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topten July 2013

This is a monthly reference source. By providing 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. You should discuss your particular situation with your Fiducial Business Advisor to answer your specific problem or concerns. (You may not rely on any answer given to avoid
a penalty.)


Q.1 I have a single member LLC sole proprietorship that is reported on Schedule C. I plan to elect S corporation status as I have heard that SE tax may be reduced. Is pass-through income from an S corporation subject to SE tax?

A.1 No, the pass-through income from an S corporation is not subject to SE tax. Several proposals have been made in Congress to change that, but none have been enacted. With that said, it is important to note that if you render services for the business and you intend to take money from the business in any form (distribution, loan repayment or rent, for example) you must first be paid a reasonable salary for the services rendered. IRS has announced that S corporation compensation is going to be a target for examination and if it is found an adequate salary was not paid, any funds going from the entity to the owner will be subject to re-characterization; resulting in payroll taxes, penalties and interest being assessed.

Q.2 I am a principal member of an LLC filed as a partnership. We filed the partnership return on time without requesting an extension. I just found out that our retirement plan contribution was not made. We claimed a deduction on the tax return. Do we have to amend?

A.2 We generally recommend an extension be requested by any entity with a retirement plan regardless of whether it is planned to file on time (make sure the extension is requested before filing the tax return). Doing so allows additional time to correct errors without penalty, or as in your case, you have until the due date of the tax return for the entity plus valid extensions, to make a deductible contribution to the retirement plan. As no extension was filed, you are subject to amending the tax return to remove the contribution deduction. If the contribution is elective the entity may choose not to make it. If not elective and it must be made, the contribution is
not deductible.

Q.3 I was divorced last year. My ex-wife and I are both under age 50. As we parted amicably, I saved money by not engaging an attorney. As part of the property settlement in the decree I agreed to cash in ½ of my 401k and give my ex-spouse the proceeds. I received a Form 1099R showing it as a taxable distribution. I thought such distributions are tax-free. Is that not true?

A.3 Distributions from a retirement plan that are pursuant to a QDRO (Qualified Domestic Relations Order) may be taxable, but are not subject to the 10% early distribution penalty. In addition, a QDRO can act to allow a transfer of the right to the retirement proceeds with the tax impact to the recipient. The QDRO may direct the proceeds be distributed to the recipient spouse – this would subject the spouse to income tax but would be free from penalty. In that case, the Form 1099 will be issued to the recipient spouse. Alternatively, the QDRO may call for a direct trustee-to-trustee transfer to the spouse’s retirement plan. This is a tax-free transfer that is not subject to penalty. As the distribution was required to be made to you and was not made pursuant to a QDRO the distribution is taxable to you in full and is subject to a 10% early distribution penalty.

Q.4 I am a general partner in a five party partnership that provides consulting services. My capital account is currently negative by $5,000. I have deducted all losses passing through from the partnership. I have just received an offer for my interest from another partner for $3,000. Do I have gain to recognize if I sell?

A.4 Your gain or loss on the sale of your partnership interest is measured by the excess of the amount received over your basis in the partnership interest. In this case, if you sell without restoring your capital account your gain on the sale will be $8,000. If the partnership has no hot assets (unrealized receivables or substantially appreciated inventory) the gain will be
capital gain.




Q.5 I converted a rather small traditional IRA to a Roth-IRA several years ago and recognized all the income. Late last year I discovered that the Roth account had a significant loss so I cashed it out before the end of the year. I had a loss of about $2,000. Is that loss deductible?

A.5 You may claim a loss as an itemized deduction subject to the 2% of AGI limitation to the extent of your unrecovered basis in the terminated Roth account.

Q.6 I am a union painter. My union requires that I wear a white shirt and white overalls when I work. May I deduct the cost of this clothing as an employee business expense?

A.6 If the shirt and overalls are suitable for everyday wear (whether or not they are actually worn off the job), the cost of those items is not deductible.

Q.7 The house I have lived in for the past 8 years was foreclosed on last year. I was personally liable for the difference between FMV and the balance of the mortgage. This year that debt was forgiven and I will receive (I am told) a Form 1099C for $150,000. Is that cancellation of debt income to me?

A.7 As long as all the debt on the house that was forgiven was acquisition debt (debt to acquire or improve the residence), and the total debt relief is under $2 million it is excludable from income. The relief for qualified principal residence debt relief income was scheduled to expire after 2012. However, the American Taxpayer Relief Act of 2012 extended the provision through 2013.

Q.8 My rental property was foreclosed on this year. I am not personally liable for the mortgage (it was secured solely by the property). The 1099A indicates the remaining principal balance of the property is $100,000 and its fair market value is $90,000. My remaining basis in the property is $120,000. Do I have income?

A.8 As you are not personally liable for the difference between the FMV of the property and the principal balance of the mortgage, the property is considered sold for the remaining principal balance of the mortgage. As your basis in the house is greater than the principal balance remaining on the mortgage, you have a loss on the sale of your rental property that is deductible as a Section 1231 loss for tax purposes. You do not have cancellation of debt as the property was the sole security for the debt and you are not considered to have had a personal obligation cancelled.

Q.9 I received a notice from Social Security that I had received $3,500 more in benefits last year than I was entitled to and that the amount
was going to be made up by reducing my benefits over the course of this year. May I deduct the repayment?


As the repayment will be made out of your benefits this year, the repayment will reduce the gross benefits reported in Box 5 of the Form SSA-1099. You will get the benefit of the repayment as a reduction in the gross benefits reported to you. You need not deduct the repayment as it will already be accounted for in the benefits reported to you from Social Security.

Q.10 I am the sole shareholder of a regular corporation. All of the assets of the corporation were sold for cash, and I don’t expect the corporation to continue. I know the corporation will pay tax on the gain on the sale. When I liquidate how is my gain
or loss determined?

A.10 Your gain or loss on liquidation is measured by the difference between the net amount you receive (fair market value of all assets distributed less liabilities assumed) and your basis in the stock of the corporation. As it is given all the assets were sold for cash, the cash remaining after paying the corporate tax is likely the measure of the assets to be distributed. Any loans to shareholder would be counted as an asset and would increase the liquidating distribution.

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