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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 formed a revocable trust several years ago and transferred assets to the trust. The trust assets generate about $7,000 annually in taxable interest and dividends. My gross income is about $24,000 annually. I mistakenly thought when I established the trust I did not have to report the income. The trust has not filed a return either. Should I amend my prior three years returns?
   
   You are correct that a revocable trust is generally considered to be a grantor trust and is disregarded for tax purposes. The trust is not required to file a return while it is a grantor trust. All of the income, loss or deduction associated with the trust is reported on your individual return. If the unreported income exceeds 25% of your gross income, the statute of limitations for assessment is six years instead of the usual three years. If IRS successfully asserts that the omission was due to fraud- there is no statute of limitations and all prior years are open.
   

2. My wife and I qualify for a $1,200 stimulus payment. We filed our return but have not received the payment. We owe back taxes for a prior year. Will IRS apply the stimulus payment to the payment to our tax bill?
   
   The stimulus payment may be applied by IRS to debts owed the government, including unpaid tax debts, unpaid federal student loan obligations and past-due child support.
   

3. I am thinking of buying the building that my S corporation business operates from. Should I simply use my S corporation to make the purchase?
   
   We generally recommend that real property be kept out of any corporation if at all possible, including an S corporation. While an S corporation may eliminate the double-tax problem that results from a C corporation, if for any reason the real property is distributed from the S corporation that distribution will be taxable to the extent the fair market value of the property exceeds its basis in the S corporation. This could result in income recognition without getting any cash. This problem may result if it is decided to sell the business and retain the building. We recommend that real property be held (by an LLC, for example, if liability protection is an issue) outside of the corporation and have the corporation lease the property.
   

4. I have a rental property that I plan to sell in the future, but it is not on the market yet. I am going to refinance the property now to take advantage of lower interest rates and I may get some cash from the refinance to make some improvements to the property to make it more marketable. Will this endanger my chances of exchanging the property tax -free?
   
   No. As long as the refinance is not related to the exchange it should not impact the exchange directly. As long as you do not receive cash (or have access to cash) and the replacement property costs as much as the sales price of the property given up, the exchange should be tax-free. You should understand that if you take on less debt than you give up on the exchange, it is considered the same as receiving cash. As you do not plan on exchanging one property directly for another, you should consult an exchange facilitator before you put your house on the market.
   

5. I am the executor of my Uncle Al’s estate. The total assets in the estate had a value of less than $20,000. There were some legal expenses totaling about $1200 and about $800 of income before the estate was settled. Do I have to file an income tax return for the estate (I was the sole heir)?
   
   As the estate had gross income of more than $600, a return is required. The net expenses in excess of income will pass through to you and may be taken as a miscellaneous itemized deduction, subject to the 2% of AGI limitation. You should check the accounting for the estate to determine any additional administrative expenses (such as appraisal fees, probate fees, etc.) that may be deductible and increase the excess expenses.
   

6. I am the sole shareholder of a C corporation. I want to have the corporation make a contribution of inventory (clothing) to a boy’s home near the store. Can the corporation deduct the fair market value of the inventory?
   
   The corporation may deduct more than the adjusted basis of the inventory if certain requirements are met. The deduction may be for up to one-half the fair market value of the product (however, it cannot exceed twice the basis of the property). To qualify for the increased charitable contribution deduction the charity must be qualified under 501(c)(3); the property must be used for the care of the ill, the needy or infants; the inventory cannot be exchanged for money or other property by the charity; a letter must be given by the charity attesting to the above; and the use of the property must be related to the charity’s exempt function or purpose.
   

7. I am selling my sole proprietorship business. The buyer wants to allocate a large amount to a covenant and a small amount to goodwill. Is this best for me as well as the buyer?
   
   The proposal is not best for you. The amount specifically allocated to a covenant will be ordinary income, while the amount allocated to goodwill will be capital gain. You should propose that as little as possible be allocated to the covenant and as much as possible be allocated to goodwill. It makes little difference to the buyer as both are amortized over 15 years.
   

8. I went through bankruptcy and was discharged under Chapter 7 year before last. Some assets were not taken. Can I continue to depreciate those assets that I still have?
   
   The basis of assets retained by you may be reduced by the amount of debt relief. A Form 982 should accompany your income tax return for the year of the discharge of debt. Tax attributes (net operating loss carryovers, credit carryovers, basis of assets, etc.) that survived the bankruptcy will be reduced by the amount of the debt relief. In many cases, the reduction of tax attributes due to debt relief leaves the taxpayer with no remaining basis to depreciate, but we need the bankruptcy information and the prior year return to determine what basis, if any, remains.