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Al's column: Are you in the right class for tax purposes?

May 14/21, 2018: Volume 33, Issue 24

By Roman Basi

In one of my previous articles, I focused primarily on the Tax Cuts and Jobs Act’s (TCJA) impact on pass-through entities: sole proprietorships, limited liability companies (LLCs) taxed as partnerships or S corporations. In this installment, I provide an analysis of the other corporate form, C corporations. 

While an S corporation election can be beneficial for many businesses, don’t discount a C corporation’s 21% flat tax rate or let the fears of double taxation haunt your entity election. With the right advice, you can reduce (if not avoid) double taxation.

For guidance, see the chart below, which provides a comparison between pass-through entities and C corporations. Notice in the “comparison” column there is a $13,650 tax savings under a pass-through entity. If the analysis stopped here, every business owner would elect a pass-through entity. However, it is important to further analyze the comparisons as the complexities extend beyond what is provided in the numbers herein.

There are three important aspects to consider when analyzing whether a C corporation election is best for your business. In most small business C corporations, the shareholders also act as employees. Generally, there are two methods to allocate compensation to these shareholders. First, in the form of a qualified dividend subject to a distribution tax with a maximum tax rate of 20% (23.8% if subject to the net investment income tax). Additionally, the qualified dividend is a non-deductible, after-tax profit distribution to the corporation. Thus, a qualified dividend of $100,000 will be taxed at the 21% corporate rate and 15% distribution rate resulting in the highest tax burden of $32,850.

A second method of compensation is payment for services rendered in the shareholder’s capacity as an employee. In this scenario, compensation is only taxed at the individual level to the shareholder/employee and is deductible to the corporation, thus avoiding the prospect of double taxation.

The issue here is the compensation must be reasonably related to the services rendered. The interplay between compensation and the number of employees should be a focus of your tax analysis when determining whether to elect C corporation or pass-through entity status.

Moreover, if investment or expansion are part of your business model, a C corporation can retain its earnings tax free so long as it can provide proof of expansion or investment. However, retained earnings can become subject to taxation, as the IRS promotes policies of providing compensation or issuing qualified dividends.

This article just scratches the surface in the comparison between C corporations and pass-through entities. A number of other factors must be analyzed to determine the best path for your business.

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Al's Column: Avoiding the pitfalls of poor estate planning

October 9/16, 2017: Volume 32, Issue 9

By Roman Basi

 

Screen Shot 2016-07-15 at 3.49.34 PMIn my previous column, “Estate Planning: Leave it to the pros,” (FCNews, Sept. 11/18), I explained—citing several recent real estate tax cases—how unqualified advisors can potentially cause a host of problems for their clients. Despite having expertise in other areas, some attorneys, accountants and other professionals that do not specialize in estate planning can do more harm than good. In this installment, I will cover some of the financial repercussions of poor estate planning.

Choosing an unqualified person or firm to handle your estate planning can result in unforeseen financial consequences. The IRS has recently stated that for all 2017 cases attorney’s fees awards will remain at $200 per hour. This may or may not seem like a significant amount to some; however, the ramification is that if someone brings an action against a professional, that person may be subject to paying the attorney’s fees of the claimant at a higher rate than what they were paid to have the work completed in the first place.

And yet, while we caution everyone on proper planning, it does appear that our current system works well for encouraging charitable contributions. A report recently stated that over 2,600 estates with a net worth of approximately $61 billion made charitable contributions in their estates. This amount was a tax deduction for the estates and the government did not receive taxes in the range of $27.4 billion. It appears the estate tax law does in fact provide a substantial means by which charitable organizations can be funded. This is one key reason why charitable organizations do not want the estate tax to go away. If the estate tax did not exist, it appears that the donations to these organizations would decrease substantially as there would be no incentive to give as estate taxes would not be lowered.

Estate planning is very important to all of us as long as the estate tax law is in existence in the U.S. As a matter of fact, the IRS has recently released information about how important the estate tax is to the U.S. Over 11,917 estate tax returns were filed in a recent year. Of the taxable estates, 13.5% did not owe taxes, but the remainder owed estate taxes such that the total amount produced income to the U.S. Treasury of $17.09 billion. (And this is only for one year.) An interesting breakdown of the assets on the tax returns showed that traded stock, state and local bonds, cash and closely held stock and real estate—other than a personal residence—amounted to a total value of $60.12 billion.

Bottom line: Don’t put off creating an estate plan. And once you have created one, be sure to keep it current as your situation changes and as laws pertaining to estate taxes change. More importantly, use qualified professionals who specialize in estate planning. Remember, the Center has specialists that stay current with the tax laws and specialize in estate planning.

Be sure to attend my presentation on Tuesday, Jan. 30 at TISE, where I will discuss different ways to reduce your taxes and protect your assets. Following my session, I will be available for free, 30-minute consultations.

