S Corporation Alert - Dbl Taxation

Email to pro1040@home.com		Consulting OnLine © Bob Parrish CPA, P.C. HOME (941) 387-0926 ~ It Is:
Preface - What This Is Introduction Objectives Your Questions What You Will Need Warning Intro Summary Related Information Plain English Explanation Object Restated Why or How It Works Alternatives Cost V. Benefit Other Reserved Tech Analysis & Citations Commentary Law Regs Cases Revenue Procedures Revenue Rulings Private Letter Rulings TAX KILLERS COST KILLERS PREPARE FOR ADVISER Entrance Interview Exit Interview From Banking Records From Customer Records From Signed Documents From Your Other Business, or Financial Records From Corporation or Organization Records (meetings, etc.) What to do PREPARE YOURSELF Action Checklist - What To Do OVERVIEW OF PROCEDURES FINANCIAL ACCOUNTING Financial Statement Presentation Notes to Financial Statements How to Make Entries What Kind of Records to Keep Bookkeeping Methods - Cash, Accrual and Other How the Business Entity Affects the Recording COMPLIANCE ALERTS - DANGERS Action Checklist Alerts & Dangers - Risks Asset Protection Your Defense TOOLS SAMPLES REQUIRED REPORTS CHECKLIST FOR DEPLOYMENT CHECKLIST FOR MONITORING INDEX *BOB PARRISH CPA, P.C.		pro1040 and Consulting OnLine are © Alert - S Corp Income Taxed Twice From the U.S. Court of Appalls (Appeals) (Jump to the Cases) Preface ~ Client Letter - What this idea is about ~ Introduction ~ Dear Client: This letter / document alerts you to one of the many appalling treatments of taxpayers and decisions both in the administration (Executive Branch) and in the courts (Judicial Branch). Related Articles: S corporation basis and distribution elections S Corporation Alert - Dbl Taxation S Corporation - Forming S Corp and Late Elections Succession and estate planning for S corporation owners. S corporation topics S Corporation S Corp Scrutiny of Distributions. Corp Formalities Learning Objectives (What You Asked) ~ Your Questions: The following questions will be answered If the taxpayer has made an election to be classified as an S Corporation, is there any danger of "Double Taxation"? Read this you will be appalled! This Topic OBJECTIVE is or What it Does Why and how it works Alternatives - Comparisons and Contrasts Cost v. Benefits Analysis - Its Value What You Will Need Nothing TOP Engagement Status Letter ~ WARNING! You have not engaged Bob Parrish CPA PC, Bob Parrish CPA, pro1040, Consulting on line, any related parties, or the ISP to perform any services for you or offer you advice. This entire site is for educational or informational purposes only. The materials are not opinions, advise, legal advice on any matter and have not been tailored to specific jurisdictions, individuals, other entities, or circumstances. You are not to use the forms, concepts, strategies, or knowledge without assistance from a professional. You must update and validate this information yourself with your own research, experience and the advice of a competent professional adviser in your jurisdiction. The author, the corporation, the ISP, Bob Parrish CPA, Bob Parrish CPA, P.C. or other parties related to those or this site do not guarantee or warrantee in any manner the suitability, usefulness, accuracy, timeliness, or results of any portions of this site, nor the links contained in this site which link to other areas. At times, information is taken from other sources and is believed to be accurate, but no verification or confirmation is performed. Furthermore, if any federal or state law invalidates a portion of this disclaimer, the other portions still apply. In addition, any allegations or actions are restricted to arbitration only and must be arbitrated by the Better Business Bureau in Sarasota Florida. Reading of these pages constitutes complete acceptance and agreement with all disclaimer provisions on all pages of this site. ....... Sunday, March 04, 2007 08:48 AM Bob Parrish CPA: Disclaimer for all except securities related articles TOP Summary This is an instance where the sole shareholder of an S Corporation was taxed twice on income. The disaster was created by the IRS disallowing deductions for amounts paid to the shareholder which the shareholder included in income. Related Information A few closely related topics & pages From Bob Parrish CPA PC (left-click this to expand it): pro1040 Home Email Bob Parrish CPA PC S Corp and Dbl Taxation US Court of Appalls - S Corp Dbl Taxed TOP
		Plain English Explanation
