Tax Tips Blog

Sharon writes: Hi, we are closing down a small LLC of which my husband is CEO and I’m the bookkeeper. The LLC owes about $10,000 to the IRS. Another company is buying our company’s assets and the transaction will net enough to pay the tax bill, but it is taking a LONG time to happen. The IRS wants its money and is about out of patience.

We want to

1. pay the IRS bill with our personal credit card

2. get a new card with a 0% rate on balance transfers

3. transfer the balance

4. When the buyer finally gets its ducks in a row, our company sells the assets and gets paid

5. our company reimburses us our legitimate company-related expense, the $10,000.

Is this legal? Are there pitfalls? The LLC also owes about $5,000 to the state; the asset sale should cover that, too. We have no room to bend rules here; there are three other soon-to-be former partners, and one is angry and would probably love an excuse to sue my husband for mishandling the company finances — so we have to be Caesar’s wife. The IRS reps themselves suggested a personal credit card payoff, but I suppose they don’t care what trouble we might get into with someone else. All advice appreciated …

My reply: There is a lot of information missing from your email regarding your situation, but two things are very clear to me:

1. Someone mishandled business funds or there would not be unpaid business taxes and
2. You should NOT pay the LLC debt personally without first discussing this matter with your personal attorney.

The collection of federal taxes is a mix of federal tax law and state property law. I have heard that there are some strange collection issues arising with LLC’s, especially those taxed as partnerships, but you never said what status this LLC elected (Partnership, Corporation, S-Corporation?). It is standard operating procedure for the IRS to suggest that the taxpayer (which is the LLC) borrow the money necessary to pay the IRS debt.

As you stated, what happens afterwards is not the IRS’s concern. Most likely the taxpayer (LLC) is not able to get a loan to pay the IRS debt without personal guarantees from the members, if it can at all. For this reason, I’d hold off on this until you spoke to your personal attorney and then your LLC’s tax attorney.

If the source of the funds for the IRS debt is the sale of the company then you want to associate the payment to the sale. Usually if all, or substantially all, of a business’s assets are sold it falls under state bulk transfer law, which ensures that creditors will be paid as a part of the transfer. Have you discussed this aspect with the IRS?

There are a lot of other issues that might be important at some point, but since your goal is to get the IRS satisfied by the proceeds of the sale, that’s what you need to work toward. If everyone’s being open and honest I see no reason why the IRS shouldn’t work with you toward this end. That being said, I would not recommend that you go any further without professional advice and that includes advice from attorneys and CPAs who are familiar with all aspects of your case.

Best wishes, Gina http://GLGcpa.com

Renee asks: I opened an UGMA account for each of my children (13 years old and 10 years old) when they were born. Their accounts have appreciated over the years and my 13 year old’s account is reaching $100,000.

I’ve been using TurboTax to do my return and including their dividends, distribution, and interest on my own tax return. On my 2005 tax return this amount was over $10,000. I am paying roughly $1500 tax for that judging my effective tax rate was 28% in 2005.

I’m about to start my 2006 tax return and I was wondering if I can begin to file a separate tax return for my 13 year old, or even my 10 year old? This would be their only source of income. I would assume that I could save some tax by doing that.

Any advice? Renee

My reply: You have never been required to report your child’s income on your own return.

You may make an election to report your children’s income on your return, until they turn 18, if they do not have any earned income or Schedule D sales to report, but I rarely advise my clients to do so as it usually causes them to pay more taxes than the law requires them to pay.

No matter how you report their income, on your own return or on their return, their income will be taxed at your marginal rate once their standard deductions are used, but it still should save you some money by reporting their income on their own return.

By reporting their income on your return you are increasing your adjusted gross income (AGI) which could cause you to reach AGI based phase outs, limiting your other deductions and/or credits and causing you to pay more taxes than is required by law.

Based on my experience in providing second opinions to taxpayers who previously used TurboTax, I’d hazard a guess that you are not reporting their income correctly on your return. You should be using Form 8814 and taking advantage of their standard deduction and a little bit of the 10% tax bracket. If you’ve made that mistake and are in the 28% bracket, you’ve probably overpaid your taxes by a few hundred dollars each year. If this is the case for you, then you can amend your returns for the last three years to correct your calculation of your tax.

In addition, this is an excellent time to consider hiring a qualified tax professional to help you. It’s their job to save you from making mistakes just like this and more.

