Sales Tax BOE Announcement

Judy Chu Announces No More Paper Returns for Most BOE Taxpayers

Sales Tax Audit? Sales Tax Problem? BOE or SBE Issues? Get Sales Tax Resolution TODAY!

Business Editors/Government Writers

SACRAMENTO, Calif.--(BUSINESS WIRE)--June 27, 2008--Judy Chu, Ph.D., Chair of the State Board of Equalization (BOE), today announced that the BOE will begin transitioning existing sales and use taxpayers to electronic filing and eliminate the use of paper tax returns.

This month, more than 90 thousand taxpayers will be notified they will no longer be receiving paper returns from BOE, but rather be expected to file on-line. This first group of existing taxpayers transitioning to e-filing includes single location quarterly prepayment accounts that are comprised of medium to large size businesses that file and make prepayments twelve times a year. These taxpayers will be expected to e-file rather than use a paper return with the reporting of third quarter 2008 returns, due October 31.

In addition to existing accounts, beginning July 1 all new businesses that apply for a seller’s permit will be set up for e-filing. There are an estimated 165,000 new seller’s permits issued each year.

The BOE-file program offers taxpayers a fast and convenient method of reporting, enhances the ease of filing, improves government efficiencies in tax administration and helps the environment by using less paper. The BOE currently prints, mails, and processes over 3.5 million sales and use tax returns annually. The taxpayers transitioning to e-filing in this phase account for approximately 1.4 million of these returns. The BOE estimates savings of up to $1.8 million in 2008-2009 with a participation rate of 25 percent to 50 percent of those eligible for e-filing.

Over the next two years, the majority of existing sales and use tax accounts will be transitioned from paper to e-filing, phased in based on account type and reporting basis.

All businesses will receive BOE-file notices in their next quarterly tax returns, expected around July 1, 2008. Taxpayers may request a one-year exemption from on-line filing.

There are several e-filing options available on the BOE website at www.boe.ca.gov. The BOE offers a free option, BOE-file. In addition, taxpayers may also choose from two fee-based electronic service providers. Accountants, bookkeepers, and other third-party return preparers can e-file on behalf of the taxpayer as well.

BOE-file has options to make payments via credit card or by check for all taxes and fees it collects. Taxpayers may use Discover, MasterCard, American Express and Visa. A convenience fee is charged and retained by the credit card processor. Besides sales tax, the BOE also administers levies on alcohol, fuel, tobacco, tires, lumber, and a number of other environmental fees. Motor Vehicle Fuel taxes, the International Fuel Taxes Agreement program and the Underground Storage Tank Maintenance Fee returns can also be filed electronically. For information regarding e-filing options available for other programs administered by BOE, visit the BOE website at www.boe.ca.gov and click on the E-services icon.

The BOE launched its first free e-file system in 2005. More than 830,000 businesses are currently eligible to use BOE-file. There are currently 879,000 active sales and use tax accounts registered with the BOE.

For more information on the BOE-file program, visit:

BOE-file Program (http://www.boe.ca.gov/elecsrv/esrvcont.htm)

Frequently Asked Questions (http://www.boe.ca.gov/elecsrv/efiling/boefilefaqtaxp.htm)

Chair Judy Chu represents the Fourth Board of Equalization District, which includes Los Angeles County. She won election to the BOE in November 2006 and was elected Chair of the Board of Equalization in January 2008. Chair Judy Chu is also a voting member of the Franchise Tax Board.

The five-member California State Board of Equalization is a publicly elected tax board. The BOE collects more than $53 billion annually in taxes and fees supporting state and local government services. It hears business tax appeals, acts as the appellate body for franchise and personal income tax appeals, and serves a significant role in the assessment and administration of property taxes.

California State Board of Equalization

Anita Gore, 916-327-8988

State Keywords: California

Industry Keywords: Public Policy/Government; Government Agencies; Public Policy; State/Local; Professional Services; Accounting

Source: California State Board of Equalization

Sales Tax Audit? Sales Tax Problem? BOE or SBE Issues? Get Sales Tax Resolution TODAY!

Carbon Dioxide and the IRS?

Gain from selling carbon dioxide allowances didn't generate foreign personal holding company income PLR 200825009

Mike Habib, EA

IRS has privately ruled that gain from the sale of surplus carbon dioxide allowances didn't constitute foreign personal holding company income (FPHCI) under Code Sec. 954(c). It concluded that the emissions allowances were excepted because they were intangible property used in the controlled foreign corporations' trade or business.

Facts. Taxpayer indirectly owns through a chain of foreign subsidiaries an unspecified percentage of the vote and value of Corporation A. The remaining interest is owned by unrelated parties. Corporation A engages in Industry M in Country A, where it is organized.

Taxpayer also indirectly owns 100% of the vote and value of Partnership B, a Country B entity that is treated as a controlled foreign partnership under Code Sec. 6038(e) . An unspecified percentage of Partnership B is directly owned by Corporation C, a controlled foreign corporation (CFC) of Taxpayer, organized in Country A. The remaining interest of Partnership B is directly owned by a domestic subsidiary corporation of Taxpayer. Partnership B engages in Industry M and other industries in Country B.

Countries A and B are members of the European Union (EU), which has developed the Emissions Trading Scheme (ETS) to regulate the emissions of carbon dioxide or its equivalent within certain industries, including Industry M. Beginning on Jan. 1, 2008, the ETS was expanded to include regulation of 5 other greenhouse gases. Corporation A and Partnership B are subject to the ETS.

Under the ETS, member states may emit specified amounts, measured in units, of the regulated greenhouse gases. The emissions capacity of each member state is represented by an allocation of allowances to it. Corporation A and Partnership B received carbon dioxide allowances from Country A and Country B, respectively, in Year 1 and Year 2. A business must surrender its allocated allowances for any year to the relevant authority in amounts equal to its emissions for the year. To the extent the measured emissions of a business exceed its allowances, a fine is imposed. However, to the extent a business has excess allowances, it may sell any surplus to another person. Corporation A and Partnership B had surplus allowances in Year 1 and Year 2, which were sold to unrelated purchasers.

Carbon dioxide allowances are traded over the counter and on exchanges such as the European Climate Exchange, the European Energy Exchange and Nordpool.

Background. Under Code Sec. 951(a), a U.S. shareholder of a CFC must include in gross income its pro-rata share of the CFC's subpart F income for the tax year.

A U.S. shareholder is any U.S. person (as defined in Code Sec. 957(c)) who owns (under Code Sec. 958) 10% or more of the total combined voting power of all classes of stock entitled to vote of such foreign corporation. (Code Sec. 951(b))

A CFC is any foreign corporation if more than 50% of the total combined voting power of all classes of its stock or more than 50% of the total value of its stock is owned by U.S. shareholders on any day during the tax year of such foreign corporation. (Code Sec. 957(a))

Subpart F income includes foreign base company income. (Code Sec. 952(a))
Under Reg. § 1.952-1(g)(1), a CFC's distributive share of any item of income of a partnership is income that falls within a category of subpart F income, as defined in Code Sec. 952(a), to the extent the item of income would have been income in such category if received by the CFC directly.