Plain English Explanation Object Restated Why or How It Works Alternatives Cost V. Benefit Other Reserved		*Your Answers* This Topic OBJECTIVE is: What it does Explanation of this topic and how it may affect you (for how it may affect you also refer to : Financial Accounting: Bookkeeping & Financials ~ Compliance - What is required for protection, defense, etc. ~ Alerts & Dangers) The taxpayer performed all services in an S Corporation. Personal property was owned by the taxpayer as an individual. The personal property was leased to the corporation. The corporation paid the leases and deducted the expenses. The IRS examined the records of the corporation and disallowed the deductions on the corporate tax return. HOWEVER - the IRS did not question the income side of the transaction on the shareholder's personal tax return. The taxpayer attempted to remove the income from his personal tax return - the IRS did not agree. This placed the taxpayer in a very unfair position. Since the corporation was an S Corporation, the disallowed deduction increased the shareholder's income on his personal 1040 by the amount of the disallowed deduction. In addition the income relating to the increased K1 (pass-through) amount was a duplication of the income on his personal 1040. The taxpayer appealed, went to the United States Tax Court and appealed the adverse decision of the Tax Court to the 9th Circuit Court of Appeals. The taxpayer lost. Regular penalties, interest and the negligence penalty were all applied. Start of Plain English Section Why or How it works - Both Sides of the Equation and Examples: The leases were on boats. Those boats were declared to be entertainment facilities. The taxpayer did not meet the substantiation requirements. Thereby the IRS was able to disallow the lease payments made by the corporation. This then resulted in an increased K1 income passes through to the shareholder. The taxpayer then argued since the corporation could not deduct the lease payments made to him, he should not be required to include the lease payments in his income. The result would be the government would charge tax on the very same income twice. Start of Plain English Section Alternatives Comparisons Contrasts Start of Plain English Section Cost v. Benefit Analysis ~ Its Value Start of Plain English Section Other Start of Plain English Section Reserved Start of Plain English Section
		Technical Analysis and Explanation
Tech Analysis & Citations Commentary Law Regs Cases Revenue Procedures Revenue Rulings Private Letter Rulings		Technical Analysis & Citations Commentary Disallowing the Deductions at the Corporate Level: The IRS chose to disallow the lease deductions. The legal counsel for the Executive Branch won the argument by proving the leased items were "Entertainment Facilities" and the items uses were entertainment functions. The legal counsel then applied the law which expressly disallows all deductions fro entertainment facilities. The government counsel for the Executive Branch then were able to prove the taxpayer did not maintain proper substantiation for the entertainment uses. Proving That the Double Taxation is Provided For in the Statutes and Common Law: The lawyers for the Executive Branch then sought to prevent the taxpayer from adjusting his personal tax return by the amount of the disallowed expenses. Since the entity that lost its tax deduction was a pass-through entity, the sole shareholder was required to increase his income by the amount of the lease expensed on the S Corporation's books (K1). This amount had already been included on the taxpayer's personal income as lease income on schedule E of his personal form 1040. Therefore the taxpayer is not staring at paying tax on the lease income and paying tax on the pass-through's income without the deduction of that same lease amount. The Executive Branch chose to and made a deliberated decision to force the taxpayer to pay tax on this income twice. The IRS and its legal counsel carefully crafted this by showing there were two separate and distinct entities - the individual and the S Corporation. IT proved the audit adjustments of the corporation do not affect the tax return of the individual (except as provided by the pass-through treatment). The government deliberately and carefully crafted its course to establish the leases were in fact paid by the corporation and were accepted by the individual as lease income. Those amounts were reported on the individual's income tax return as income - thereby admitting both receipt and acceptance of the payments from the corporation as lease income. Start of Technical Analysis Law The IRS used §274(a)(1)(B) to disallow all the expensed lease payments, because it proved the boats were for entertainment. This would not seem to be a surprise or unexpected viewpoint or challenge. I will remind the reader, the unexpected result is that of double taxation. SECTION 274. DISALLOWANCE OF CERTAIN ENTERTAINMENT, ETC., EXPENSES (a) ENTERTAINMENT, AMUSEMENT, OR RECREATION (1) IN GENERAL: No deduction otherwise allowable under this chapter shall be allowed for any item-- (A) ACTIVITY: With respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, unless the taxpayer establishes that the item was directly related to, or, in the case of an item directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), that such item was associated with, the active conduct of the taxpayer's trade or business, or (B) FACILITY: With respect to a facility used in connection with an activity referred to in subparagraph (A). In the case of an item described in subparagraph (A), the deduction shall in no event exceed the portion of such item which meets the requirements of subparagraph (A). Facility: This definition includes