, I was involved with an individual income tax audit with a client over multiple periods of 1040 Schedule C (self-employed) filings.  The individual drove a decent amount in their business and had taken the mileage deduction on multiple vehicles that were used for business purposes.  The individual had maintained mileage logs for each vehicle and properly claimed the deduction on their schedule C.  During the audit, the IRS examiner requested that the individual obtain maintenance records to substantiate the total miles driven in each vehicle during the year.  This request was not to produce a mileage log of business miles driven, but records from oil changes and other maintenance records to show and verify the total number of miles, personal, business and commuting, over the course of the year.  For example, the examiner wanted to see the report from Grease Monkey stating the total mileage on the vehicle and be able to track and substantiate the mileage driven to see if the business miles claimed appeared reasonable and within the total mileage driven on the vehicle.

After the above incident, it is apparent the IRS is not only requiring a mileage log, but some form of 3rd party document to verify that the miles claimed are in line with the actual miles driven.  This being said, in addition to maintaining a mileage log, it is apparent that taxpayers taking the mileage deduction would be best served by maintaining all reports and maintenance records to verify their mileage.  Remember this the next time you take your car to the shop for an oil change or any repair!  It is probably best to even make a copy of the maintenance records and maintain the document with your mileage log and other tax related documents.  Tell your mechanic to keep the receipt clean!

John McGuire is a tax attorney and business attorney at The McGuire Law Firm.  Mr. McGuire’s practice focuses on tax issues before the IRS, tax planning, business transactions and tax implications to his individual and business clients.

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How is my Settlement Taxed?

How is my settlement taxed?  If you are involved in a lawsuit and are anticipating compensation for damages, this is a question you may be asking yourself and it is important to understand the tax implications related to your settlement.  The article below has been prepared by John McGuire, a tax attorney and business attorney at The McGuire Law Firm to discuss the taxation of settlements for lost wages, lost profits and loss in value of property.  Please remember that this article is for informational purposes only and to consult directly with your attorney and tax advisors.

If your lawsuit is an employment related lawsuit for a claim such as involuntary termination or unlawful discrimination, the proceeds received for lost wages, severance pay or back pay are considered taxable wages and are subject to self-employment tax.  Thus, these settlement proceeds are subject to federal income tax, social security tax and Medicare tax.  Furthermore, these proceeds should be subject to withholding and therefore the payor (generally the employer) should issue a W-2 to reporting the wages or salary (income) and taxes withheld.  You would thereafter need to report this income on your 1040 individual income tax return.

What about lost profits from a trade or business.  Settlement proceeds received from lost profits will also be subject to self-employment tax and would be included in your business income.  Issues and facts may vary, but in general, proceeds for lost profit would be reported as income to your business as if the business had made the money.

What if your lawsuit involves property and the lost value of property or loss in value of property?  If the settlement amount for a loss in value of property is less than the adjusted basis in the property, than the settlement amount should not be taxable, but you need to remember to thereafter reduce the adjusted basis in the property by the settlement amount for future gain or loss determinations.  On the other hand, if the settlement amount you receive exceeds the adjusted basis in the property, this excess amount is income.  The income may be capital gain income, and a full discussion of this issue would be better served in a separate article.  You can review the instructions for Form 4797 and Schedule D, which discuss capital gain & loss, and the Sale of Business Property.

What if a portion of my settlement proceeds are allocated for interest?  Generally, the interest portion of the settlement would be taxable as interest income, and thus would subject to ordinary income tax.

What about punitive damages?  Punitive damages are generally considered “other income” and thus would be subject to ordinary income tax.Please note, you may be required to make estimated tax payments based upon your settlement amount, which you can review under IRS Publication 505.

John R. McGuire is a tax attorney and business attorney at The McGuire Law Firm.  John’s practice focuses primarily on tax issues & matters before the IRS, tax planning for businesses & individuals and business transactions and contracts from the formation of a business to the sale of a business.  John can be reached at John@jmtaxlaw.com

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You can contact The McGuire Law Firm to schedule a free consultation with a tax attorney in Denver, Colorado or Golden, Colorado.

Minimum Gain Chargeback Provisions

If you have reviewed partnership agreements or operating agreements for an LLC you have probably read provisions relating to Minimum Gain Chargeback.  That being said, the Minimum Gain Chargeback provisions may have put you to sleep, and may not even be practical based upon the facts and circumstances of the partnership.  However, Minimum Gain Chargeback provisions are important to understand if in fact they were to apply to your situation and circumstances.  The article below has been prepared by a tax attorney and business attorney from The McGuire Law Firm to provide an explanation of Minimum Gain Chargeback.

Minimum Gain Chargeback provisions deal with non-recourse debt and the allocations of non-recourse debt.  Such provisions are mandatory if the partnership wishes to allocate non-recourse deductions to the partners in any manner other than per the member’s pro-rata portion of capital interest in the partnership.  Therefore, it is important to identify when a Minimum Gain may be realized.  Minimum Gain occurs when deductions are claimed on property that decrease the partnership’s book basis in the property below the actual balance of the non-recourse debt on the property.  A situation whereby you may see Minimum Gain is when property is depreciated.  The depreciation will drive the partnership’s book basis of the property below the amount of the loan on the property.  When a partnership does have Minimum Gain, the Minimum Gain Chargeback is an allocation of the gain to the partners or members who have received the benefit of non-recourse deductions, or who may have received distributions from the partnership that can be attributed to the non-recourse loan.   In short, if a partner has received a benefit from the depreciation of property whereby they did not bear the economic risk of the loan to acquire the property (because the debt was non-recourse and not personally guaranteed), the benefit can be “charged back” to the partner.

So when does the “charge back” occur?  The deductions or distributions taken by the partners are charged back when the property that was subject to the non-recourse debt is sold, transferred or otherwise disposed of, or when there is a change in the character of the non-recourse debt.  A change in the character of the non-recourse debt could be the debt converted to a recourse liability or the debt being forgiven.

Now, the million dollar question: What is the amount of the charge back?  The partnership’s minimum gain is generally going to be the excess of the non-recourse liabilities over the adjusted tax basis of the property subject to or securing the non-recourse debt.  Perhaps an example will help illustrate this.   Assume J&J, LLC had purchased property for $200,000 and took $100,000 in depreciation on such property.  Thereafter, J&J LLC obtain non-recourse financing of $250,000.  The minimum gain would be $150,000, which is the non-recourse debt of $250,000 less the adjusted basis of $100,000.

It is important to remember that a partner is not subject to a charge back for monies they contribute to repay a non-recourse debt, and it is possible for the partnership to request a waiver of the chargeback under certain circumstances.

John McGuire is a tax attorney at The McGuire Law Firm whose practice focuses primarily on tax matters before the IRS, business transactions and tax issues as they apply to his individual and business clients.  In addition to his law degree, John holds an advanced degree in taxation (LL.M.).  Please feel free to contact John with any questions.

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