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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 bought my principal residence many years ago and it has built up equity. I also have a second home. I have the opportunity to buy my brother’s interest in a vacation home (a potential third home) we inherited from our mother. For personal reasons I do not want to get into, I will not secure any debt with the vacation house. To buy his half of the property I am going to refinance my principal residence and pay him $90,000. Will the interest I pay on the home equity portion of the refinance be deductible?
   
   As long as your total home equity debt (the amount refinanced in excess of the remaining principal balance of the acquisition debt of your residence right before the refinance) does not exceed $100,000, you may use the proceeds for personal purposes and still claim a deduction for the mortgage interest.
   
2. My wife and I receive standard Social Security benefits (our only income- about $24,000 total for the both of us) for 2007 and I understand we qualify for a stimulus payment. We have not filed a return as we are not required to. How do we get the payment?
   
   To receive the stimulus payment ($600 for MFJ) you will have to file a Form 1040A- no tax will be due- reporting the Social Security benefits received that indicate your eligibility for the stimulus payment before the payment will be made.
   
3. I am the sole shareholder of my S corporation, and its sole employee. I had a larger profit this year than I anticipated. I extended both my individual return and the corporate return. I do not have a retirement plan for the corporation. Is there anything I can do now?
   
   Yes- you may establish and fund a SEP-IRA up until the extended due date of the corporate return. The corporation may contribute up to 25% of your compensation up to a maximum amount of $45,000. You will be an active participant for 2008 if the SEP is established and funded during 2008- but the S corporation may deduct the contribution on its Form 1120S for 2007.
   
4. I inherited a house from my Uncle late last year. I tried to rent it, but had no takers until earlier this year. Do I begin depreciating the property this year; when I first had a tenant?
   
   No. As long as the property was available for rent, you would depreciate it from that point. Even though you had no tenants, the property is considered to have been placed in service when it was ready and available to be rented. As you will have no income for the property, I would suggest that you keep whatever documentation (copy of ads showing the property was available for rent) you have with your copy of the tax return.
   
5. I gave my current residence to my four children last year. I still live in the house and pay all the maintenance costs and the property tax. I do not and will not pay rent. My children do not live with me. I was told by a good friend that estate tax will be avoided on the residence upon my death and the house will pass automatically to my children. Is this true?
   
   It is likely that your friend confused the probate process with estate tax exposure. As the title to the property passes immediately on death to your children, the value of the house is excluded from the state probate system. However, as you continue to occupy the house without paying a fair market rent and you maintain the house as your principal residence, its value will be included in your estate for estate tax purposes.
   
6. I am a sole proprietor and I have been in business for several years. My wife has been my only employee during that time. I just hired a couple of new employees this year. I want to institute a medical reimbursement plan, but do not want to cover the new employees. Can I exclude them?
   
   You may institute a medical reimbursement plan that provides coverage to all employees and their dependents (so that you can get coverage through your spouse) except those with less than three years of service; those under age 25; those who are part-time (less than 35 hours per week) or seasonal (less than 9 months per year); or those who are covered by a union plan or that are non-resident aliens. Credit may be given for past service, and the plan may be less restrictive (as long as that lesser restriction applies to everyone), if desired.
   
7. I am one of three shareholders of an S corporation. Two of us are going to buy out the third shareholder. What happens to the reporting for the S corporation before and after the buy-out? Do we have to allocate a share of profit or loss for the part of the year the departed shareholder had nothing to do with?
   
   Generally, an S corporation allocates profit and loss on a per-share, per-day basis for the tax year. However, when a shareholder terminates his or her entire interest, an election may be made under Section 1377(a)(2) to treat the tax year as if it consisted of two separate tax years. A statement is attached to the corporate return indicating the agreement and all of the shareholders must sign the agreement.
   
8. I own a hair salon and operate it as a sole proprietor. I am there daily and operate my own chair along with running the business. I rent chairs to other stylists. As part of the rental arrangement I provide a receptionist to make appointments, a hair washer, clean-up services and supplies. May I report the rent income and expenses on Schedule E?
   
   The rental of the space is incidental to the provision of the services. As such, the chair rental would be considered to be a trade or business and not a real property rental. The activity is properly reported on Schedule C, subject to SE tax. Given that you regularly participate in the operation and management of the business on a day-to-day basis, and assuming you are at risk, any losses incurred are deductible (will not be deemed passive losses).