yachts, hunting lodges, fishing camps, swimming pools, tennis courts, bowling alleys, automobiles, airplanes, apartments, hotel suites, and homes in vacation resorts. This definition has been held to include the leasing of a ranch for hunting (On Shore Quality Control Specialist, Inc. v. Commissioner, T.C. Memo. 1996-95), a hot-air balloon used to entertain customers (Dodd v. Commissioner, T.C. Memo. 1992-341), and motorboats used for business discussions and to entertain clients. Substantiation: The tax statutes provide that the taxpayer has the burden of proof for taking tax deductions on entertainment expenses. The reader can find those rules in the law and the related regulations at §274. You will also find related topics in the pro1040 site - for example: Car - law requirements for recordkeeping Travel Deductions Recordkeeping Travel - Entertainment - Gifts Start of Law Section Start of Technical Analysis Regs Start of Regs Section Start of Technical Analysis Cases S Corp and Dbl Taxation (pdf format) This is the first Case in this item and is in the U.S. Tax Court USTC S Corp Dbl Taxation (MS Word Format) US Court of Appalls - S Corp Dbl Taxed (pdf format) final case Start of Cases Section Start of Technical Analysis Revenue Procedures Start of Revenue Procedures Section Start of Technical Analysis Revenue Rulings Start of Revenue Rulings Start of Technical Analysis Private Letter Rulings Start of Private Letter Rulings Start of Technical Analysis TOP
		Tax Killers
TAX KILLERS		This is about Activity Based Taxplanning - maximizing deductions, minimizing cash outlay and maximizing the amount of cash retained and the net worth. Activity Based Taxplanning (ABT) is a methodology developed by Bob Parrish CPA, that assists people with the tax issues by focusing on the activity (or actions - events) that are being undertaken or contemplated (or have already taken place). The, research is compiled from the myriad of sources to help you complete the activity with the least tax cost, while maintaining compliance the tax laws, other laws and regulations and place yourself in a position to protect your objectives. Tax is a subject that many view in order to cut costs. Taxes are a cost just as any other cost. It happens this cost is somewhat intangible and is defined by legislation without a tangible item to view and control. The money is spent and the control of the expenditure is more appropriately administered by someone trained in the law. In order to prevent this from happening to you - you must "second guess" the IRS personnel, the IRS legal counsel and the judges of the courts. Therefore, the risk is quite high the opposition will be successful somewhere in the chain of events. However, there are some actions and planning available to you for your defense. Do not claim any expense for a "facility" Meet the requirements for substantiation Place "hemlock clauses" in the corporation Articles of Incorporation, Bylaws and minutes of meetings. Hemlock Clauses - This is a statement in the Articles, the Bylaws and Minutes that will attempt to at least diminish and in some instances mitigate an attempt to charge you twice for taxes on income. It is in my opinion important to place these clauses in the Articles because the Articles are on file with the state in which the corporation filed the Articles and thereby places the public on notice since the Articles are open to public inspection. It is important to place them in the bylaws for the obvious reason this is a governing instrument of the corporation. It is important to place them in the minutes showing acceptance and agreement of the officers. The drafting of these clauses will need to anticipate the following possibilities: Deductions at the corporate level will be disallowed Income at the corporate level will be increased Deductions at the shareholder or employee level will be disallowed Income at the shareholder or employee level will be increased This list is not intended to be exhaustive. There probably will be additional considerations in your circumstances. If the agreement between the corporation and the recipient, and the Articles are constructed so that the payments are "contingent" upon future events or the non-occurrence of future events, and/or require return of income or reimbursements then a possibility is made the "double taxation" can be reduced - but may require the realization in multiple tax years. If the shareholder/employee is reimbursed for a corporate expense and this is disallowed then the requirement would be the reimbursement must be returned to the corporation. It is advised this be structured like the "Accountable Plan" rules and the time period for the return of the reimbursement be as similar as plausible given the fact the IRS may not make a challenge for several years. If the shareholder/employee also has business transactions with the corporation in a different capacity - such as landlord/tenant, lessor/lesee, etc. then the person drafting the "hemlock clauses" should draft additional clauses in this light. The agreement between the parties and the Articles, Bylaws and