Code Sec. 954(a) defines four categories of foreign base company income, including FPHCI.
Code Sec. 954(c)(1)(C) provides, in part, that FPHCI includes the excess of gains over losses from transactions in any commodity. Commodity, for this purpose, includes tangible personal property of a kind that is actively traded or with respect to which contractual interests are actively traded. (Reg. § 1.954-2(f)(2)(i)) There are, however, exceptions. For example, net commodities gain that is included in FPHC income for subpart F purposes does not include active business gains or losses from the sale of commodities, if substantially all of the CFC's commodities are property described in Code Sec. 1221(a)(1) (inventory), Code Sec. 1221(a)(2) (property used in a trade or business subject to depreciation), or Code Sec. 1221(a)(8) (supplies used or consumed by the CFC in its trade or business). (Code Sec. 954(c)(1)(C)(ii))

Code Sec. 954(c)(1)(B)(iii) provides that FPHCI includes the excess of gains over losses from the sale of property which does not give rise to any income. However, under Reg. § 1.954-2(e)(3)(iii), property that does not give rise to income excludes intangible property (under Code Sec. 936(h)(3)(B)) to the extent used or held for use in the CFC's trade or business.

Reg. § 1.954-2(a)(5) provides special rules for calculating FPHCI applicable to distributive shares of partnership income. Under Reg. § 1.954-2(a)(5)(ii)(A), the exclusion provided by Reg. § 1.954-2(e)(3) applies only if such exception would have applied to exclude the income from FPHCI if the CFC had earned the income directly, determined by taking into account only the activities of, and property owned by, the partnership and not the separate activities or property of the CFC or any other person.

Code Sec. 936(h)(3)(B)(iv) and Code Sec. 936(h)(3)(B)(vi) include in the definition of intangible property any franchise, license, or contract, or any similar item, which has substantial value independent of the services of any individual.

Reg. § 1.954-2(a)(2) provides coordination rules for overlapping categories under the FPHCI provisions. Under those rules, gain or loss from commodities transactions under Code Sec. 954(c)(1)(C) take priority over gain under Code Sec. 954(c)(1)(B).

Analysis. IRS said it was currently studying the question of whether carbon dioxide allowances should be viewed as commodities for purposes of Code Sec. 954(c)(1)(C). However, it stated that, solely for purposes of PLR 200825009, IRS believes it is appropriate at this point to analyze carbon dioxide allowances as property that does not give rise to income under Code Sec. 954(c)(1)(B)(iii). No inference is intended as to whether the allowances are properly considered commodities for purposes of Code Sec. 954 or any other Code section.

The ruling noted that Reg. § 1.954-2(e)(3)(iv) provides that intangible property is excluded from FPHCI to the extent used or held for use in the CFC's trade or business. But this is applied to CFC partners by taking into account only the activities of the partnership.

In this case, possession of carbon dioxide allowances is necessary to operate in Industry M. Because each allowance permits the holder to engage in a business activity otherwise unlawful, without penalty, the allocation of an allowance by a member state is the granting of an intangible property right to each business to emit carbon dioxide to a set limit. The value of the allowance is independent of the performance of services by any individual. Thus, for purposes of Code Sec. 954(c)(1)(B), the allowances are intangible property under Code Sec. 936(h)(3)(B). However, to qualify for the exclusion of Reg. § 1.954-2(e)(3)(iv), the intangible property of Corporation A and Partnership B must be used or held for use in Corporation A and Partnership B's trade or business.

Based on the facts presented, IRS concluded that Corporation A and Partnership B held the carbon dioxide allowances to offset emissions resulting from the operation of their businesses in Industry M. Thus, Corporation A and Partnership B held the emissions allowances for use in their trade or business. Therefore, the allowances are intangible property held for use in a trade or business within the meaning of Reg. § 1.954-2(e)(3)(iv) and gain from their sale is properly excluded from the definition of FPHCI found in Code Sec. 954(c)(1)(B)(iii) by Corporation A and Corporation C.

Bottom line. Gain from the sale of surplus carbon dioxide allowances by Corporation A and Partnership B does not constitute FPHCI within the meaning of Code Sec. 954(c) to Corporation A or Corporation C.

Tax man is coming soon

House Subcommittee Passes IRS Funding Bill

The House Appropriations Financial Services Subcommittee this week passed a bill that would appropriate $11.4 billion to IRS for FY 2009.

The bill would grant IRS budget authority to spend $5.1 billion on enforcement, $2.2 on taxpayer services, and $3.8 billion on operations.

The total is about $40 million more than the president's request for the agency. The bill will next be considered by the full House Appropriations Committee before it goes to the House floor.

Closing the Tax Gap: An estimated $290 billion in taxes owed go unpaid every year. The IRS Oversight Board noted in a recent report that “the tax gap is an injustice to compliant taxpayers who ultimately are bearing the financial burden of those who do not pay what they owe, whether intentionally or not.”
• Enforcement: $5.1 billion, $337 million above 2008 and matching the President’s request, to catch tax cheats through audits, collection efforts, and technology improvements.

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As you can see from the above, over $5,000,000,000 (Five Billion), allocated for IRS enforcement. Enforcement will encompass aggressive collection efforts for collecting back taxes, and additional tax audits to ensure compliance and catch tax cheats.

So, if you owe the IRS, contact us today to resolve your tax matter. Don't let the IRS punish you, you could settle your tax debt for less than you owe.

Business Economic Stimulus

Business Provisions of the Economic Stimulus Act of 2008

Mike Habib, EA

The Economic Stimulus Act of 2008 contains two provisions that provide tax benefits for businesses. The first provision increases the limit up to which a business can expense property purchased and placed in service during its 2008 tax year. The second provision provides an additional 50 percent special depreciation allowance for property acquired and placed in service during calendar year 2008.

Unlike the economic stimulus payments that millions of individuals have already received, the tax benefits for businesses are not automatic; businesses must act to take advantage of the new provisions by purchasing qualifying property.

The Joint Committee on Taxation estimates that businesses stand to lower their 2008 tax bills by roughly $45 billion as a result of the two business provisions in the Economic Stimulus Act of 2008; these provisions accelerate into 2008 the tax benefits that otherwise would not have been available until future years.

The following are some details about these two key tax benefits:

Section 179 Expensing

• In general, section 179 provides that, instead of depreciating property, a business with a sufficiently small amount of annual property purchases may choose to expense the cost of the property. For taxable years beginning in 2008, the Economic Stimulus Act increased the section 179 expensing limit allowing more property to be currently expensed.
• The Economic Stimulus Act increased the maximum section 179 expense deduction to $250,000 for qualified section 179 property that is placed in service in tax years that begin in 2008. This is a 95 percent increase from the previous limitation of $128,000.
• The Economic Stimulus Act also increased the total amount of qualifying property a taxpayer may purchase before the section 179 expensing limit begins to be reduced. Under the new law, the $250,000 deduction amount is reduced only when a business acquires more than $800,000 of qualifying property. Prior to changes made by the Economic Stimulus Act, the reduction began when a business acquired more than $510,000 of qualifying property.
• The new law does not alter the section 179 expense limit for sport utility vehicles, which remains at $25,000.
• More than 4.5 million small businesses claimed the section 179 expense deduction for tax year 2005, the most recent year for which this information is available. These businesses placed almost $44 billion of section 179 property in service in 2005 and claimed related deductions of approximately $41 billion (data derived from Depreciation and Amortization forms filed with Forms 1040).

