Florida Tax Attorney Blog

If someone owes you money that you do not think you will be able to collect, you may have a bad debt for tax purposes. Pursuant to I.R.C. § 162(a), there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. In this respect, I.R.C. § 166(a)(1) allows a deduction for any debt which becomes worthless during the taxable year. As a threshold matter, two things must be established in order for a taxpayer to qualify for a bad debt deduction: (1) that the debt was bona fide at the time it was created; and (2) that the debt became worthless within the tax year.

Bona Fide Debt

A debt is "bona fide" if it arises from a valid and legally enforceable promise to pay a fixed or determinable sum of money. As a threshold matter, it is necessary to confirm that the loan at issue is, in fact, debt (as opposed to disguised equity). In this respect, the basic question is: was there was a genuine intention to create a debt, with a reasonable expectation of repayment, and did that intention comport with normal business practices? The answer to this question turns on the application of judicially developed factors to the facts and circumstances of the particular case.

Worthlessness

In order for a bad debt deduction to be claimed for tax purposes, the debt at issue must be "worthless." In this respect, worthlessness is a question of fact to be determined by the totality of the circumstances. In general, a debt is "worthless" if the facts and circumstances indicate: (1) that the debt is uncollectible; and (2) that legal action to enforce payment would in all probability not result in satisfaction on a judgment. Uncollectibility and unlikely recovery must be established by reference to identifiable events that demonstrate worthlessness and justify abandonment of hope of recovering the debt.

Partnerships and LLCs taxed as partnerships are pass-through entities in the sense that all of the income and expense items pass through the entity to the individual partners and are reported on the partners' individual tax returns. In order to prevent abuse, the tax code places several limits on the deductibility of partnership losses. One such limit is the "at risk" principle found in Section 465 of the Internal Revenue Code. Pursuant to that statute, a partner (or LLC member in an LLC taxed as a partnership) may deduct partnership losses only to the extent that he or she is "at risk." In other words, partnership losses are deductible only to the extent of the partner's financial risk exposure (i.e. how much money the partner stands to lose). Of course, a partner is "at risk" to the extent of cash contributions that have been made to the partnership. I.R.C. § 465(b)(1). However, a partner is not considered at risk for required future capital contributions unless and until the partner actually contributes the funds. Prop. Treas. Reg. § 1.465-22(d).

At the same time, however, a partner's amount at risk includes borrowed amounts to the extent that the partner is personally liable for repayment of a partnership debt. I.R.C. § 465(b)(2); Prop. Treas. Reg. § 1.465-24(a). In this respect, a partner is "personally liable" for at-risk purposes if he has ultimate liability to repay the partnership debt obligation. In other words, we are looking for the person upon whom the liability will eventually fall upon as a practical matter. At a high level then, the determination as to whether a partner is "at risk" with respect to a partnership or LLC debt appears to be a specific application of economic substance principles. Since economic reality controls the at-risk analysis, logic would dictate that a partner should be entitled to an increased at-risk amount to the extent that a deferred or future contribution obligation makes the partner potentially liable for a partnership debt, notwithstanding the rule articulated in Prop. Treas. Reg. § 1.465-22(d). This result is arguably supported by judicial authority.

In Hubert v. Commissioner, the Sixth Circuit effectively held that a partner's contribution obligation can support an increased at-risk amount to the extent that it operates in a way that causes the partner to become liable for a portion of the partnership's debts. Similarly, the Tax Court has held a partner to be at risk with respect to a deferred contribution obligation where the partnership pledged its right to receive that future contribution to an unrelated institutional lender as collateral for a bank loan. See Melvin v. Commissioner. The Tax Court reasoned that the deferred capital contributions would ultimately serve as the source of repayment in the event of the partnership's default on the loan.

In light of the foregoing, a partner may be at risk with respect to future contribution obligations. This increased at-risk amount would allow the partner to deduct a greater portion of his distributive share of a partnership loss. Note, however, that the circumstances under which a future contribution obligation is sufficient to support at-risk basis are very specific.

If you need help calculating your at-risk amount or structuring a partnership loan transaction to support an increased at-risk amount, contact me today.

It's that time of year again. Florida commercial property owners can expect to receive their property tax assessments in the next few weeks.