Best wishes, Gina www.GLGcpa.com

Charlie asks:I have been contributing to a Roth IRA to the max amount and a little bit to a 401k. My employer also runs a profit sharing type plan that they contribute to. Now, the question is, am I also able to contribute to an SEP-IRA? I do contract work on the side and receive 1099s. For status I am single and my W2 income will be in the 60-70k range and my self employment will be about $10k. Am I able to also do an SEP with the profits from the self-employment (assume this would be after business-expense deductions relating to the SE). What tax advantages would that offer me over a taxable brokerage acct? Thanks, Charlie

My Reply: Hello Charlie, thanks for writing.

Yes you should be able to contribute to a SEP due to the profits from your self-employment income. You can learn more by reading IRS Publication 560.

As far as tax advantages are concerned, you will get a current deduction for the entire contribution and tax on the earnings is deferred until your withdraw the money in retirement.

Best wishes, Gina www.GLGcpa.com

Craig asks:I was told that my investment newsletter services tax-deductible, but I don’t know where to put them on my tax return? Do I spread the cost over the investments I bought based on the news services’ advice?

My reply:The cost of your investment newsletters are considered a miscellaneous itemized deduction on Schedule A, subject to the 2% of Adjusted Gross Income (AGI) exclusion. The cost of these newsletters does not affect your basis in your investments. You can read more about this in IRS Publication 550.

Important note: Many tax deductible expenses do not end up providing a tax deduction. Salespeople will rightfully tell you when something they are selling MAY be tax deductible, only they always seem to say it as it definitely IS deductible and failed to mention the various exclusions that apply. The most painful of these is usually related to a home purchase that they have been told will result in a big annual tax savings, which for many people does not. It is always a mistake to purchase something because you believe it will provide you with a tax deduction without first asking your tax adviser if it is true in your case.

Best wishes, Gina www.GLGcpa.com

Ruth asks: My father died recently, and I’m trying to organize his financial affairs. I’m the only heir, and executor of his estate. He had a lot of debt and very few assets, so there will not be enough money to pay everything. He has a small amount of money in a bank account, and that’s it. No real estate, no investment accounts, his car wasn’t paid off, and there are no other assets. I will have to prepare his tax return for this year, and he’ll owe at least some income tax. He had a pension, which was taxable, and even though some federal tax was withheld, he always owed a few hundred in taxes at the end of each year. I know the IRS is high on the list of priorities of who gets paid first. (I”m still working my way through the Nolo Press book on estates, but the book seems to assume everyone who dies has money left over, so it’s not always helpful.) I want to make sure there’s enough money to pay the taxes. But funeral expenses are also at the top of the list, and I paid out of pocket for his cremation (they wouldn’t release his ashes to me until I paid, so I had to just write a check out of my own bank account, since his estate hasn’t been probated yet). I think, legally, I can be reimbursed for that.

My question is, who gets paid first out of an estate. If I use up all of his money to pay for funeral expenses, and there’s not enough to pay the IRS, what happens? Do any other bills get priority over the IRS? His car is going to be sent back to the lien holder, and I’m going to hold off on reimbursing myself for the funeral expenses until I see how much money is available - I think there will be enough for both that and the IRS, but I can’t be sure until I get his W2 forms.

I just wanted to be sure before I did anything, because I know the IRS can (at least theoretically) come after the executor if the tax isn’t handled correctly. If for some reason he owes a lot of taxes (if he changed his withholding, for example), I don’t want the IRS to come after me. What about medical expenses? Where do they fall in the hierarchy of creditors? I haven’t received any bills, but I saw a preliminary accounting at the hospital when I picked up his things, and his final hospital bill will be over $100,000. I know there won’t be enough money to cover all of it, but if there’s some left over after the funeral expenses and the IRS, I’ll have to use it for something. Since the estate is so small, I’d rather not pay a lawyer or tax accountant if I don’t have to - his taxes were always very simple (1040EZ) so hopefully I can do it myself. Thank you, Ruth

My reply: My condolences on your loss. Since real estate is not involved and there are no assets, my first thought is whether or not probate would be required and even if required if there was an express option available in your state. Theses questions are best answered by a lawyer, since these laws vary by state.

I realize, due to the estate’s lack of funds you do not want to contact a lawyer, but a short consultation with a local lawyer would be in your best interest. Your county should have a lawyer referral service of some kind. Even if you must pay for it, an hour of legal advice will be worth it. Make your list of questions and keep the discussion on point.