Special Depreciation Allowance

• The Economic Stimulus Act also provided a 50 percent special depreciation allowance for property acquired and placed in service during 2008. Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property over several years. It is an annual allowance for the wear and tear, deterioration or obsolescence of the property.
• Under the new law, a taxpayer is entitled to depreciate 50 percent of the adjusted basis (after subtracting any section 179 deduction taken on that property) of qualified property during the year the property is placed in service. For example, if the taxpayer purchased and placed in service in 2008 a single piece of property at a cost of $450,000 that qualified for section 179 expensing and the 50 percent special depreciation allowance, $250,000 of the cost could be immediately expensed (under section 179 ) and the remaining $200,000 of adjusted basis would be available for the 50 percent special depreciation allowance. The taxpayer would also be permitted to take regular depreciation on the remaining $100,000 of adjusted basis during that year. This is similar to the special depreciation allowance that was previously available for certain property placed in service generally before Jan. 1, 2005, often referred to as “bonus depreciation.”
• The types of property that qualify for the 50 percent special depreciation allowance are section 168 property with a recovery period of 20 years or less, off-the-shelf computer software, water utility property and qualified leasehold improvement property.
• To qualify for the 50 percent special depreciation allowance, a taxpayer must meet all of the following tests:
• The taxpayer must have acquired the property after December 31, 2007, and before Jan. 1, 2009. If a binding contract to acquire the property existed before Jan. 1, 2008, the property does not qualify for the special depreciation allowance.
• The property must be placed in service before Jan. 1, 2009 (before Jan. 1, 2010, for certain transportation property and certain property with a long productions period).
• The original use of the property must begin with the taxpayer after Dec. 31, 2007. In other words, the property must be “new” property.
• Prior to the enactment of the Economic Stimulus Act the total depreciation amount (including the section 179 deduction) a business could deduct for a passenger automobile was $2,960. The Economic Stimulus Act increased this limitation by $8,000. Therefore, the maximum limit is increased to $10,960 for automobiles for which the special bonus depreciation allowance is claimed.
• Prior to the enactment of the Economic Stimulus Act, the total depreciation amount (including the section 179 deduction) a business could deduct for a truck or van used in a business and first placed in service in 2008 was $3,160. The Economic Stimulus Act increased this limitation by $8,000. The new maximum limit is increased to $11,160 for trucks and vans for which the special bonus depreciation is claimed.

The Economic Stimulus Act is the most recent legislation that provides depreciation tax benefits. Previously, the Job Creation and Worker Assistance Act of 2002 allowed an additional first-year depreciation deduction equal to 30 percent of the adjusted basis of qualified property for property acquired on or after Sept. 11, 2001, and generally placed in service before Jan. 1, 2005. The Jobs and Growth Tax Relief Reconciliation Act of 2003 provided an additional first-year depreciation deduction equal to 50 percent of the adjusted basis of qualified property for property acquired after May 5, 2003, and generally placed in service before Jan. 1, 2005.

For professional tax advice contact us today.

Disaster Victims Tax Relief

More disaster victims in Indiana, Iowa and Wisconsin qualify for tax relief IRS website [http://www.irs.gov/newsroom/article/0,,id=108362,00.html]

Mike Habib, EA

IRS has announced on its website that additional counties in Indiana, Iowa and Wisconsin have been declared disaster areas on account of recent severe storms, tornadoes and flooding. As a result, more victims of the disaster have additional time to make tax payments and file returns. Certain other time-sensitive acts also are postponed.

Who gets relief. Only taxpayers considered to be affected taxpayers are eligible for the postponement of time to file returns, pay taxes and perform other time-sensitive acts. Affected taxpayers are those listed in Reg. § 301.7508A-1(d)(1) and thus include:

• any individual whose principal residence, and any business entity whose principal place of business, is located in the counties designated as disaster areas;
• any individual who is a relief worker assisting in a covered disaster area, regardless of whether he is affiliated with recognized government or philanthropic organizations;
• any individual whose principal residence, and any business entity whose principal place of business, is not located in a covered disaster area, but whose records necessary to meet a filing or payment deadline are maintained in a covered disaster area, or whose tax professional/practitioner is located in a covered disaster area;
• any estate or trust that has tax records necessary to meet a filing or payment deadline in a covered disaster area; and
• any spouse of an affected taxpayer, solely with regard to a joint return of the husband and wife.

What may be postponed. Under Code Sec. 7508A, IRS gives affected taxpayers until the extended date (specified by county, below) to file most tax returns (including individual, estate, trust, partnership, C corporation, and S corporation income tax returns; estate, gift, and generation-skipping transfer tax returns; and employment and certain excise tax returns), or to make tax payments, including estimated tax payments, that have either an original or extended due date falling on or after the onset date of the disaster (specified by county, below), and on or before the extended date.

IRS also gives affected taxpayers until the extended date to perform other time-sensitive actions described in Reg. § 301.7508A-1(c)(1) and Rev Proc 2007-56, 2007-34 IRB 388, that are due to be performed on or after the onset date of the disaster, and on or before the extended date. This relief also includes the filing of Form 5500 series returns, in the way described in Rev Proc 2007-56, Sec. 8. Additionally, the relief described in Rev Proc 2007-56, Sec. 17, relating to like-kind exchanges of property, also applies to certain taxpayers who are not otherwise affected taxpayers and may include acts required to be performed before or after the period above.

The postponement of time to file and pay does not apply to information returns in the W-2, 1098, 1099 or 5498 series, or to Forms 1042-S or 8027. Penalties for failure to timely file information returns can be waived under existing procedures for reasonable cause. Likewise, the postponement does not apply to employment and excise tax deposits. IRS, however, will abate penalties for failure to make timely employment and excise deposits, due on or after the onset date of the disaster, and on or before the information return delayed date (specified by county, below), provided the taxpayer made these deposits by the information return delayed date.

IRS will waive the failure to deposit penalties for employment and excise deposits due on or after the onset date of the disaster, and on or before the deposit delayed date (specified by county, below , as long as the deposits were made by the deposit delayed date.

Affected counties and dates for storms, floods and other disasters in 2008 are as follows:
Arkansas: The following are presidential disaster areas qualifying for individual assistance: Arkansas, Benton, Cleburne, Conway, Crittenden, Grant, Lonoke, Mississippi, Phillips, Pulaski, Saline and Van Buren counties.

For these Arkansas counties, the onset date of the disaster was May 2, 2008, the extended date is July 21, 2008, the information return delayed date was May 19, 2008, and the deposit delayed date was May 19, 2008.

Colorado: The following are presidential disaster areas qualifying for individual assistance: Larimer and Weld counties.

For these Colorado counties, the onset date of the disaster was May 22, 2008, the extended date is July 25, 2008, the information return delayed date was June 6, 2008, and the deposit delayed date was June 6, 2008.