The Bad News

Your commercial property may be overvalued for property tax purposes. In Florida, real property is assessed through a mass appraisal process. In this respect, property appraisers use computer models and sometimes even aerial photographs to determine square footage and other material aspects of the property. After gathering this information about the property, property assessors use comparable sales and other general market indicators to value the property for assessment purposes.

This type of mass appraisal is necessary as a practical matter given the number of properties that must be valued. However, mass valuation techniques often fail to account for meaningful details, resulting in assessments that inaccurately value the property. Moreover, property tax assessments are performed a year in arrears. This means that your 2012 assessment is based on 2011 market indicators.

The Good News

You can fight back! As a Florida property owner, you have the right to appeal the County's assessment of your commercial property. If you believe that your assessment does not fairly reflect the value of your property, you may want to consider appealing the assessment. But the window for appeal is small, so you have to act fast!

In Florida, taxpayers only have 25 days to appeal the assessment. With assessments delivered in early August, the deadline for appeal typically falls around September 10. If you think the County has overvalued your commercial property, contact me today.

In a recent case, the United States Tax Court addressed an increasingly hot topic: the deductibility of business expenses. More specifically, the Tax Court addressed the substantiation requirement (i.e. the extent of support that a taxpayer must provide to support a business expense deduction).

Summary of Facts:

Taxpayer was employed as a mortgage banker by a company called Quick Loan Funding and Homefield Financial Inc. He was paid wages reported on Forms W-2, Wage and Tax Statement, of $ 127,319.47 and $ 79,052.24, respec-tively.

Taxpayer included three Schedules C with his individual tax return for three separate businesses in 2007. First, tax-payer reported gross receipts of $ 2,309 and claimed deductions for car and truck expenses of $ 10,242 in connection with his business as a mortgage banker. Respondent disallowed this expense. Second, taxpayer reported no gross re-ceipts or sales but claimed total expenses of $ 69,893 ($11,922 of which was for car and truck expenses) in connection with an advertising business. Respondent disallowed all of the ZE Advertising Co. claimed expenses. Finally, taxpayer reported gross receipts of $ 43,218, claimed costs of goods sold of $ 22,587, and claimed miscellaneous advertising expenses of $ 25,560 in connection with a search engine optimization business. The IRS disallowed all deductions.

Holding:

The Tax Court upheld the IRS' disallowance of taxpayer's claimed business expenses. Consequently, taxpayer was liable for taxes on the claimed deductions. Furthermore, taxpayer was liable for accuracy-related penalties for improperly claiming unsubstantiated business expense deductions.

Discussion:

Deductibility of Business Expenses

I.R.C. § 162(a) allows a deduction for "ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." In this respect, a business expense is "ordinary" if it is normal, usual, or customary within the taxpayer's particular trade, business, or industry. Commissioner v. Heininger, 320 U.S. 467, 471 (1943); Deputy v. du Pont, 308 U.S. 488, 495 (1940). Similarly, a business expense is "necessary" if it is appropriate and helpful for the development of the business. Id.

When is an Expense a "Business Expense"?

In Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987), the United States Supreme Court held that to be considered to be carrying on a trade or business within the meaning of section 162, "the taxpayer must be involved in the activity with continuity and regularity and . . . the taxpayer's primary purpose for engaging in the activity must be for income or profit." In determining whether a taxpayer's involvement with the alleged business was sufficiently continuous and regular, it is not controlling that the taxpayer intended to operate a business, because a business may not exist or yet have commenced without a single customer. There is no business in active operation where there are no customers and no evidence of any sales efforts that could lead to customers. Goodwin v. Commissioner, 75 T.C. 424, 433 (1980), affd. 691 F.2d 490 (3d Cir. 1982); Wolfgram v. Commissioner, T.C. Memo. 2010-69.

In Baacel Roumi v. Commissioner, the taxpayer failed to establish that his claimed advertising business was in fact an ongoing business for profit as required by Section 162(a). Taxpayer presented no evidence that the business was in operation in 2007. Indeed, taxpayer testified at trial that his advertising business was "in development" in 2007. Moreover, the advertising company's taxpayer identification number was not established until January 2008. Furthermore, taxpayer did not present evidence that the business had ever generated revenue or that he had claimed expense deductions relating to it in prior tax years. On this basis, the Tax Court held that the taxpayer failed to persuasively explain why an active business generated no gross receipts or sales yet managed to generate $ 69,893 in expenses.

