Category Archives: Taxes

LLC or S Corp

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Question from a reader: Structure of a business as LLC or S Corp. I would like to know what is betther for a clothing company LLC or S Corp? Which are the benefits and disavantages of each option?

It appears that you have done your homework and is narrowing down your decision to two choices: LLC or S-Corp.

When making your selection there are several significant areas for considerations- a) employment tax, b) liabilities, and c) ease of operation.

a) Employment Tax: A major factor is taxes paid on earnings. The owner of an LLC is considered to be self-employed. Consequently, the entire net income from your earnings is subject to the 15.3% in “self-employment tax” which goes toward social security and Medicare.

In an S corporation, only the salary paid to the employee-owner is subject to employment tax. The remaining income is subject to income tax but not employment taxes.

b) Liabilities. We live in a litigious society. A LLCs generally will give you superior liability protection than a S-Corp.

c) Flexibility in ownership and ease of operation. There are no restrictions on the ownership of an LLC. An LLC is simpler to operate because it is not subject to the formalities by which S corps must abide.

There are additional factors which could impact your decision: investment in real estate or other passive investments, multistate operations, number of owners.

These are general comments. You should discuss your specific legal issues with your personal attorney.

Vacation Homes, Timeshares

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Categories:

  1. Personal-residence rules: Properties rented 14 days/year or less;
  2. Personal-residence rules: Properties rented > 14 days/year and is less than personal use days.  Personal use days = max(less than 14 days, 10% of the rental days)
  3. Rental property rules: Properties rented > 14 days/year and is greater/equal to than personal use days.  Personal use days = max(less than 14 days, 10% of the rental days)

Examples:
a. Rent for 210 days and vacation for 22 days, then you’re under the personal-residence rules.  (rental, 210days x 10% < vacation, 22 days)

b. Rent for 210 days and vacation for 21 days, then you’re under the rental property rules. (rental, 210days x 10% >= vacation, 21 days)

Timeshares

  • If you use your timeshare yourself and not rent it out, then deduct your share of the mortgage interest (as interest on a second home) and the property taxes on Form 1040, Schedule A.
  • If you rent out the unit a portion of the time, the correct tax approach is to allocate expenses based upon personal and rental use by all owners. If these figures are difficult to obtain then use your best guess as to a reasonable allocation, e.g. 50%, and follow the personal residence rules. This approach will permit you to deduct the personal portion of the mortgage interest (as interest on a second home) and the property taxes on Form 1040, Schedule A.

Different Tax Treatment of Economically Equivalent Portfolios

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On December 2, 2011, The Joint Committee on Taxation released a report on income tax treatment for different financial instruments and products.

Thomas Barthold, chief of staff of the joint committee testified “While the underlying economics of two different financial situations may be identical, the tax treatment under the present law may not be equal”.

Mr. Barthold gave the example of two portfolios. Portfolio A holds $100 worth of stock and sells a call option on the stock with a strike price of $112 with a settlement date of two years. The premium is use to buy a put option on the stock with a $112 strike price and a two-year settlement date. The series of transactions results in a $12 profit characterized as a long-term capital gain and taxed at a maximum rate of 15%.

Portfolio B invests $100 in a zero-coupon bond paying 6% interest a year. Imputed interest income of $12 is taxed at ordinary rate up to 35%.

This concept is presented in the example below:

Reporting of Income and Deductions for Registered Domestic Partners

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Registered domestic partners (RDP) in California, Nevada, and Washington will need to split community income and deductions for federal tax purposes.

Following are instruction from IRS Publication 17.

Nevada, Washington, and California domestic partners. A registered domestic partner in Nevada, Washington, or California (or a person in California who is married to a person of the same sex) generally must report half the combined community income of the individual and his or her domestic partner (or California same-sex spouse). See Publication 555. All three of these states have both community property laws and registered domestic partners laws.

However these new regulations do not allow same-sex couples to file a joint return.

Example: Community property income includes W-2 earnings and other assets acquired since a marriage or partnership. As an example if one partner has earned income of $200,000 and the second partner stays home, then each partner will report $100,000 of W-2 earnings on their separate returns. In order to match the return to the W-2′s, the working partner will report 100% of the earned income on one line and subtract 50% of the income on a separate line. Each taxpayer must attach an explanation of the adjustment.

Effective dates. These provision are optional for CY2010 and manditory for CY2011.

references:

  • Publicaton 17. http://www.irs.gov/pub/irs-pdf/p17.pdf
  • Internal Revenue Manual http://www.irs.gov/irm/part25/irm_25-018-001.html
  • Chief Counsel Advice Memorandum (CCA) http://www.irs.gov/pub/irs-wd/1021050.pdf
  • Chief Counsel Advice Memorandum (CCA) http://www.irs.gov/pub/irs-wd/11-0063.pdf

Indexing for Superior Performance

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Passive Investments Can Provide You With Superior Performance

“When you’re underperforming the index, you go home at night and cry in your beer,” he said, adding: “It’s not fun, but who said this business should be fun. We’re too well paid to hang our heads and say boo hoo.” Bill Gross, Pimco.

In a May 2011 study, New York-based Greenwich Associates (a) found that 50% of asset-management firms interviewed and 33% of institutional funds interviewed indicated they expect to increase their allocations to ETFs by 2013.

Just why are asset-management firms and institutional funds employing ETFs?  The reasons include:

  • Use ETFs as part of their regular rebalancing procedures;
  • Employ ETFs for more strategic purposes, such as hedging;
  • Use ETFs as a liquidity sleeve in their portfolios; and
  • Save in fees.

If the smart money is using ETFs shouldn’t you?

Yes.  I think that you should definely use ETFs.  The reasons are many:

    • Many of us work full time and we don’t have time to research individual stocks.
    • Few professionals are able to beat the market indexes over multiple market cycles.
    • Fees for ETFs are significantly lower than actively managed stock funds.
    • Investment in certain ETF (e.g. SPY) exposose the investors to market risk with minimal stock risk.
    • Easier to achieve diversification, an important rule to investing.  Index-based funds tend to have many more individual securities in the fund.
    • Easier to protect our equity investments by use of puts or selling limited holdings.
    • Provides liquidity.
    • Are more tax-efficient that active funds due to their lower turnover ratios.
TakeawaysInvestments in ETFs can provide you with superior investment results.

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(a) http://www.greenwich.com/WMA/in_the_news/news_details/1,1637,1958,00.html?vgnvisitor=eKibl6WLopw=

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First-Time Homebuyer Credit Letter

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IRS is notifying taxpayers who claimed the first-time homebuyer credit. There are different IRS letters for different situations including purchase of a home in 2008, 2009 or 2010, repayment schedule for homes purchased in 2008 or the sale or change in the use of the main home. Taxpayers receiving the letter are encouraged to tell their tax preparers or accountants about their first-time homebuyer credit.

more: http://www.irs.gov/newsroom/article/0,,id=204671,00.html

January 29, 2011