Masonry Magazine April 1989 Page. 25
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 in closely held businesses 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.
Who Should Own Business Real Estate?
Your business is about to take another giant step - moving into its own building. Your business is typical. It does business as a corporation. The real question then is, should the corporation own the real estate? Or should you own the real estate and lease it to the corporation? Hands down, the tax answer is, you should own and lease.
Putting the real estate into your operating corporation could lead to double taxation when the property is sold down the road. The corporation would suffer the first tax on the sales's profit and the stockholders would be hit with a second tax on distribution. If your corporation already owns the real estate, look into electing S corporation status as a way to avoid the second tax after a 10-year waiting period.
Charge the corporation a reasonable rent - the same amount that would be paid if dealing with a stranger - to avoid any problems with the IRS. With the depreciation period for commercial real estate at 31.5 years, the real estate venture should show a net profit.
Do not put the real estate in another corporation. Let a family partnership own the real estate. This gives you an opportunity to spread income to other family members and reduce the overall income tax cost. Lower-bracket family members are the best choice. For example, children, grandchildren or elderly parents on a fixed income can be the perfect partners. Remember, children under age 14 are taxed at their parents' rate on unearned income over $1,000.
Leasing real estate to your operating corporation is a great way of getting money out of your closely held business. 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.
THE NEW KIDDIE TAX
Tax reform has changed the rules of the game for a favorite American tax sport - shifting income to low-bracket children. Now children under the age of 14 can have a portion of their unearned income taxed at their parents' highest tax rate.
Here are the basics: The first $500 of unearned income is tax free to the child, the next $500 is taxed at 15 percent and anything in excess of $1,000 is taxed at the parents' rate. Children aged 14 or older are not subject to the tax. It's been dubbed the "Kiddie Tax." The tax is tough, but there are still a few escape hatches.
Since the tax does not apply to earned income, hire your children to work in your business. The first $3,100 earned in 1989 (indexed up for inflation each year) is totally tax-free to the child. Make sure to pay reasonable salaries, which are deductible as business expense.
Consider giving the kids stock in your closely held business. Such stocks rarely pay dividends. It's income, not property ownership, you want them to avoid.
It also makes sense for your pre-14 year olds to own tax-free municipal bonds. U.S. Series EE Savings Bonds are also good investments. The income on these bonds can be deferred until the bond matures. Even though the income was earned before the child reached age 14, it will not be taxed until the bond matures.
One more point: It is a good idea to have each of your young children fill up as much as possible of their tax-free cup ($500 for unearned income, $3,100 for earned) every year.
HOW TO MAKE SURE S CORPORATION LOSSES ARE DEDUCTIBLE
Every year more corporations elect to do business as S corporations. But suppose your S corporation loses money. Can you, assuming you actively participate in the operation of the business, deduct your share of the losses? Surprise. The answer may be yes or no.
The answer is yes if your tax basis is equal to or larger than the loss. In general, your tax basis is increased by the cost of your stock, loans and your share of the profits; it is decreased by your share of the losses and distributions.
In most cases, corporate losses are financed through a bank loan. If so, it is important to structure that loan correctly to ensure yourself a loss deduction. A recent tax court case (Leavitt, 90 TC 16) showed the wrong way to structure a loan. Here's the story.
An S corporation lost money during its first three years of business. The corporation borrowed money from the bank to finance its activities, and the three corporate shareholders personally guaranteed the loans. The corporation made the principal and interest payments directly to the bank.
The shareholders deducted the corporate losses on their tax returns each year. They claimed that their personal guarantees of the bank loan increased their tax basis. Not so, said IRS. The Tax Court agreed, saying that since the personal guarantees did not cost the shareholders anything, there was nothing to add to basis.
The shareholders argued that their guarantee of the loan was really the same as though they had borrowed money from the bank and then loaned it to the corporation. But the Tax Court ruled that since the bank was looking first to the corporation for repayment of the loan, and the shareholders did not in fact pay anything on the loan, the shareholders had no basis in the corporation against which to deduct the corporation's losses.
The shareholders could have saved the day by structuring the loan differently. They should have borrowed the money directly from the bank and then lent it to the corporation, charging the same rate of interest as the bank. When payments were due on the bank note, the corporation would have made distributions to the shareholders continued on page 27