Continue reading "MAKE SURE YOU CAN SUBSTANTIATE BUSINESS EXPENSE DEDUCTIONS" »

The new year is upon us, and so is tax season. And as tax season quickly approaches, it is important for Florida business owners to be aware of their tax obligations. Here's the 411 on when and how to file and pay:

FEDERAL:

Income Tax

Corporations

Due: March 15 if the corporation operates on a calendar year. Otherwise due on the 15th day of 3rd month following the end of tax year.

• C-corporations - Form 1120

• LLC Taxed as a Corporation - Form 1120

• S-corporation - Form 1120S (Note: an S-corp itself is generally not liable for any tax

Partnerships

Due: April 15 if the partnership operates on a calendar year. Otherwise due on the 15th day of 4th month following the end of tax year.

• Partnership - Form 1065

• LLC Taxed as a Partnership - Form 1065

LLCs

• Most LLCs with more than one member file a partnership return (Form 1065).

Due: April 15 if the LLC operates on a calendar year. Otherwise due on the 15th day of the 4th month following the end of the LLC's tax year.

• To be taxed as a corporation, a Form 8832 must be filed. LLCs taxed as corporations file a corporate return (Form 1120).

Due:March 15 if the LLC operates on a calendar year. Otherwise due on the 15th day of the 3rd month following the end of the LLC's tax year..

Single-Member LLCs

• Sole Member = Individual - Form 1040.

If you would prefer to have the LLC file as a corporation, you must file Form 8832. LLCs taxed as corporations file a corporate return (Form 1120).

• Sole Member = Corporation - Form 1120 (for C-corps) or Form 1120S (for S-corps)

Employment Tax
Businesses with employees must withhold federal income, Medicare and Social Security taxes from wages. When and how these taxes are paid to the government depends on a business's aggregate annual employment tax liability.

• Small Businesses With Annual Employment Tax Liability of Less Than $1,000: Payments may be made annually on January 31 by filing Form 944, Employer's Annual Federal Tax Return.

• Businesses With Annual Employment Tax Liability in Excess of $1,000: Payments are generally made on a monthly or semi-weekly basis. For businesses with total annual deposits in excess of $200,000, the Electronic Federal Tax Payment System is required. Businesses with total annual deposits of less than $200,000 may use Form 8109-B to make these payments. The tax should be reported on Form 941, Employer's Quarterly Federal Tax Return

Unemployment Tax

Due: Jan. 31, April 30, July 31, Oct. 31

• Must be paid for employees who were paid $1,500 in wages within a calendar quarter or who were employed for any portion of a day in 20 different weeks during the year.

• Due at the end of the month that follows the last day of each quarter.

• Electronic Payment or Form 8109-B.

• Paid on a quarterly basis, but reported on an annual basis (Form 940).

FLORIDA:

Florida Corporate Income Tax

Due: April 1 if the corporation operates on a calendar year. Otherwise due on the 1st day of 4th month following the end of tax year.

• Corporations that do business in Florida are subject to a 5.5% state corporate income tax.

• C-corporations generally pay tax on Form F-1120. However corporations with a tax liability that is less than $2,500 may file a short form, F-1120A.

Estimated Tax Payments: Corporations that owe more than $2,500 in Florida corporate income tax for the year must make estimated tax payments on Form F-1120ES on or before the last day of the fourth, sixth and ninth months of the taxable year and on the last day of the tax year.

Limited Liability Companies:

• LLCs which are classified as corporations for federal tax purposes are required to file a Florida corporate income tax return.

• LLCs which are classified as partnerships for federal tax purposes are required to file a Florida Partnership Information Return (Form F-1065) if they are doing business in Florida and one or more of their owners are corporations.

• A corporate owner of an LLC that is classified as a partnership for Florida and federal income tax purposes must file a Florida corporate income tax return.

S-Corporations: An S-corporation is not required to file a Florida corporate income tax return (except in cases where the S-corp has federal taxable income).Florida Unemployment Tax

Due:Jan. 31, April 30, July 31, Oct. 31:

A Florida business is required to report wages and pay taxes to the Unemployment Compensation program if:

• It paid $1,500 in wages within a calendar quarter;

• Employed one person for any portion of a day in 20 different weeks during the calendar year; or

• is liable for federal unemployment tax.

Generally paid on a quarterly basis by submitting Form UCT-6 to the Florida Department of Revenue.