Minutes should provide for the complete recharacterization of the transactions. In the event the challenge by the IRS results in double taxation as in this example, then the drafter must make an attempt to provide a tax deduction to the entity suffering the double taxation. In parallel with this drafting one should consider attempting to recharacterize the payments which were disallowed to a transaction which will not produce income to the recipient and not provide a deduction to the payer. Focusing on the first part of this solution one should attempt to make the recipient responsible for repayment of the income stream and provide a tax deduction to the recipient, of the income stream, for the repayment to the corporation. As part of this drafting one must consider changing the entire character of the arrangement should the IRS attempt to restructure the arrangement as claimed on the tax returns. For example, if the corporate deductions for rent were to be disallowed then the agreement could be changed to a loan, the agreement could be changed to a contract for services, the agreement could be voided, or any other tool the person performing the drafting can create that would withstand court scrutiny. If the IRS should attack the treatment by the shareholder/employee, then similar provisions should be incorporated into the records and documents. TOP
		Cost Killers
COST KILLERS		Management Info Sys, Decision Support Systems, Activity Based Management and Costing, Cost Accounting) TOP
		Prepare for Your Adviser CPA or Attorney (or inform yourself about this topic)
PREPARE FOR ADVISER Entrance Interview Exit Interview From Banking Records From Customer Records From Signed Documents From Your Other Business, or Financial Records From Corporation or Organization Records (meetings, etc.) What to do		About the Preparation Procedures If you have decided this task must be done, the first procedure is to be certain you have all the facts important to this topic. So that you may know the value, to you personally, of this topic you must have facts of your circumstances. So that you may comply with applicable rules, you must have all the facts. Factual research is time consuming and if not performed wisely will be very expensive if not performed properly, and thoroughly. IF you decide to make this a do-it-yourself project you should seek the advice of a professional qualified in your jurisdiction to assist you with defining important information and then to overview the information you have gathered. What to gather - an Organizer and Prepare for your CPA, Attorney or Financial Adviser Entrance Interview Gather all your individual and corporation records for all transactions between you and your company. Omit NOTHING. Include the following and any other relevant items: Corporate minute book Articles of Incorporation Agreements between the shareholder/employee and the corporation Description of all dealings between the shareholder/employee and the corporation - include dates, amounts, objective of the transaction or event and another relevant information Exit Interview Be certain you fully understand your responsibilities and actions. From Banking Records Copies of checks, deposits and any requirements the bank has made for you and your company. From Customer Records From Signed Documents From Your Other Business, or Financial Records From Corporation Records or Organization Records (meetings, etc.) What to do Start of Preparing For You CPA Section TOP
		Prepare Yourself - Become Knowledgeable About Forms, Checklists, Etc.
INFORM YOURSELF Action Checklist - What To Do OVERVIEW OF PROCEDURES		How to do this - What to Do: Seek assistance from Bob Parrish, as requirements change from time to time and circumstance to circumstance. Action Checklist - What To Do OVERVIEW OF PROCEDURES First set a conference with your CPA and have your CPA perform the factual analyses to identify potential problem areas. For the Tax Law analyses you can usually depend upon your CPA. However you will need to assist advice from your legal counsel on the impact of other statutes and common law - and law specific to your jurisdiction. Back to Start of What To Do Back to Start of What To Do TOP
		Financial Accounting - Bookkeeping and Financial Statements
FINANCIAL ACCOUNTING Financial Statement Presentation Notes to Financial Statements How to Make Entries What Kind of Records to Keep Bookkeeping Methods - Cash, Accrual and Other How the Business Entity Affects the Recording		Financial Statement Presentation You will need to be certain the company and personal records are prepared to be in agreement with all the underlying records: Articles of Incorporation Minutes Bylaws Agreements Contracts Checks and Deposits State laws and Acts Federal Tax Law Although this section is directed to Financial Accounting I shall not cover Generally Accepted Accounting Principles at this time. Back to Start of Financial Accounting: Bookkeeping & Financials Notes to Financial Statements Back to Start of Financial Accounting: Bookkeeping & Financials How to Make Entries Back to Start of Financial Accounting: Bookkeeping & Financials What Kind of Records to Keep Back to Start of Financial Accounting: Bookkeeping & Financials Bookkeeping Methods - Cash, Accrual and Other Back to Start of Financial Accounting: Bookkeeping & Financials How the Business Entity Affects the Recording Sole Proprietor Corporation - C & S Partnerships - General, Limited, Limited Liability Company, Registered Limited Liability Partnership or Company Trusts Tax Exempt Back to Start of Financial Accounting: Bookkeeping & Financials TOP