Georgia: The following are presidential disaster areas qualifying for individual assistance: Bibb, Carroll, Douglas, Emanuel, Jefferson, Jenkins, Johnson, Laurens, McIntosh and Twiggs counties.

For these Georgia counties, the onset date of the disaster was May 11, 2008, the extended date is July 22, 2008, the information return delayed date was May 27, 2008, and the deposit delayed date was May 27, 2008.

Iowa: The following are presidential disaster areas qualifying for individual assistance: Adams, Allamakee, Benton, Black Hawk, Bremer, Buchanan, Butler, Cedar, Cerro Gordo, Chicksaw, Clayton, Crawford, Delaware, Des Moines, Fayette, Floyd, Freemont, Hardin, Harrison, Jasper, Johnson, Jones, Linn, Louisa, Mahaska, Marion, Mills, Monona, Muscatine, Page, Polk, Story, Tama, Union, Warren and Winneshiek counties.

For these Iowa counties, the onset date of the disaster is May 25, 2008, the extended date is July 28, 2008, the information return delayed date was June 9, 2008, and the deposit delayed date was June 9, 2008.

Indiana: The following are presidential disaster areas qualifying for individual assistance: Adams, Bartholomew, Brown, Clay, Daviess, Dearborn, Decaturm Greene, Hamilton, Hancock, Henry, Jackson, Jennings, Johnson, Knox, Marion, Monroe, Morgan, Owen, Parke, Putnam, Randolph, Rush, Shelby, Sullivan, Vermillion, Vigo and Wayne counties.

For these Indiana counties, the onset date of the disaster was May 30, 2008, the extended date is Aug. 7, 2008, the information return delayed date was June 16, 2008, and the deposit delayed date was June 16, 2008.

Maine: The following are presidential disaster areas qualifying for individual assistance: Aroostook and Penobscot counties.

For these Maine counties, the onset date of the disaster was April 28, the extended date is July 8, the information return delayed date was May 13, 2008, and the deposit delayed date was May 13, 2008.

Missouri: The following are presidential disaster areas qualifying for individual assistance: Barry, Jasper and Newton counties.

For these Missouri counties, the onset date of the disaster was May 10, 2008, the extended date is July 22, 2008, the information return delayed date was May 27, 2008, and the deposit delayed date was May 27, 2008.

Mississippi: The following are presidential disaster areas qualifying for individual assistance: Bolivar, Warren, Washington and Wilkinson counties.

For these Mississippi counties, the onset date of the disaster was March 20, 2008, the extended date is July 7, 2008, the information return delayed date was April 4, 2008, and the deposit delayed date was April 4, 2008.

Oklahoma: The following are presidential disaster areas qualifying for individual assistance: Craig, Latimer, Ottawa and Pittsburg counties.

For these Oklahoma counties, the onset date of the disaster was May 10, 2008, the extended date is July 14, 2008, the information return delayed date was May 27, 2008, and the deposit delayed date was May 27, 2008.

Wisconsin: The following are presidential disaster areas qualifying for individual assistance: Crawford, Columbia, Dodge, Green, Sauk, Milwaukee, Racine, Richland, Vernon, Washington, Waukesha and Winnebago counties.

For these Wisconsin counties, the onset date of the disaster was June 5, 2008, the extended date is Aug. 13, 2008, the information return delayed date is June 20, 2008, and the deposit delayed date is June 20, 2008.

Claiming disaster loss on previous year's return. A taxpayer that sustains a loss attributable to a disaster occurring in a Presidential disaster area may elect to deduct that loss on his return for the tax year immediately preceding the tax year in which the disaster occurred. (Code Sec. 165(i)) Generally, a taxpayer must make this election by filing a return, an amended return, or a refund claim on or before the later of (i) the due date of his income tax return (determined without regard to any filing extension) for the tax year in which the disaster actually occurred, or (ii) the due date of his tax return (determined with regard to any filing extension) for the immediately preceding tax year. The election is irrevocable 90 days after it is made. (Reg. § 1.165-11(e)) Because of the new disaster area designation, taxpayers in affected counties designated as disaster areas in 2008 can elect to claim a 2008 disaster loss on their 2007 returns, instead of on their 2008 returns.

Observation: Claiming the disaster loss for the year before the loss occurred saves taxes immediately, without having to wait until the end of the year in which the loss was sustained. In some cases, the deduction may result in a net operating loss, which could result in a refund from an earlier year to which it is carried. On the other hand, deducting the loss in the year the loss actually occurred may result in bigger tax savings if the taxpayer is in a higher bracket in that year.

CFC Controlled Foreign Corporation Tax Problem?

Regs crack down on tax avoidance repatriations of CFC earnings
Preamble to TD 9402, 06/23/2008; Reg. § 1.956-1T; Preamble to Prop Reg 06/23/2008; Prop Reg § 1.956-1

Mike Habib, EA

IRS has issued temporary and proposed regs to determine the basis of certain U.S. property acquired by a controlled foreign corporation (CFC) in certain nonrecognition transactions that are intended to repatriate earnings and profits of the CFC without income inclusion by the U.S. shareholders of the CFC under Code Sec. 951(a)(1)(B).

Background. IRS is aware that certain taxpayers are engaging in certain nonrecognition transactions in which a CFC acquires certain U.S. property (within the meaning of Code Sec. 956(c)) without resulting in an income inclusion to the U.S. shareholders of the CFC under Code Sec. 951(a)(1)(B).

Illustration: USP, a domestic corporation and the common parent of an affiliated group that files a consolidated tax return, owns 100% of the outstanding stock of US1 and US2, both domestic corporations that join USP in the filing of a consolidated tax return. US1 owns 100% of the stock of CFC, a controlled foreign corporation. US2 issues $100 million of its stock to CFC in exchange for $10 million of CFC stock and $90 million cash. USP takes the position that: (i) US2's transfer of its stock to CFC in exchange for $10 million of CFC stock and $90 million cash is an exchange to which Code Sec. 351 applies; (ii) US2 recognizes no gain on the receipt of $10 million of CFC stock and $90 million cash in exchange for its stock under Code Sec. 1032(a) ; (iii) CFC recognizes no gain on the issuance of its stock to US2 under Code Sec. 1032(a) ; (iv) CFC's basis in the US2 stock is zero under Code Sec. 362(a) ; and (v) US1 and US2 do not and will not have an income inclusion under Code Sec. 951(a)(1)(B) as a result of CFC holding the US2 stock (which constitutes U.S. property under Code Sec. 956(c) ). (Preamble to TD 9402, 06/23/2008)

IRS believes these transactions raise significant policy concerns because the transactions may have the effect of repatriating earnings and profits of a CFC without a corresponding dividend inclusion, or an income inclusion under Code Sec. 951(a)(1)(B) by reason of the CFC's investment in U.S. property.

Code Sec. 956 was enacted to require an income inclusion by U.S. shareholders of a CFC that invests certain earnings and profits in U.S. property on the ground that the investment is substantially the equivalent of a dividend being paid to them.