Florida Sales and Use Tax

Due: First day of the month

• Businesses with taxable transactions must register with the Florida Department of Revenue by filing Form DR-1 or e-filing via the Florida Department of Revenue's website.

• Businesses that collect more than $20,000 annually in sales and use tax must pay through electronically.

• Businesses that collect less than $20,000 annually may use Form DR-15.

• Returns and payments are generally due on the first day of the month following the month in which the tax was collected. However, businesses that do not collect substantial amounts of sales and use taxes may file and pay on a less frequent basis. Specifically, businesses that collect less than $1,000 per year may file on a quarterly basis; businesses that collect $500 or less per year may file on a semiannual basis; and businesses that collect $100 or less per year may file on an annual basis.

Florida Discretionary Surtax

Due: First day of the month

• Some counties impose an additional surtax on transactions that are subject to the state sales and use tax.

• In such counties, this surtax is reported on Form DR-15 with sales and use tax.

Use Tax on Out-of-State Purchases

Due:First day of the month following the quarter in which purchase was made

• When out-of-state sellers fail to collect Florida sales tax, buyers must make the payment on their own.

• Applies to merchandise purchased from the Internet, shopping networks, mail order catalogs, etc.

• Applies to merchandise purchased while traveling out of state and shipped to Florida.

• Paid on Form DR-15MO

Florida Tangible Personal Property Tax

Due: April 1

• Florida businesses that own tangible personal property (e.g., computers, furniture, equipment) must this tax annually.

• Inventory is not subject to tax.

• Paid to county property appraiser on Form DR-405.

If you have been considering purchasing new computers, equipment, vehicles, or other assets for your business, it might be a good idea to make the purchase before ringing in the new year. This is because the Internal Revenue Code currently contains two provisions which allow immediate write-offs for certain qualified purchases (as opposed to gradual cost recovery over time in the form of depreciation deductions).

Section 179 Deduction. The maximum deduction allowed has been increased to $500,000 (instead of reverting to $25,000 as scheduled), and the maximum purchase price has been increased to $2 million. This includes new and used capital equipment. In addition, it includes software.

However, in order to qualify for the Section 179 deduction, the property must be acquired for use in your trade or business. For mixed use property (i.e. property used for both business and non-business purposes), the Section 179 deduction is still available if the property is used more than 50% of the time for business. In that case, the cost of the property should be multiplied by the percentage of business use, and the resultant business cost will be the basis for your Section 179 deduction. For the types of property that qualify for the Section 179 deduction, see the IRS website.

Section 168(k) Bonus Depreciation. Under Section168(k), a taxpayer is permitted to write off the entire purchase price immediately (as opposed to gradually recovering the cost through depreciation deductions over time). This is a big deal because the costs of these types of capital investments are typically recovered over a 7- to 15-year period. In some cases, the recovery period may even be 20 years. Significantly, Section 168(k) applies after the application of Section 179. This means that in cases where Section 179 does not allow immediate expensing of the full cost, the entire cost may, nevertheless, be deductible after application of Section 168(k). Note, however, that unlike Section 179, Section 168(k) only applies to new property. For more information regarding the types of property that qualify for the Section 168(k) deduction, see the IRS website.

Option to Opt Out of Bonus Depreciation. The IRS recently ruled that taxpayers may forego bonus depreciation at their option. It may seem illogical to forgo this kind of tax benefit. However, such abstinence is worth considering in cases where a business has expiring net operating losses or capital loss carryovers. In those cases, the loss carryovers should be used currently, and cost recovery deductions should be saved for later.

Under Subchapter S of the Internal Revenue Code, qualifying corporations can elect S corporation status, which allows the corporation to be treated as a flow-through entity for income tax purposes. This means that the income, deductions, and other tax attributes of the corporation flow through to the shareholders, who report corporate earnings on their individual tax returns. While this may seem insignificant, self-employed individuals can realize huge tax savings by operating as an S corporation.

Here's how it works:

The earnings of an S corporation can be allocated to shareholders in one of two ways: (1) as salary; or (2) as a distribution of profit.
Significantly, any amounts in excess of salary (i.e. distributions of profit) are not subject to FICA (Social Security) or Medicare taxes.

Therefore, self-employed individuals can partially opt out of the 12.4% FICA (Social Security) tax (on first $106,800 of salary) and the 2.9% Medicare tax to the extent that earnings are classified as a distribution of profit (rather than as salary).