 

Roman Basi is an attorney and CPA with the firm Basi, Basi & Associates at the Center for Financial, Legal & Tax Planning. He writes frequently on issues facing business owners. For more information, please visit taxplanning.com.

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Financial: Estate planning—Leave it to the pros

September 11/18, 2017: Volume 32, Issue 7

By Roman Basi

 

Screen Shot 2017-05-15 at 9.35.04 AMWe all know the old saying, “Leave it to the experts.” Well, several recent estate tax cases clearly show us individuals who set up estates but are not specialists can create a lot of problems for their clients. Attorneys, accountants and other professionals that do not specialize in this area of the law are warned their actions might hurt clients instead of help them.

In illustration: A recent IRS case said a family member who had a power of attorney could not change a revocable trust and set up a limited partnership one week prior to the death of the father to remove the value of the assets out of the father’s estate. The court held the transaction was illusory and the full value of the business would be included in the estate. With an estate tax exemption of $5,490,000 at the federal level and potentially significantly lower ones at the state level, this can result in an estate tax that puts the business into bankruptcy or into a forced sale. In particular, estates in New York, Illinois, Massachusetts, New Jersey and Connecticut are reportedly where the greatest amount of estate tax is paid.

Another case involved an attorney who didn’t comply with deadlines in filing estate taxes. The tax court held that reliance on the attorney was reasonable and no penalty or interest would be due. The attorney even had the estate pay more taxes than were due on the tax return.

Remember this: Just because you get advice doesn’t mean you are going to get away with an unreasonable position. Take, for example, the case where an estate was liable for late filing and late payment penalties because it relied on an attorney who had committed malpractice in representing the estate. The court held that reliance on such an attorney was not reasonable cause for late payments.

Attorneys are not the only ones who have erred. An accountant handling an estate for someone who did not owe estate taxes failed to file a tax return. As a result, the qualified election for property to a spouse was lost. In the end, the court granted extra time to make the election so the surviving spouse did not have to pay extra taxes.

In another case involving taxes, a father had his sons create a new business that sold the equipment the father’s company manufactured. The “expert” in this case advised the sons’ company should hold the technology for the manufacturing. However, the expert advisor did not follow up and see that legal documents were created to actually transfer the technology to the sons’ company. Accordingly, the tax court concluded the transfer did not really exist, and the expert’s opinions were summarily disregarded. The result was a very high value on the father’s manufacturing company, which was determined to own the manufacturing technology, and this raised the total value of the father’s estate.

This is a very common problem I see in estate planning whereby plans are created, but the actual transfer of legal title of the assets does not always occur. In fact Illinois recently passed a law that allowed for a trust to be the constructive owner of a property that was not actually deeded into the trust—so long as the intent was to transfer the property into said trust. It happens so often that Illinois had to create a law to help advisors who do not follow through.

In my next column, I will discuss other implications of poor estate planning.

 

Roman Basi is an attorney and CPA with the firm Basi, Basi & Associates at The Center for Financial, Legal & Tax Planning. He writes frequently on issues facing business owners.

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Al's Column: Protect your assets, reduce your taxes

August 28/September 4: Volume 32, Issue 6

By Roman Basi

 

Screen Shot 2016-07-15 at 3.49.34 PMThere has never been a better time than now to have a discussion on how to create the best asset protection for your business and reduce the tax liability from both the perspective of the business and personally.

The House Ways and Means Committee continues to forge ahead in its effort on tax reform. In July the committee held a hearing with several small business owners who testified about the effects of the current, albeit complicated, tax code and how the new proposals put forth by a subcommittee as well as the White House would help encourage investment across the country.

Asset protection and tax liability go hand in hand; to achieve one, the other must be properly structured. One of the newest methods for asset protection gaining steam across the country is the advent of the Series Limited Liability Company—a Limited Liability Company that has elected to create multiple divisions (or series) that will operate within the company.

While not all states have created these legal structures yet, the number grows each year. And even if your business operates in a state that does not have such an entity, it is quite possible they will allow one that is registered in another state to be filed as a foreign entity in the state in which you are located. The state of Florida, for example, recently revised its Limited Liability Company Statute. While it does not currently have a Florida Series Limited Liability Company, the state expressly provided for the benefits and protections of them if they are filed as a foreign entity.

With a Series Limited Liability Company, each division can possess its own assets and have its own liabilities; the liabilities of one division do not cross over to another. So, for example, if you have a company that has machinery and equipment, you can create a series that owns the machinery and a separate series that owns the equipment—yet you still only have one company. The main benefit, experts say, is you have divided up any liabilities between the two categories of assets, protected them from each other but still have the simplicity of only dealing with one company.