Under Code Sec. 951(a)(1)(B), each U.S. shareholder (as defined in Code Sec. 951(b)) of a CFC (as defined in Code Sec. 957(a)) must include in its gross income for its tax year in which or with which the tax year of the CFC ends, the amount determined under Code Sec. 956 with respect to such shareholder for such year (but only to the extent not excluded from gross income under Code Sec. 959(a)(2)).

Regs under Code Sec. 367(b) prevent the repatriation of a U.S. person's share of earnings and profits of a foreign corporation through what would otherwise be a nonrecognition transaction.

Under Code Sec. 362(a), for property acquired by a corporation in connection with a Code Sec. 351 transaction (relating to transfer of property to corporation controlled by transferor), the basis is the same as it would be in the hands of the transferor, increased by the amount of any gain recognized to the transferor on the transfer.

No gain or loss is recognized to a corporation on the receipt of money or other property in exchange for stock of that corporation. (Code Sec. 1032)

Temporary regs. When a CFC acquires stock or obligations of a domestic issuing corporation, that constitute U.S. property under Code Sec. 956(c), from such corporation pursuant to an exchange in which the CFC's basis in the property is determined under Code Sec. 362(a), the temporary regs apply. As a result, solely for Code Sec. 956 purposes, the temporary regs cause the CFC's basis in the property to be no less than the fair market value of the property transferred by the CFC in exchange for the property. For this purpose, “property” has the meaning set forth in Code Sec. 317(a), but includes any liability assumed by the CFC in connection with the exchange notwithstanding Code Sec. 357(a). (Reg. § 1.956-1T(e)(6))

The temporary regs also apply when property whose basis is determined under the regs is transferred to a related person (related person transferee), or by a related person transferee to another related person, pursuant to an exchange in which the related person transferee's basis in the property is determined, in whole or in part, by reference to the transferor's basis in the property. This rule is intended to prevent taxpayers from attempting to avoid the general rule of the temporary regs by subsequently transferring the property to a related person in another nonrecognition transaction. (Reg. § 1.956-1T(e)(6))

Basis determined under the temporary regs applies only for purposes of determining the amount of U.S. property acquired or held by a CFC under Code Sec. 956 , and accordingly the amount of a U.S. shareholder's income inclusion under Code Sec. 951(a)(1)(B) with respect to the CFC. (Reg. § 1.956-1T(e)(6))

The temporary regs apply only to determine the basis of U.S. property acquired by a CFC pursuant to an exchange that is within their scope. All other basis determinations are made under the rules in Reg. § 1.956-1(e)(1)(4). (Preamble to Prop Reg 06/23/2008)

Illustration: Applying the facts from Illustration (1), the results are as follow under the temporary regs. The US2 stock acquired by CFC in the exchange constitutes U.S. property under Reg. § 1.956-1T(e)(6)(ii) because CFC acquires the US2 stock from US2, the issuing corporation. Therefore, because CFC's basis in the US2 stock is determined under Code Sec. 362(a), then for purposes of Code Sec. 956, CFC's basis in the US2 stock is, under Reg. § 1.956-1T(e)(6)(iii) no less than $90 million, the fair market value of the property exchanged by CFC for the US2 stock (the $10 million of CFC stock issued in the exchange does not constitute property for purposes of Reg. § 1.956-1T(e)(6)(iii)). Under Reg. § 1.956-1T(e)(6)(iv), for purposes of Reg. § 1.956-2(d)(1)(i)(a), CFC is treated as acquiring its basis of no less than $90 million in the US2 stock at the time of its transfer of property to US2 in exchange for the US2 stock. The result would be the same if, instead of CFC transferring $90 million of cash to US2 in the exchange, CFC assumes a $90 million liability of US2. Reg. § 1.956-1T(e)(6)(vi), Example 1.

Effective date. The temporary regs apply to U.S. property acquired in exchanges occurring on or after June 24, 2008. No inference is intended as to the basis of U.S. property acquired by a CFC pursuant to a comparable transaction occurring before that date. IRS may, where appropriate, challenge such pre-June 24 transactions under applicable provisions or judicial doctrines. (Reg. § 1.956-1T(f), Preamble to TD 9402, 06/23/2008)

IRS increases mileage rate

Business standard mileage rate increases for last half of 2008 - other rates also rise

Mike Habib, EA

IRS has announced that the optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) will increase 8¢ from 50.5¢ to 58.5¢ per mile for business travel from July 1, 2008 to Dec. 31, 2008 to better reflect the real cost of operating an auto in this period of rapidly rising gas prices. The rate for using a car to get medical care or in connection with a move that qualifies for the moving expense will also increase 8¢ for the last half of 2008 from 19¢ to 27¢ per mile.

Observation: IRS's increase in the business standard mileage rate is undoubtedly a result of recent pressure brought to bear on IRS to take action to relieve taxpayers suffering from skyrocketing gas prices (see Newsstand e-mail 6/18/08). On June 11, 2008, Senator Norm Coleman (R-MN) sent a letter to IRS Commissioner Shulman, requesting that IRS increase the 2008 standard mileage rates to better reflect the high cost of travel. Coleman noted that in the past, in 2005, IRS raised the standard mileage rates for the last four months of the year, rather than waiting until year-end, due to a large increase in gas prices. Earlier, on June 6, 2008, National Treasury Employees Union (NTEU) President Colleen Kelley also wrote to Commissioner Shulman, on behalf of federal government employees, asking him to consider making a mid-year adjustment to the 2008 standard mileage rates.

Observation: The plight of taxpayers suffering from ever increasing gas prices has not been ignored by legislators. On May 19, 2008, Sen. Charles Schumer (D-NY) introduced a bill in the Senate, S. 3032, the “Reimburse Our American Drivers (ROAD) Act of 2008,” that would temporarily increase the standard mileage rate to 70¢ per mile on travel for business, medical, and moving expense-related purposes. Federal employees would also be allowed to use this rate. The rate would be in effect during all of 2008. The legislation has been referred to the Senate Finance Committee for consideration.

Observation: As the gas prices at the pump continue to rise at a record breaking pace, it is questionable whether the additional 8¢ per mile will provide significant relief to taxpayers, or turn out to be a matter of too little too late.

Background. The mileage allowance deduction replaces separate deductions for lease payments (or depreciation if the car is purchased), maintenance, repairs, tires, gas, oil, insurance and license and registration fees. The taxpayer may, however, still claim separate deductions for parking fees and tolls connected to business driving. (Rev Proc 2007-70, Sec. 5.04) IRS generally adjusts the standard mileage rate annually, based on a yearly study of the fixed and variable costs of operating an automobile.

Employers that require employees to supply their own autos may reimburse them at a rate that doesn't exceed the business mileage allowance for employment-connected business mileage, whether the autos are owned or leased. (Rev Proc 2007-70, Sec. 9.01) Additionally, an employee's personal use of lower-priced company autos may be valued at the optional mileage allowance if the conditions specified in Reg. § 1.61-21(e)(1) are met.