As an example, consider a personal trainer who opens a personal training studio. Let's say that after paying all expenses, our trainer earns $100,000 during 2011. If the entire $100,000 is paid out as salary, the trainer will pay $15,300 in payroll taxes. ($12,400 FICA (Social Security) tax; $2,900 Medicare tax).

If, instead, $53,323, which is the average salary for a certified personal trainer according to the American Council of Exercise, is classified as salary and the remaining $46,677 is classified as a distribution of profit, the trainer will pay $8,158 in payroll taxes ($6612 FICA (Social Security); $1,546 Medicare). This amounts to payroll tax savings of $7,142, or 46.6%!

This loophole is popularly referred to as the "Edwards gambit," named after American attorney and politician, John Edwards, who notoriously avoided more than $500,000 in Medicare tax by employing the Subchapter S corporate structure for his law firm. In the four years before becoming a U.S. Senator, Edwards earned some $27 million as a personal injury lawyer. Of this $27 million, he classified about $1.5 million as salary and the remaining $25.5 million or so as a distribution of profit. In this way, he avoided paying Medicare tax on more than $25.5 million of earnings and saved $591,112.

To be sure, Edwards' tax avoidance tactic was widely criticized by political adversaries as evasive and deceptive. But the fact is that this tax avoidance strategy, when employed in a reasonable and non-abusive manner, remains permissible under the current tax law. So, don't hate the player, hate the game.

Continue reading "S CORPORATION COULD MEAN HUGE TAX SAVINGS FOR SELF-EMPLOYED INDIVIDUALS" »

One of the IRS's most commonly invoked arguments in the corporate context is the economic substance doctrine. Under this doctrine, tax benefits are denied if the transactions giving rise to the claimed tax benefits lack "economic substance" apart from tax considerations.

Of course, this begs the question: when does a transaction with favorable tax consequences have "economic substance" apart from the tax benefits?

As every good tax attorney knows, the answer is always a resounding, "it depends."

Over the years, different courts have formulated varying approaches for evaluating the economic substance (or lack thereof) of a transaction. Some courts have adopted a two-prong test requiring corporate taxpayers to establish: (1) economic substance; and (2) a business purpose. See e.g., Pasternak v. Commissioner, 990 F.2d 893, 898 (6th Cir. 1993). Other courts have adopted a disjunctive approach requiring corporate taxpayers to establish either: (1) economic substance; or (2) a business purpose. See e.g., Black & Decker Corp. v. U.S., 436 F.3d 431 (4th Cir. 2006). Still, other courts have considered all relevant factors in evaluating questionable transactions, with economic substance and business purpose constituting non-determinative factors to be considered. See e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d. Cir. 1998); Sacks v. Commissioner, 69 F.3d. 982, 985 (9th Cir. 1995).

In an effort to clarify the law on this point, Congress added Section 7701(o) to the Internal Revenue Code last year. Pursuant to Section 7701(o)(1), a transaction has "economic substance" if: (1) it changes the taxpayer's economic position in a meaningful way (apart from Federal income tax effects); and (2) the taxpayer has a substantial non-tax purpose for entering into the transaction.

Still, this begs the question: what types of non-tax benefits must a corporate taxpayer establish to demonstrate a "meaningful" non-tax change in economic position and what type of purpose must a corporate taxpayer have to establish a "substantial" non-tax purpose?

Continue reading "TECHINCAL COMPLIANCE WITH THE TAX CODE MAY BE INSUFFICIENT IN THE CORPORATE CONTEXT" »

I recently came across an article which discussed the operation of a business as a sole proprietorship. The article correctly identifies the informality and ease with which a sole proprietorship can be formed as advantages of this form of business organization. In addition, it correctly recognizes the sole proprietor's exposure to personal liability as a disadvantage of this form of business organization.

What the article fails to address, however, is the vast extent of a sole proprietor's risk exposure and the ease with which an entrepreneur can form a limited liability entity to protect against this risk.

Legally, there is no distinction between a sole proprietor and his or her business. This means that a sole proprietor's personal assets (e.g., real estate, car, boat) can be taken by business creditors to satisfy business debts and liabilities. However, an entrepreneur does not have to assume this risk.

Continue reading "ENTREPRENEURS SHOULD AVOID SOLE PROPRIETORSHIPS" »