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TOP TAX QUESTIONS OF THE MONTH

This is a monthly reference source. By providing these 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. We can call and talk over your particular situation with the Research Department before we try to answer the specific problem YOU may have. You may not rely on any answer given to avoid a penalty assessed by IRS.

1. I am the sole shareholder of a regular corporation formed in 1990. On formation, I transferred some property (land and building) to the corporation tax free under Section 351. Is there such a thing as a “reverse” tax-free transfer?
   
   Unfortunately, a tax-free incorporating transfer is a “one-way” transaction. A distribution of the property by the corporation to you will be treated for tax purposes as if the corporation had sold the property for its fair market value (taxed to the corporation) and is distributing a dividend (taxable to you). The good news today is that the dividend is a qualified dividend is taxed at a maximum rate of 15%. The bad news is that the difference between the property’s net book value and fair market value is taxed to the corporation.
   
   An option to explore would be an election to S corporation status. While built-in gain is taxed at a flat 35% rate, if the assets present on conversion to S status are retained for at least 10 years, the built-in gain tax does not apply. This would at least eliminate the double-tax aspect. Get your corporate information together and we can discuss it.
   
   
2. I am currently operating a single-member LLC as a sole proprietorship. I am bringing on another member, and the LLC will be taxed as a partnership. She will contribute her services only. She will have a 40% profit/loss percentage and initially will have no capital interest. Is the receipt of the membership interest taxable to her?
   
   In general, the receipt of a profits interest in exchange for services is not taxable unless the profits interest relates to a specific, highly reliable income stream; the new member disposes of the LLC interest within 2 years; or the interest is in a publicly traded LLC or partnership. If a capital interest is received for services, the member is taxable on the value of the services and the LLC may deduct the amount (that amount also represents basis in the membership interest).
   
   
3. My mother passed away late last year. She designated me and my three sisters as beneficiaries of her IRA. We directed a lump-sum payment. Where do I report that payment on the Form 1041 for her estate?
   
   If you and your sisters were specifically designated as beneficiaries, the distribution is reported on your individual returns (Form 1040), not on the Form 1041 for the estate. If the estate was the designated beneficiary of the IRA, the distribution to the estate would be reported on the Form 1041 for the estate. If distributions of the proceeds were made to the beneficiaries of the estate, income would be reported to the beneficiaries to the extent of distributable net income (roughly the taxable income less expenses) of the estate. The distributable net income would be reported on the Form K-1 issued the beneficiaries by the estate to the extent of the distribution.
   
   
4. I am the sole shareholder of an S corporation, and I have not established a retirement plan in the S corporation for 2006 yet. I understand I may establish and fund a SEP up to the due date of the employer’s return, plus valid extensions. If I extended the S corporation return but filed it before the extended due date may I establish and fund the SEP by the extended due date of the shareholder’s individual return?
   
   The SEP is established at the S corporation level and it must be established by the due date, plus valid extensions, of the S corporation return. You have until the extended due date for the S corporation return regardless of whether the corporate return was filed before the extension expires. You may not, however, wait until the extended due date for your individual return to establish and fund the S corporation SEP-IRA.
   
   
5. I am the executor of my aunt’s estate, and I am also one of three beneficiaries. The estate will close in the next month or two. The only assets in the estate are some stocks and an investment account generating some interest and dividends. The return for this year will be the final return for the estate. I think the winding up expenses will be more than the income, but I am not sure. Can I have the estate pay the tax on the income earned from the stocks and investment account?
   
   In its final year, an estate becomes a pass-through entity. The income passes through to the beneficiaries and is not taxed to the estate. This treatment is not elective. If the estate has expenses incurred in excess of income, those excess expenses will be reported to the beneficiaries and are deductible as itemized deductions subject to the 2% of AGI limitation.
   
   
6. I am the sole shareholder of a C corporation. The C corporation acquired a building years ago. I now plan on moving and I am considering the use of a facilitator in a tax-free exchange to acquire a new building. I want to hold the new property outside the corporation. Can this be done tax free?
   
   To qualify for tax-free treatment, the proceeds held by the facilitator must be reinvested for the benefit of the same entity that placed the property into the exchange. As your C corporation owned the property placed with the facilitator of the exchange, the corporation must acquire the replacement property to quali fy the transaction as a tax-free exchange under Section 1031.
   
   
7. My father formed a revocable living trust before he died late last year. However, he did not transfer any assets into the trust. I am handling his affairs. He had several brokerage accounts that have generated income. Do I have to file a tax return for the trust? Can the trust have a fiscal year?
   
   As the trust was never funded and will generate neither income nor expense, no tax return is required. In general, a trust return is required if a trust has any taxable income, gross income of $600 or more or has a nonresident beneficiary. Check your father’s will to determine if the trust is to be funded by the estate. The will may call for assets to be placed in the trust. If so, a Form 1041 will be filed for the estate for the period it is open, and once assets are placed in the trust, a Form 1041 will be filed for the trust. While an estate may have a fiscal year, a trust must generally use a calendar year.
   
   
8. I am the sole shareholder of a C corporation. Its assets will be sold next week. If I elect S corporation status now, will I avoid the “double tax” problem?
   
   Unfortunately, the election to S status will not provide tax relief. The assets present on the election to S status are subject to the built-in gains (BIG) tax. The amount subject to the BIG tax (assessed at the at the S corporation level at a flat rate of 35%) is the difference between the assets net book value and fair market value at the time of the conversion to S status. Any assets present on the conversion to S corporation status that are disposed of within 10 years of the election are subject to the BIG tax.
   
   
9. I had a single member LLC which I was using to operate my business. I now have a partner- so the LLC is now a two member LLC, taxed as a partnership. My partner contributed some equipment and operating cash for his interest. There was no debt and there is no debt in the LLC. Is the change from a single to two member LLC taxable to me?
   
   In general, the formation of a partnership is not a taxable event. As you indicate that the transaction does not result in your receipt of any cash or other property in exchange for your interest (the cash from the oncoming partner is to be used for business operations), you are considered to have contributed the current business assets and your partner the equipment and cash to a new partnership. This is not a taxable event for either you.
   
   
10. I just received a condemnation award of from the city of $900,000 on property that I rent out. I want to replace it with another rental property. My basis in the condemned property is $400,000. Is there anything I can do to avoid gain?
    
    You have three years from the end of the year in which proceeds were first received to purchase replacement property to defer gain under the involuntary conversion rules. If you spend at least $900,000 on replacement property within the three-year time frame, you will have no gain on the condemnation award. Instead, your basis in the replacement property will be reduced by the amount of the gain deferred ($500,000). If you spend more than $400,000 but less than $900,000 within the three-year time frame, you will defer gain dollar-for-dollar in the amount of that excess. If you spend $400,000 or less on replacement property during the three year replacement period, you will not defer any gain.