A separate rate for using a car to get medical care or in connection with a move that qualifies for the moving expense deduction. (Rev Proc 2007-70, Sec. 7.02) The mileage rate for driving an auto for charitable use (14¢ per mile) is a statutory rate that's not adjusted for inflation. (Rev Proc 2007-70, Sec. 7.01)

When the new rates are effective. The revised standard mileage rates in Ann. 2008-63 apply to deductible transportation expenses paid or incurred for business, medical, or moving expense purposes on or after July 1, 2008, and to mileage allowances that are paid both (1) to an employee on or after July 1, 2008; and (2) with respect to transportation expenses paid or incurred by the employee on or after July 1, 2008.

However, the standard mileage rates in Rev Proc 2007-70, 2007-50 IRB 1162, continue to apply to deductible transportation expenses paid or incurred for business, medical, or moving expense purposes before July 1, 2008, and to mileage allowances paid: (1) to an employee before July 1, 2008, or (2) with respect to transportation expenses paid or incurred by the employee before July 1, 2008. All other provisions of Rev Proc 2007-70 remain in effect. (Ann. 2008-63)

As Seen On TV

TV ads and TV Tax Relief Commercials claiming "Pennies On The Dollar" Tax Settlements - As Seen On TV

Mike Habib, EA

Many Tax Relief and Tax Negotiation firms advertise on TV claiming that they can settle your tax debt for "pennies on the dollar". Now, you, as a taxpayer must be informed of what options you have and should research these firms at the Better Business Bureau www.BBB.org

Here is our Customer BEWARE REPORT on certain Tax Negotiation Companies that advertise on TV claiming "pennies on the dollar" tax settlements.

Customer…Beware!

How To Keep From Getting Ripped Off?

Many “Tax Negotiation” companies out there will absolutely rip you off. These unscrupulous firms will take your money regardless of whether they can help you or not. They'll lie to you and tell you they can get all the penalties and interest wiped out. They'll lie to you and tell you they'll settle with the IRS for "pennies on the dollar" when they know damn well you don't possibly qualify for the Offer in Compromise program.

How do they get away with this? Easy, most of the people you talk to at these unscrupulous firms are sales representatives. They have NO license to protect. You don't actually speak to the EA (Enrolled Agent), the CPA (Certified Public Accountant) or the attorney that these firms claim to have. Nope, you speak to some slimy unlicensed salesman. Some of these firms make up titles like Tax Resolution Specialist, or Tax Consultant. What a scam! In fact, many of these unscrupulous firms aren't tax firms or law firms at all, they’re just sales organizations!

We NEVER take on any client that we don't believe we can truly help. But, I absolutely guarantee you that 90% of the unscrupulous tax negotiation firms that advertise on TV and the internet would take any client and their money regardless of whether they could help them or not. And that stinks!

So, what should you do?

1) Always speak with the “licensed representative” who is on the Power of Attorney, that will actually represent you, usually the principal / owner of the firm,

2) Stay away from any firm/website that doesn't clearly give the names and bios of the licensed representative (Enrolled Agents, CPAs & Attorneys),

3) Ignore guarantees, promises and so-called testimonials. They're nothing more than meaningless hype; instead check the Better Business Bureau rating – A MUST!

4) Ask tough questions. If the answers don't make sense, don't hire the firm. What kind of tough questions? Are you an EA, CPA or attorney? When they say, "I'm a tax resolution specialist", ask them, is that a State or Federal license?

5) Finally, use your good common sense. You know when something isn't right. You work too hard for your money to give it away to some slime ball that makes promises you know he can't keep. Only deal with someone who is “Licensed” and who “Specialize” is Tax Resolution.

Don’t get ripped off! Do the right thing-hire a Licensed Representative!

Compliments of: Mike Habib, EA http://www.myirstaxrelief.com/

State Employment Tax Changes

Recap of recent state employment tax laws, developments, and changes taking effect in July

Several states and localities are making employment tax changes that take effect in July. In addition, several new employment tax laws and developments have occurred recently. Here are some of the highlights from the following states:

Alabama
Unemployment. Effective for benefit years beginning after July 5, 2008, a claimant must serve a one-week waiting period prior to receiving unemployment benefits. The maximum weekly benefit will also increase from $235 to $255 [L. 2008, H427].

California
Employment Taxes. A state of emergency was declared on June 12th in the following counties: Sacramento, San Joaquin, Stanislaus, Merced, Madera, Fresno, Kings, Tulare, and Kern, due to the drought. Affected employers may request up to a 60-day extension of time to file their state payroll reports and deposit state payroll taxes with the Employment Development Department (EDD). All requests will be evaluated on a case-by-case basis. For further information, contact the Taxpayer Assistance Center at (888) 745-3886 [EDD Announcement, 6/13/2008].

Wage and Hour. The California Court of Appeal has ruled that an employee who received a premium holiday pay rate for work performed on Labor Day, and who worked 12 hours on Labor Day and 60 hours during the week, was only entitled to overtime based on her regular pay rate. The employer is entitled to credit the time-and-a-half premium pay on holidays against otherwise earned overtime [ Advanced-Tech Security Services, Inc. v. Superior Court, Cal. Ct. App., Second App. Dist., Division Five, Dkt. No. B205186, 6/3/08].

Colorado
Unemployment. The Colorado Department of Labor & Employment (DLE) reminds employers to review adjustments to their account on line 15 of Form UITR-1, Unemployment Insurance Tax Report (Tax Report), before determining their tax payment for the quarter [DLE UI Quarterly News, 2nd Quarter 2008].

Connecticut
Employment Taxes. The state is setting up a joint task force on worker misclassification issues (i.e., employee vs. independent contractor) [L. 2008, H5113].

Unemployment. New registration requirements go into effect for professional employer organizations (PEOs), beginning in 2009 [L. 2008, H5113].

Wage Payment. Effective Oct 1, 2008, wage deductions are permitted for contributions that are attributable to automatic enrollment in IRC §401(k), 403(b), 408, 408A, or 457 retirement plans [L. 2008, S157].

District of Columbia
Time Off. Effective Nov. 13, 2008, all Washington, D.C. employers must provide paid leave for illness and absences associated with domestic violence, sexual abuse, or stalking of employees or their family members [D.C. Register, Vol. 55, No. 21, 005886, 5/23/08; DC Law 17-152, 5/13/08].

Idaho
Wage and Hour. Effective July 1, state employees who do not qualify for the executive exemption under Idaho law, or the administrative or professional exemption under federal law, and state employees not designated as exempt under any other complete exemption in federal law, are eligible for overtime compensation.

Illinois
Wage and Hour. The minimum wage rate will increase from $7.50 per hour to $7.75 per hour on July 1.
Iowa
Wage and Hour. Effective July 1, the following enterprises are exempt from Iowa minimum wage rules, regardless of whether sales are $300,000 or more: (1) enterprises engaged in the business of laundering, cleaning, or repairing clothing or fabrics; (2) enterprises engaged in construction or reconstruction; (3) hospitals and schools; and (4) public agencies.

Indiana
Wage Payment. A federal court has ruled that store managers who were no longer employed by a company were not entitled to unpaid bonuses, since one contingency for receiving the bonuses was continued employment. The bonuses did not qualify as wages under either Indiana wage payment or wage claim statutes because of the contingency [ Harney v. Speedway SuperAmerica, LLC, CA7, Dkt. No. 07-3488, 5/30/2008].