Second, if there is equity in the car, then it maybe reasonable for you to sell it then pay off the lien holder. If there is no equity in the car, call the lien holder and notify them of his death. The lien holder gets the car and any unsecured debt joins the other unsecured creditors of the estate.

Third, although I believe I will be detailing out the order of payment correctly here, it is best to quickly review this with your attorney. Expenses of administration, including funeral expenses, get paid first. After these expenses are paid taxes should be paid with the remaining available funds, if any. If there’s no money left then the taxes go unpaid. If there is money left after paying taxes, then the unsecured creditors get paid. Medical expenses are included with the unsecured creditors. While federal law (31 USC 191-192 (?)) gives the government absolute priority, IRS realizes that there are necessary expenses of administration, including funeral expenses, and that encumbered assets wouldn’t be in the estate without money advanced by lien holders.

IRS will probably not bother you if you reimburse for the cremation and the car goes back to the lien holder. Here’s what I would suggest regarding the taxes, assuming there isn’t enough of his money to pay them. Prepare and file the return without payment. When you get the first notice, write back and tell them he died, provide a copy of the death certificate, and tell them the estate had no assets with which to pay the tax. That should take care of it.

As for the unsecured creditors, you should have a bunch of certified copies of the death certificate. Send one copy to each creditor (and then another copy when they claim they didn’t receive the first one) and tell them there’s no money to pay them, and then ignore them. Again, I believe you should consult with an attorney. You don’t have to hire a lawyer to do the paperwork or taxes, which they might not want to be bothered with for such a small estate, anyway, especially if there’s a simplified set of procedures available. But I think it would give you some peace of mind to get some confirmation of the overall game plan, especially to be sure you’re in compliance with any odd provisions your state might have.

Best wishes, Gina www.GLGcpa.com

Trina asks:I’m self-employed with a highly variable income. Last year I made a little money in the first quarter and second quarter and then more in the 3rd quarter with significantly more in the last quarter of the year. I paid estimated taxes in each quarter based on the income I had and assuming a pretty high tax rate. At the end of the year I got hit with a penalty for not paying my estimated taxes in 4 equal payments. I used Turbotax for my taxes. This year I’m on the same boat pretty much. Is there anything I can do to get out of the penalty? I have no way to guess my income for the year based on what I make in the first quarter and would not be able to pay enough in estimated taxes even if I could accurately predict the final result. Thanks, Trina

My reply: Hello Trina, thanks for visiting.

Since you did not earn your income evenly throughout the year (like a W-2 wage earner typically does) and you calculated your estimated taxes based on the income you earned, your estimated tax payments were not the same each quarter.

Assuming you calculated the taxes that you owed correctly each quarter, you utilized an acceptable method and most likely should not be subject to a penalty.

In order to inform the IRS that you used this method and that you calculated the amount you owed correctly each quarter you should have filed Form 2210 with it’s schedule AI (Annualized Installments) along with your tax return. On that form, you show how your income was earned over the year and that your estimated tax payments matched that income. If everything is done correctly (making the correct payments and completing the forms correctly), the IRS would not have assess a penalty.

My guess is that TurboTax has the ability to compute and print Form 2210, but I do not use TurboTax so I am not sure. If it does have this ability you may want to go back and try to print this form and send it to the IRS, but please be careful when completing this form as this can be a very complex calculation, as you have more than one option for computation.

As I’m sure I said many times before it is usually in the best interest of sole proprietors (or anyone who has a business) to have a professional help them with their taxes. You may want a professional to help you prepare the form correctly and respond to this notice. For more information you may wish to review IRS Publication 505, Withholding and Estimated Tax.

Best wishes, Gina www.GLGcpa.com

Reed asks: I have a question about LLCs and federal taxes. I know that if you create an LLC and don’t file an 1120 (i.e. you don’t pay yourself as a W2 employee of your own business), then whatever income you make in the LLC just flows through to your personal taxes. What I don’t know is how your taxes and deductions change when you do file an 1120. Do you end up with an extra level of federal taxes? Here is what I suspect, and am hoping to find some confirmation for… For anything you do pay yourself as a W2, since that is an expense of the business, your W2 tax situation is all that is relevant. In other words, if the income to the LLC was $100, and you paid yourself $100, then effectively the LLC made a $0 profit and you calculate your federal taxes the way you would if you weren’t incorporated. I’m doing some big hand-waving there to simplify the question, since (for example) self-employment taxes are something I believe is deductable for an 1120′d LLC.