Reducing tax liability
With the changes in the tax code on the horizon, it is increasingly important to understand the current taxation on your business and if your choice of entity selection will be the best going forward. For example, the House subcommittee is proposing to lower the S Corporation tax rate to a flat 25%, which might help someone who is in a high individual tax bracket but hurt a small business owner who is in a lower individual income tax bracket. To that end, a proper analysis of your current tax structure becomes very important when looking at the tax liability of your company to determine whether you need to consider changing the tax status of the business.

I will discuss both topics—asset protection and reducing your taxes—during my presentation at the International Surface Event (TISE) on Tuesday, Jan. 30, from noon to 1 p.m. I will also be available for free, 30-minute consultations after my education session that afternoon. Visit the TISE website today at intlsurfaceevent.com for the complete education program, event activities and registration details.

 

Screen Shot 2017-05-15 at 9.35.04 AMRoman Basi is an attorney and CPA with the firm Basi, Basi, & Associates at The Center for Financial, Legal & Tax Planning. He writes frequently on issues facing business owners.

 

 

 

 

 

 

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Al's Column: Choosing the right business entity profile

May 8/15, 2017: Volume 31, Issue 24

By Roman Basi

 

(First of two parts)

Screen Shot 2017-05-15 at 9.35.04 AMIn the past, choosing a business entity under which to operate was easy. Either businesses operated as a sole proprietorship, a partnership or they incorporated as an “S” corporation or a “C” corporation. There were clear advantages and disadvantages to each one. The sole proprietorship and partnership had the advantage of simplicity and lack of formal arrangements. The C corporation was for national companies, and the S corporation was for those individuals needing asset protection and a formal entity in which to operate.

Today the business structure is not a default arrangement. Businesspeople have an alphabet soup of business types from which to choose. Though many of the new forms offer limited liability and single layer taxation, the tax and legal differences are not nearly as clear as they used to be. This series will discuss three types of business entities and point out some subtle and not widely known differences between the chosen entities.

All three entities are excellent for any small businessperson to operate a company. When deciding which entity to operate under, the owner must take into consideration legal liability, tax circumstances while operating and dissolution, the person’s goals and the size of the operation among other factors. Tax circumstances are of utmost importance when choosing an entity. However, ease of transferability, legal protection and other factors are affected under each entity type.

Limited liability Co. With an LLC, there are no restrictions on ownership. An S corporation, on the other hand, has restrictions. To hold an S corporation status, one must be a resident and citizen of this country. Also, no more than 100 people are allowed to own stock. If the requirements are violated, the company losses its S corporation status and it can’t attain that status for years.

Screen Shot 2016-07-15 at 3.49.34 PMWith an LLC, these restrictions do not exist and its status is not jeopardized. While most LLCs will maintain membership of well under 100 members, the option or ability to expand the number of investors rapidly does exist. Many immigrants just starting business can benefit from this classification as well without suffering from double taxation.

While there are formalities with the LLC, failure to follow usual formalities is not grounds for imposing personal liability. This is a major convenience and aids in limiting liability. The other types of businesses identified here are all subject to being disregarded as an entity if the owner does not obey formalities. This is what is known as “veil piercing,” which happens when company owners don’t observe formalities in paperwork, meetings and otherwise use the business as an “alter ego.”

While the owner of the business cannot use the company to defraud people out of money, the LLC liability protection does not require the formality by which corporations must abide. Hence the LLC can be a better insulator against liability if maintenance of meetings and documents is going to be an issue.

Shares of an LLC are easier to put into a trust than an S corporation. To put shares of an S corporation into a trust, special trusts must be used. It can be somewhat complicated and LLCs tend to work very well instead of S corporations if you want to transfer ownership through a trust.

With an LLC, no unemployment taxes are due on income—unlike both the C corporation and S corporation. While this is not a huge tax savings it is significant. If your business is going to make less than $10,000 per year, LLCs might be the way to go. If you’re an at home business, this is particularly important.

Part two will cover the pros and cons of the other entities.

 

Roman Basi is an attorney and CPA with Basi, Basi & Associates at the Center for Financial, Legal & Tax Planning. He writes frequently on issues facing small business owners.

 

 

 

 

 

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Al's Column: Protecting your identity against theft

February 13/20, 2017: Volume 31, Number 18

By Roman Basi

 

(Second of two parts)

Screen Shot 2017-02-03 at 3.41.25 PMIn part I of this series, I talked about the various ways business owners can protect themselves from identity theft (FCNews, Jan. 30/Feb. 6). In this installment, I talk about the telltale signs that your identity and personal information may have been compromised and what to do to rectify the situation.

How to determine if your identity has been stolen. Two words will guide you here: “seek” and “watch.” One thing many people neglect to do is to monitor their credit report. Credit reports are available either online or through the mail with the three major reporting bureaus. They can be provided to you once a year at no cost to you. Even if you do not suspect identity theft, it is a good idea to get and view your credit report each year. In doing so, you can check to see if anyone else is using your social security number and you can have erroneous items removed.