Withholding. Indiana law requires the withholding of adjusted gross income tax and local option income tax from a pension distribution, if the payee requests withholding. The withholding request must be made in writing and should include the payee's Indiana county of residence [Indiana Information Bulletin IT13, 06/01/2008].

Kansas
Withholding. Effective July 1, employers with an annual total withholding tax liability of over $45,000 (before July 1, over $100,000) may be required to remit taxes by electronic funds transfer [Kan. Stat. Ann. §75-5151, as amended by L. 2007, H2434, §13].

Unemployment. Wage reports, contributions returns, and payments due after June 30, 2008, must be filed electronically by employers with 250 or more employees, and third-party administrators with 250 or more client employees.

Kentucky
Wage and Hour. The minimum wage rate will increase from $5.85 per hour to $6.55 per hour on July 1.
Massachusetts
Wage and Hour. Effective July 13th, treble damages will be awarded for all wage and hour violations, even if there was no “willful misconduct” by the employer.

Maryland
Time Off. The Flexible Leave Act amends the state's family leave provisions, effective Oct. 1, 2008. The provision will apply to employers with 15 or more employees working in the state. Employers will not only be able to allow employees to take “leave with pay” for the birth or adoption of a child, but also to care for a spouse, child, or parent. “Leave with pay” includes sick leave, vacation time, and compensatory time. In cases where an employee earns more than one type of leave, the employee may elect the type and amount of paid leave to be used [L. 2008, H40].

Minnesota
Withholding. Effective beginning after Dec. 31, 2008, payments to independent contractors are subject to state backup withholding if they are subject to federal backup withholding. Previous legislation that required third-party bulk filers to withhold from independent contractors was deleted before the provision took effect [L. 2007, H3149].

Mississippi
New Hire Reporting. Beginning in July, certain employers, third-party employers, contractors, and subcontractors will be required to register and use the federal Department of Homeland Security E-Verify program for all new hires. Required compliance is phased in through July 2011, based on the number of employees.

Michigan
Wage and Hour. The minimum wage rate will increase from $7.15 per hour to $7.40 per hour on July 1.
Montana
Unemployment. Effective July 1, the administrative fund tax for governmental experience-rated employers is 0.09% of total wages.

Nevada
Employment Taxes. The Nevada Tax Commission has approved a tax amnesty program that calls for waiving interest and penalty on certain tax liabilities, including the modified business tax (on payroll). The program is scheduled to start on July 1, 2008, and end on Sept. 30, 2008. To be eligible for amnesty, a business or taxpayer must be in full compliance with state law and pay the entire tax due by the end of the amnesty period. The Nevada Department of Taxation is in the preliminary stages of developing specific guidelines and requirements for the program [ Nevada Press Release, 6/2/08].

Unemployment. Effective July 1, all unemployment tax payments of $10,000 or more (including interest and penalties) must be remitted electronically.

Wage and Hour. Effective July 1, the state minimum wage will increase to $5.85 per hour for employees who receive qualified health benefits, and to $6.85 per hour for all other employees.

New Jersey
Withholding. Employees are allowed to exclude certain employer-provided commuter transportation benefits from their taxable gross income, up to a maximum amount that is adjusted annually for inflation. The maximum amount for 2008 is $1,440, up from $1,410 for 2007. Amounts in excess of $1,440 must be included in an employee's gross wages on Form W-2 or other written statement [Div. Tax. Notice of Employee Commuter Transportation Benefit Limits, 06/02/2008].

Oklahoma
Withholding. A federal district court has suspended the enforcement of a statute that required contractors to withhold from workers who could not produce federal documents showing that they were authorized alien labor. The court found the Oklahoma law to be an attempt to regulate behavior, not to impose a new tax. The injunction continues until the merits of the case are finally decided [Chamber of Commerce of the U.S.A. v. Henry, DC OK, Dkt. No. CIV-8-109-C, 6/4/2008].

The governor has signed into law a tax amnesty bill. A taxpayer will be entitled to a waiver of penalty, interest, and other collection fees due on eligible taxes (including withholding taxes), if the taxpayer voluntarily files delinquent tax returns and pays the taxes due during the compliance initiative. The program is scheduled to take place from Sept. 15 until Nov. 14, 2008 [L. 2007, S2034 (c.395), §1].

Oregon
Time Off. The state Supreme Court has ruled that while employers are required to provide minimum rest breaks as per Or. Admin. R. § 839-020-0050(1)(b) , violations do not give rise to a wage claim for additional wages [Gafur v. Legacy Good Samaritan Hosp. & Med. Ctr., Or. Sup. Ct., Dkt. No. SC055175, 5/15/08].

Pennsylvania
Withholding. Effective July 1 through Dec. 31, 2008, Philadelphia tax rates are reduced to 3.98% for residents and 3.5392% for nonresidents. The tax rate that should be used is the rate in effect on the date that the taxable compensation is actually paid to the employee. For example, wage tax on a paycheck dated July 1, 2008, for wages paid for the period from June 16 to June 30, 2008, should be withheld at the rate in effect as of July 1, 2008 [Philadelphia Bill No. 080161, 05/22/2008; Important Notice: Wage Tax Rate Reduction, Philadelphia Dept. of Rev., 06/04/2008].

South Carolina
New Hire Reporting. New legislation requires all employers to verify the employment eligibility of new hires beginning as early as Jan. 1, 2009 [L. 2008, H4400].

Withholding. Effective June 4, 2008, withholding agents must withhold 7% state income tax on compensation paid to an individual that was reported on Form 1099, if the individual: (1) fails to provide a taxpayer identification or Social Security number; (2) fails to provide a correct taxpayer identification or Social Security number; or (3) provides an IRS-issued taxpayer identification number issued for nonresident aliens. There are exceptions to this rule [S.C. Code Ann. §12-8-595, as amended by L. 2008, H4400].

Texas
Unemployment. The state has begun mailing checks to experience-rated employers eligible to receive the surplus tax credit [TWC Tax Department Tip of the Month, June 2008].

Vermont
Withholding. Effective July 1, the state may grant EFT filers up to six additional days for payment (prior to that, four additional days).

Virginia
Withholding. The Virginia Supreme Court has ruled that the requirement in Va. Code Ann. § 58.1-1815 to “truthfully account for and pay over such tax” is violated by one who willfully fails either to “account for” or “pay over” the tax. Therefore, a criminal penalty could be assessed against a person who failed to pay his withholding tax obligation, even though he had truthfully accounted for the obligation [Gibson v. Cmwth. of Virginia, Va. Sup. Ct., Dkt. No. 072023, 6/6/2008 ].

West Virginia
Withholding. A business registration certificate may be revoked for repeated, willful refusal to remit state withholding taxes when due [West Virginia Administrative Decision 08-052 F, 06/08/2008].