My reply: If your LLC has just one member, the default position is to ignore it for tax purposes. So if you were conducting a business, you’d file schedule C for the LLC. If the LLC was renting real estate, you’d file schedule E. If it was operating a farm, schedule F. And so on.

If the LLC has more than one member, it’s treated like a partnership by default, and would file form 1065.

However, either kind of LLC (single- or multi-member) can elect to be taxed like a corporation. And if the LLC makes that election, it can further elect to be taxed like an S Corporation. These are positive elections - you need to make them and file the election with the IRS. And there are time frames on these elections.

You need to file these elections before certain dates to make them effective for a particular year. Once you make one of these elections, it remains in effect for all future years.

So if an LLC elects to be taxed like a corporation (a regular or C corp), it would file form 1120. The corp would normally pay a wage to its members and/or officers and deduct that wage (and related payroll taxes) from it’s income. The member would report the W-2 income and pay tax on their personal return. Any income left would be taxable to the LLC at standard corporate rates. And the corp could also pay dividends, which would be taxable to the members, but not deductible to the corp.

If the LLC elects to be an S corp, it would file form 1120S. It still needs to pay a wage to it’s members. And it would still deduct that wage and payroll taxes. But the net income of the LLC taxed as an S Corp would flow through to the member(s) and be taxed on their personal return along with the W-2 income. That pass through income is not subject to Self-employment tax.

Alice asks: If someone has all their money in joint or POD/TOD bank accounts and dies, I know that the money is not subject to probate, but if estate taxes are due, how does the IRS get it? It seems to me that the IRS is entitled to get it even though the money passes directly, but I’m not sure of the mechanics, and would love an explanation. I would also think that if there were other assets in the estate that could be sold to satisfy the estate tax, then the executor would be free to choose to sell those and let the money pass to whoever the joint owner or beneficiary is, including if that turned out to be the executor. Can you explain that to me? Logically, it seems that I have it, but I’m not sure that I’m correct or what law effects such a situation. Thank you, Alice

My reply: Hello Alice, thanks for writing.

There is a statutory lien on the transferred money. For estate and gift taxes is in Internal Revenue Code section 6324. As you note, there can be major differences between the assets included in the gross estate for tax purposes and the assets under the control of the executor. In addition to the joint tenancy property you mention, there’s IRAs some life insurance benefits, annuities, etc.

The executor’s actions are primarily controlled by state law, but in general he’s in charge of the assets, pays the bills, and distributes what’s left in accordance with the decedent’s instructions (usually their will). He’s not a free agent and can wind up with personal liability if he doesn’t fulfill his fiduciary responsibilities.

In essence the IRS lien allows the liability to be transferred to the heirs or beneficiaries if the executor can’t or won’t pay the estate tax from other assets. Because the lien attaches to the gross estate by operation of law, no special paperwork is required to establish this transferred liability. IRS can just drop a levy on the heir’s assets up to the amount inherited. In practice the heirs get together and pay the taxes. The alternative would be for the IRS to take it where they could get it, with the rest of the estate going to the heirs’ lawyers as they fight it out between themselves in court after IRS is out of the picture.

Best wishes, Gina www.GLGcpa.com

Ben asks:My question is regarding my subscription to investment newsletters and paid subscriptions to investment websites. Can I deduct that when i do taxes, if so what documentation will i need. I also have a sharebuilder account and pay a monthly fee for that. What about any losses i have incurred? Also, how would i go about getting the standard 30 for the spanish american war? Ben

My reply:Hello Ben! The costs of your investment subscriptions are deductible as miscellaneous itemized expenses on Schedule A, provided that you itemize deductions and that the total of your miscellaneous itemized deductions exceeds 2% of your Adjusted Gross Income (AGI). You should retain your receipts to prove this deduction, if necessary.

The monthly fee in your sharebuilder account is either another miscellaneous itemized deduction or a commission charged for the purchase of shares. If the fee is linked to the specific transactions it is a commission and adds to the cost basis of the shares purchased. If it is a flat fee that is charged whether or not you have any transactions or regardless of the number of transactions, it is a deductible investment expense.

Capital gains and losses don’t affect your taxes until you sell the investment. At that point you report the sale on Schedule D and calculate your gain or loss.

The $30 refund of the Spanish American War tax, also referred to as the Telephone Tax Refund, has a special line in the “payments” section of Form 1040 or its variants.