More importantly, get into the habit of monitoring your credit on a regular basis—not only in situations where you anticipate having to take out a loan, for example. You can even sign up to receive automated texts or e-mail alerts. If you notice errors in your credit report, the best thing to do is make a complete list of them. Look at your personal information as well as your credit history. It’s estimated about 75% of consumer credit reports contain at least one mistake, and it’s likely a majority of those contain multiple errors.

The second thing to do is to watch for any suspicious activity. Do you receive your bills late? Are there any erroneous or fraudulent charges on your credit card? Are your bills coming at all? Do you have excellent credit but get denied requests to extend your credit line? Has the IRS stated that your income is higher than what you reported on your most recent tax returns? If so, it is possible and even likely that your identity has been stolen or contains substantial errors. If any of this happens it is time to get on the ball and find out the source of the problem. It could simply be an error, but it is better to be safe than sorry.

What to do if your identity is stolen. Again, two words should guide you here: “report” and “counter.” In the event of a breach and confirmation that your identity has been stolen, you need to report it immediately. First, contact all of your credit card companies; they will know what to do. Also, have them send you a credit card statement so you can determine what is correct and what is not. Next, contact all three credit bureaus and have a security hold placed on your accounts. Then, contact the local police and Federal Trade Commission. In the event you received information through the Internal Revenue Service, contact them and explain your story. These organizations will aid you in stopping the thief from going any further or doing more damage.

Lastly, contact other relevant financial institutions. As soon as you’ve begun the process of disputing incorrect credit report entries, contact the affected financial institutions, in writing, to apprise them of the situation. A letter similar to the one you send to the credit agencies, including copies of police reports and other documentation is best.

Don’t let a thief enjoy the fruits of all your labor.

 

Roman Basi is an attorney and CPA with the firm of Basi, Basi, & Associates at The Center for Financial, Legal & Tax Planning. He writes frequently on issues facing business owners.

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Financial: Valuing your business

January 16/23, 2017: Volume 31, Number 16

By Roman Basi

(First of two parts)

Each year more business appraisals are being created. While statistics are unreliable on the matter, it seems as though the word is getting out. If you are a closely held business, there’s a need to have your business appraised. This article focuses on the what, who, when and how.

Many businesspeople are not familiar with what a valuation is, why they need it and how to get a valuation done. In fact, many businesspeople are more familiar with the value of their house or automobile as opposed to the value of their business. This is surprising because their business may be worth more or carry more equity than their house. In the business world, not knowing the value of a business can translate into the loss of a lifetime of work in value and dollars.

Following are some of the basics:

What is a valuation? There are many misperceptions about valuations. Many business owners believe a successful valuation can be calculated based on simple multiples. For instance, someone is always inquiring as to whether he or she can multiply the gross income or net profit by a certain number based upon some theoretical condition of the business to reach a value conclusion. Neither the IRS nor any potential buyer will accept these multiples as a sound valuation. Two decades of experience in this profession and a whole host of IRS letter rulings, memorandums, statutes and cases demand that a simple multiple in determining value cannot be used to arrive at a valid figure. Business valuations are much more sophisticated than what a multiple can determine.

A business valuation is a report written by a qualified appraiser for purposes including business succession, estate and tax planning, litigation, buy-sell situations and other purposes. A business valuation will reflect the value of a business a willing buyer would agree to pay in an arm’s length transaction. IRS Revenue Ruling 59-60 reflects much of the methodology used in a valuation. The value of a business tends to be different than the actual selling cost of the business in 99 out of 100 cases.

The ‘who’

By definition, the valuation must be in the form of a written report. Oral reports from a valuator simply will not suffice because buyers, sellers and the IRS will not see much credibility in an oral report. It is also impossible to remember every important detail of a thorough report. That is why a written report is highly recommended and in some cases, required.

Furthermore, the valuation must be done by a qualified appraiser. First, the appraiser must be someone who does not have a bias concerning the value of the company. Generally friends, relatives and employees are excluded automatically from the definition. Also, the company accountant should not conduct the valuation since he or she is not in a position to be objective.

Next, the appraiser must be an expert on the matter. Being a CPA or attorney is simply not enough to certify a person as a qualified appraiser. The appraiser, by definition, must have the experience and training in both the areas of valuation and in the industry in question. The IRS and the courts will disqualify individuals who try to value companies when the business appraiser does not, in actuality, know or understand the industry.

In part II I will talk about the times “when” a valuation is critical.

 

Screen Shot 2017-01-16 at 12.28.07 PMRoman Basi in an attorney and CPA with the firm of Basi, Basi, & Associates at The Center for Financial, Legal & Tax Planning, Inc. He writes frequently in issues facing business owners.