Wage and Hour. The minimum wage rate will increase from $6.55 per hour to $7.25 per hour on July 1.
Wisconsin
Withholding. Wisconsin will follow federal rules that require “disregarded entities” to pay their own employment taxes and file their own employment tax reports, beginning with wages paid in 2009. As an “employer,” a disregarded entity must obtain a Wisconsin employer identification number [Wisconsin Dept. Rev. Tax Bulletin 156, 04/01/2008].

The state has issued a tax release that clarifies the circumstances under which “public speaking services” are subject to Wisconsin's nonresident entertainer prepayment law [Wisconsin Dept. Rev. Tax Bulletin 156, 04/01/2008].

Wyoming
Unemployment. Effective July 1, 2007, employers were required to submit “Wyoming Employee Wage Listings” as part of their quarterly reporting responsibilities. Beginning in 2009, the state may increase an employer's tax rate by a 2% penalty rate if the employer has failed to submit the wage listing [Wy. Quarterly Connection, 1st Qtr. 2008].

How to choose a business structure

Choosing a Business Structure

FS-2008-22 Of all the choices you make when starting a business, one of the most important is the type of legal organization you select for your company. This decision can affect how much you pay in taxes, the amount of paperwork your business is required to do, the personal liability you face and your ability to borrow money. Business formation is controlled by the law of the state where your business is organized. This fact sheet provides a quick look at the differences between the most common forms of business entities. The most common forms of businesses are: Sole Proprietorships Partnerships Corporations Limited Liability Companies (LLC) While state law controls the formation of your business, federal tax law controls how your business is taxed. Federal tax law recognizes an additional business form, the Subchapter S Corporation. All businesses must file an annual return. The form you use depends on how your business is organized. Sole proprietorships and corporations file an income tax return. Partnerships and S Corporations file an information return. For an LLC with at least two members, except for some businesses that are automatically classified as a corporation, it can choose to be classified for tax purposes as either a corporation or a partnership. A business with a single member can choose to be classified as either a corporation or disregarded as an entity separate from its owner, that is, a “disregarded entity.” As a disregarded entity the LLC will not file a separate return instead all the income or loss is reported by the single member/owner on its annual return. The answer to the question “What structure makes the most sense?” depends on the individual circumstances of each business owner. The type of business entity you choose will depend on: Liability Taxation Recordkeeping Sole Proprietorship A sole proprietorship is the most common form of business organization. It’s easy to form and offers complete control to the owner. It is any unincorporated business owned entirely by one individual. In general, the owner is also personally liable for all financial obligations and debts of the business. (State law may also govern this area depending on the state.) Sole proprietors can operate any kind of business. It must be a business, not an investment or hobby. It can be full-time or part-time work. This includes operating a: Shop or retail trade business Large company with employees Home based business One person consulting firm Every sole proprietor is required to keep sufficient records to comply with federal tax requirements regarding business records. Generally, sole proprietors file Schedule C or C-EZ, Profit or Loss from Business, with their Form 1040. Sole proprietor farmers file Schedule F, Profit or Loss from Farming. Your net business income or loss is combined with your other income and deductions and taxed at individual rates on your personal tax return. Sole proprietors must also pay self-employment tax on the net income reported on Schedule C or Schedule F. You may also be able to deduct one-half of SE tax on your 1040. Use Schedule SE, Self-Employment Tax, to compute this tax. Sole proprietors do not have taxes withheld from their business income so you will generally need to make quarterly estimated tax payments if you expect to make a profit. These estimated payments include both income tax and self-employment taxes for Social Security and Medicare. Partnership A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business. A partnership does not pay any income tax at the partnership level. Partnerships file Form 1065, U.S. Return of Partnership Income, to report income and expenses. This is an information return. The partnership passes the information to the individual partners on Schedule K-1, Partner’s Share of Income, Credits, and Deductions. Partnerships are often referred to as pass-through or flow-through entities for this reason. Each partner reports his share of the partnership net profit or loss on his personal Form 1040 tax return. Partners must report their share of partnership income even if a distribution is not made. Partners are not employees of the partnership and so taxes are not withheld from any distributions. Like sole proprietors, partners generally need to make quarterly estimated tax payments if they expect to make a profit. General partners must pay self-employment tax on their net earnings from self employment assigned to them from the partnership. Net earnings from self- employment include an individual’s share, distributed or not, of income or loss from any trade or business carried on by a partnership. Limited partners are subject to self-employment tax only on guaranteed payments, such as professional fees for services rendered. Corporation A corporate structure is more complex than other business structures. It requires complying with more regulations and tax requirements. It may require more tax preparation services than the sole proprietorship or the partnership. Corporations are formed under the laws of each state and are subject to corporate income tax at the federal and generally at the state level. In addition, any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal tax returns. The corporation is an entity that handles the responsibilities of the business. Like a person, the corporation can be taxed and can be held legally liable for its actions. If you organize your business as a corporation, you are generally not personally liable for the debts of the corporation. (Exceptions my exist under state law.) When you form a corporation, you create a separate tax-paying entity. Unlike sole proprietors and partnerships, income earned by a corporation is taxed at the corporate level using corporate tax rates. Regular corporations are called C corporations because Subchapter C of Chapter 1 of the Internal Revenue Code is where you find general tax rules affecting corporations and their shareholders. A corporation files Form 1120 or 1120-A, U.S. Corporation Income Tax Return. If a shareholder is an employee, he pays income tax on his wages, and the corporation and the employee each pay one half of the social security and Medicare taxes and the corporation can deduct its half. A corporate shareholder pays only income tax for any dividends received, which may be subject to a dividends-received deduction. Subchapter S Corporation The Subchapter S corporation is a variation of the standard corporation. The S corporation allows income or losses to be passed through to individual tax returns, similar to a partnership. The rules for Subchapter S corporations are found in Subchapter S of Chapter 1 of the Internal Revenue Code. An S corporation has the same corporate structure as a standard corporation. It is a legal entity, chartered under state law, and is separate from its shareholders and officers. There is generally limited liability for corporate shareholders. The difference is that the corporation files an election on Form 2553, Election by a Small Business Corporation, to be treated differently for federal tax purposes. Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income. It is treated in the same way as a partnership, in that generally taxes are not paid at the corporate level. An S corporation files Form 1120S, U.S. Corporation Income Tax Return for an S Corporation. The income flows through to be reported on the shareholders’ individual returns. Schedule K-1, Shareholder’s Share of Income, Credits and Deductions, is completed with Form 1120S for each shareholder. The Schedule K-1 tells shareholders their allocable share of corporate income and deductions. Shareholders must pay tax on their share of corporate income, regardless of whether it is actually distributed. Limited Liability Company A Limited Liability Company (LLC) is a relatively new business structure allowed by state statute. LLCs are popular because, similar to a corporation, owners generally have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation. Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities. Most states also permit “single member” LLCs, those having only one owner. A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check your state’s requirements and the federal tax regulations for further information. There are special rules for foreign LLCs. For additional information on the kinds of tax returns to file, how to handle employment taxes and possible pitfalls, refer to Publication 3402, Tax Issues for Limited Liability Companies. Which structure best suits your business? One form is not necessarily better than any other. Each business owner must asses his or her own needs. It may be important to seek advice from business experts and professionals when considering the advantages and disadvantages of a business entity.