LLC and S-Corporation Late Filing Penalties
Generally, LLC and S-Corporations do not pay income tax. However, these entities are subject to late filing penalties if tax returns are filed late. The federal penalty recently increased to $195 per partner/shareholder per month for a maximum of 12 months. California late filing penalty is $18 per partner/shareholder.
New Business Venture
If you are filing do business as a corporation, defining equity elections and dilution exposure often moves front and center. One often over-looked election – to protect against potential loss – is the 1244 election. This code section allows you to take an ordinary deduction for a loss of up to $100,000 (married, filing joint) on qualifying stock. If the company prospers, the tax protection is immaterial. However, if the company fails, without the election you’ll be looking at a capital loss limitation of $3,000 each year for a long time. Section 1244 treatment is only available to stock acquired under its original issuance.
Deducting International Travel
You may deduct travel outside the United States even if you don’t spend your entire time on business. If you meet any of the following exceptions, travel expenses are fully deductible:
- You were outside the United States no more than one week (7 consecutive days).
- You were outside the United States and less than 25 percent of the time was spent on non-business (personal) travel.
- You can establish that a personal vacation was not a major consideration, even if you have substantial control over arranging the travel.
You may deduct expenses for your car, van, or truck when used for business purposes using either actual expenses or the standard mileage rate. Generally, the standard mileage rate will prove more beneficial with older vehicles or when business use remains less than 50%. When using the actual expense method, deductible expenses include business percentage of gas and oil, insurance, licenses, parking fees, registration fees, repairs, tires, tolls and even garage rent. The cost of the vehicle is depreciated over a five-year schedule – but subject to annual limitations. If your newly purchased vehicle weight is greater than 6,000 pounds, up to $25,000 may be deducted in the first year.
Travel & Entertainment Tax Trips
In order to be deductible, any convention or seminar has to be deductible as a trade or business expense. Expenses related to seminars for investment purposes are not deductible. The nondeductible expenses include travel, lodging, meals, and the cost of the seminar itself. Thus, none of the costs associated with seminars related to investments, financial planning, or income producing activities (rental of property where it’s not a trade or business) are deductible.
Seminars for job-related education are deductible, but you must meet certain tests. First, there must be bona fide educational seminars and they must be for more than a nominal portion of the stay. For example, the IRS will disallow a deduction if you spent one hour per day in education and the rest lounging on the beach. When Congress wrote the law, they gave an example of situations where a deduction would be denied if participants simply showed up and received a videotape to take home.
Second, the seminar must meet the other tests for deducting education expenses. That is, if your company pays the expense and the topics are related to your current job, the company can take a deduction. If you pay for the seminar personally, you can deduct the expenses on your personal tax return (subject to the 2% floor), but only if the course work is to maintain skills in your present job. If it could qualify you for a new job, no deduction is allowed. You can deduct conventions and seminars on cruise ships, but only if the cruise ship calls on ports in the U.S. or its possessions, is registered in the U.S.; and the convention is directly connected to the active conduct of your trade or business.
Partnerships, S-Corporations, & LLC’s Losses or Bad Debts
While computing your basis in a partnership, S-Corp or LLC may sound like an esoteric subject; however, it is vitally important. Your basis will determine whether a distribution to you is taxable or nontaxable, or losses incurred by the business are deductible or nondeductible on your personal return. It will also determine your gain or loss if you sell all or a portion of your interest in the entity. Unfortunately, while the theory is similar, the rules for computing basis are more complex for partnerships and LLCs than they are for S corporations.
Fred Flood owns a 50% interest in Tight-Seal LLC. His basis in the LLC at the beginning of 1999 is $5,000. Sue Sharp is the other 50% owner. Her basis at the beginning of the year is $100,000. During the year Tight-Seal has losses of $40,000 ($20,000 for each partner) and distributes $30,000 to each partner. The result? Sue’s starting basis is so high she doesn’t have a problem. The distribution isn’t taxable to her and she can deduct her share of the $40,000 loss. Fred is not so lucky. He can only deduct $5,000 of his $20,000 share of the loss. The remaining $15,000 can be carried forward. Unfortunately though, Fred’s loss reduces his basis to $0 meaning the $30,000 distribution is taxable income to him.
If your equity investment is small and your basis low, you should compute your basis regularly or at least before the entity makes distributions and certainly before the end of the tax year.
Losses or Bad Debts Requirements to Claim a Deduction
Losing money can be a devastating experience, but the loss of that money does not always create a tax loss. For instance, if you work for an employer who skips town before you can get your paycheck, the lost earnings are not tax deductible. You may have grounds for legal action, but that does not give you a tax write-off. If you offer a non-refundable deposit on a house and the financing doesn’t go through, you have lost money that is not tax deductible.
On the other hand, if make a down payment to a contractor to complete work and the work is never completed, you have a tax loss. If you have a building demolished, the remaining basis of the building is added to the basis of the land that will influence the gain or loss upon sale of the land.
You may also have a loss if you hold a delinquent promissory note. However this can be a nebulous area. In order to take the loss, you must have a bonafide debt. To further complicate the matter, if the loan is to a related party, the IRS is reluctant to allow the loss. The exchange of money may be viewed as a gift. An individual must prove that the non-business debt is totally worthless in order to take the loss. This means that all measures to collect the debt have been taken. It does not, however, require court action.
Requirements to Claim a Deduction
There are two basic requirements to claiming a deduction – expense validity and documentation. In the case of a business expense, you must show the expense was incurred for a business reason. Sometimes that’s obvious; sometimes it is not so clear. The IRS is unlikely to question the business purpose of tax books purchased by an accountant. However, if there’s any possibility of personal use (e.g., supplies purchased by a contractor could be used for work done on his or her home), make sure you can prove business use. Documentation – keep copies of your payments (canceled checks, credit card receipts, etc.) and a receipt, invoice, bill, etc. for the item. In Nicholas M. Romer (T.C. Memo. 2001-168) the taxpayer (a CPA) used his airplane for business and claimed a deduction for the fuel. The IRS disallowed some of the expenses because he did not have receipts and could not show business use. The Court also disallowed some travel and entertainment expenses for lack of substantiation and a failure to demonstrate a business purpose.
Investor or Trader
If you are an investor, any losses you incur are limited to offsetting your gains or up to $3,000. If you are a trader, your losses are fully deductible against ordinary income. In a recent case, a taxpayer was employed full-time as an engineer earning $75,000 per year. The taxpayer engaged in 323 trades during the first six months of the year, but 303 of those trades occurred during a three-month period. The taxpayer held most of the securities for less than a month. The taxpayer claimed trader status and deducted an $85,000 loss from the trades as a fully deductible ordinary loss incurred in a trade or business. The Court disagreed. It noted in order to qualify as a trader (as opposed to an investor) the taxpayer’s transactions must have constituted a trade or business. In determining whether a taxpayer who manages his own investments is a trader, and thus engaged in a trade or business, relevant considerations are the taxpayer’s investment intent, the nature of the income to be derived from the activity, and the frequency, extent, and regularity of the taxpayer’s securities transactions. The taxpayer’s transactions were frequent, regular and continuous only for a three-month period while he kept his full-time job as an engineer.