Masonry Magazine August 1988 Page. 15
TAX MATTERS
Irving L. Blackman is the most published CPA in the country and spreads his tax knowledge as a dynamic speaker. Mr. Blackman specializes closely held business and will consult with readers of this column. He is a partner in Blackman Kallick Bartelstein, a Chicago-based accounting and business consulting firm. Direct your questions to 300 S. Riverside Plaza, Chicago, IL 60606, or call (312) 207-1040.
This Time The IRS Went Too Far
Talk about overreaching. Here's a tale that would be completely unbelievable if it didn't involve the Internal Revenue Service. It starts with a self-employed attorney, Jerry, who couldn't pay his 1979 income taxes. So in 1981, the IRS levied on his Keogh account, in which he had accumulated over $22,000.
First a little background: If you voluntarily withdraw funds from your Keogh account, you can get rocked with a 10 percent early withdrawal penalty. The penalty will not be assessed if the taxpayer has attained age 59½ or is disabled. Jerry was not yet 59½ nor disabled.
You would think the levy would end the story, but the IRS had only started its attack. They imposed the 10 percent penalty on Jerry for making an early withdrawal of his retirement funds. Then, they hit him with a negligence penalty for not paying the 10 percent penalty. And then they added another negligence penalty for not including the distribution in his 1981 income.
Jerry fought back, taking the matter to court (Jerry Larotonda-89 TC 25, 1987).
Even the judge agreed the IRS had gone too far. Sure, the Keogh distribution should be counted as additional income, the judge ruled. But tacking on the early withdrawal penalty would be like rubbing salt into the wound. Even though the attorney didn't qualify for any of the exemptions to the 10 percent penalty, the judge noted, Jerry clearly didn't use the early distribution as a ploy for tax avoidance. By the same token, the judge denied the IRS' bid for negligence penalties.
Construct Your House With Company Cash
One of the biggest problems confronting successful business owners is how to get surplus cash out of their corporations without paying tax on it. If they take it as a salary or dividend, it's taxable. If they take it as a loan, the rules regarding personal and investment interest can eliminate or reduce their interest deduction. But here's a nifty way to take the cash, avoid paying tax, and secure your personal interest deduction: Give the corporation a first mortgage on your home.
The new law severely curtails interest deductions for taxpayers. Personal interest is not deductible at all, and investment interest is deductible only to the extent of investment income (subject to the phase-in provisions). But interest on home mortgages is still fully deductible, as long as the loan doesn't exceed the cost of the home, providing that the mortgages on the taxpayer's first and second home don't exceed $1 million combined.
But why borrow from the bank and let it earn the interest when you can borrow from your own corporation, perhaps at a more favorable rate? As long as you dot your "i"s and cross your "t"s, you can nail down substantial tax deductions by letting your corporation finance your home.
Be sure your corporation charges market-rate interest on the loan, and be sure to document the loan with a promissory note and a mortgage recorded at the courthouse. Adhere strictly to the payment schedule called for in the note, and correctly classify the loan and your subsequent repayments on the corporate books. If you carefully follow these guidelines, you can dip into the company till without personally paying tax.
Want to learn more about getting cash out of your business? Send for the Special Report, How to Take Money Out of Your Closely Held Corporation, $25, to Blackman Kallick Bartelstein, 300 South Riverside Plaza, Chicago, IL 60606.
Buy-Sell Pegs Value of Business
Closely held businesses, by their very nature, have few stockholders. Almost uniformly the stockholders do not want any shares of stock to fall into strange hands. This purpose is most often accomplished by the use of a buy-sell agreement between the shareholders. The question often comes up... does the price fixed in the agreement hold up for estate tax purposes?
The answer to this this important question can be a loud "Yes" if the agreement is properly drafted. An interesting case points the way. Here's the story.
Five shareholders entered into an agreement that provided that all transfers of stock were subject to its terms. A written consent was required for all transfers. In the absence of such a consent, a selling shareholder had to give 60 days notice to the other shareholders and the corporation. All shares were to be sold to the corporation or the other shareholders at book value. The agreement was enforceable against all the shareholders and the estate of a deceased shareholder. The right of shareholders to own stock was dependent on their continuation in their position as a director, officer or employee. When this relationship was severed, a shareholder was required to sell his stock in accordance with the agreement.
One of the shareholders, Mabel, died and her shares were offered for sale to the corporation at book value, $251,800. The IRS claimed the fair market value of the shares was $460,000 and wanted that value to be reported for estate tax purposes.
The court (Estate of Mabel G. Seltzer, TCM 1985-519) turned thumbs down on the IRS' claim holding that an enforceable agreement, which fixed the price to be paid, can limit the value of the shares for estate tax purposes. After all, in this case, the estate was obligated to demand no greater value than the book value of the shares. The court pointed out that if Mabel had attempted to sell the stock on the date of her death, she would have been limited to a book value price by the terms of the agreement. The fact that the fair market value may have been higher was ruled to be immaterial.
Real Home-Grown Tax Savings
Futurists tell us that more employees will be working at home. They also foretell that a greater share of American business will be done by self-employed people working out of their homes. So, let's explore the strange world of home office tax breaks and pitfalls.