		Compliance Requirements
COMPLIANCE		Compliance Checklist Back to Start of What is required for protection, defense, etc. TOP
		Alerts and Dangers
ALERTS - DANGERS Action Checklist Alerts & Dangers - Risks Asset Protection Your Defense		Action Checklist Back to Start of Alerts & Dangers Alerts & Dangers - Risks Back to Start of Alerts & Dangers Asset Protection Back to Start of Alerts & Dangers Your Defense Back to Start of Alerts & Dangers
		Tools - Spreadsheets - Documents - Checklists - Organizers
TOOLS Spreadsheets & Math		Spreadsheets & Computations Back to Start of Spreadsheets & Math TOP
		Sample Forms
SAMPLES		Consult with your adviser - call, write, email or drop by to seek the advice of Bob Parrish CPA. If you are not a current client, then Bob Parrish CPA PC can furnish a second opinion or can be your primary adviser. This entire site is for educational or informational purposes only. The materials are not opinions, advise, legal advice on any matter and have not been tailored to specific jurisdictions, individuals, other entities, or circumstances. You are not to use the forms, concepts, strategies, or knowledge without assistance from a professional. You must update and validate this information yourself with your own research, experience and the advice of a competent professional adviser in your jurisdiction. Back to Start of Contracts, Trusts, etc. TOP
		Required Reports
REQUIRED REPORTS		Back to Start of Reports Required TOP
		Checklist for Deployment
CHECKLIST FOR DEPLOYMENT		Checklists for Deployment Back to Start of Checklists - Deployment
		Checklist for Monitoring
CHECKLIST FOR MONITORING		Back to Start of Checklist - Monitoring TOP
		Index
INDEX		TOP Click on the text -- (a) to expand or collapse the outline if the text has no underline OR (b) to jump to the topic if the text has an underline Action Checklist Alerts & Dangers Alternatives Analyses Plain English Analysis - Your Answers Technical Analysis Asset Protection Bookkeeping How to Make Entries Bookkeeping What Kind of Records to Keep Bookkeeping Methods - Cash, Accrual and Other Bookkeeping How the Business Entity Affects the Recording Cases Checklists - Deployment Checklist - Monitoring Client Letter Compliance - What is required for protection, defense, etc. Cost V. Benefit Cost Killers Defense Entrance Interview Exit Interview Financial Accounting: Bookkeeping & Financials Financial Statement Presentation How To Do This What to Gather - Organizer & Prep for CPA or Attorney What To Do Financial Accounting: Bookkeeping & Financials Compliance - What is required for protection, defense, etc. Alerts & Dangers Increase Wealth Tax Killers Cost Killers Mgt Control and Reporting Inform Yourself Action Checklist - What To Do OVERVIEW OF PROCEDURES DETAILED STEPS STARTING PRINT ALL THE REQUIRED DOCUMENTS PRESENTATION STANDARDS OBTAIN THE STANDARD WORKPAPER FORMS NEEDED OBTAIN THE DOCUMENTS FOR THIS JOB Forms - Checklists - Etc. How to use the forms FINAL OVERVIEW FINAL STEPS Information Sources Info Needs From Banking Records Info Needs From Customer Records Info Needs From Signed Documents Info Needs From Your Other Business, or Financial Records Info Needs From Corporation or Organization Records (meetings, etc.) Introduction Intro Summary Client Letter What this is about Engagement Letter Objectives - Your Question What is needed Law Notes to Financial Statements Objectives Object Restated Plain English Analysis Prep for CPA or Attorney Private Letter Rulings Procedures OVERVIEW OF PROCEDURES DETAILED STEPS STARTING PRINT ALL THE REQUIRED DOCUMENTS PRESENTATION STANDARDS OBTAIN THE STANDARD WORKPAPER FORMS NEEDED OBTAIN THE DOCUMENTS FOR THIS JOB Forms - Checklists - Etc. How to use the forms FINAL OVERVIEW FINAL STEPS Regs Related Information Revenue Procedures Revenue Rulings Samples Spreadsheets Tax Killers Technical Analysis Technical Commentary Tools Spreadsheets & Math Contracts, Trusts, etc. Reports Required Checklists - Deployment Checklist - Monitoring Warning What to do What You Will Need Why or How It Works Your Questions
		Contact Information
BOB PARRISH CPA, P.C.		Bob Parrish CPA, P.C.

pro1040 and Consulting OnLine are © Alert - S Corp Income Taxed Twice

Preface ~ Client Letter - What this idea is about ~ Introduction ~

Learning Objectives (What You Asked) ~ Your Questions: The following questions will be answered

What You Will Need

Engagement Status Letter ~ WARNING!

Plain English Explanation

Technical Analysis and Explanation

Tax Killers

Cost Killers

Management Info Sys, Decision Support Systems, Activity Based Management and Costing, Cost Accounting)

Prepare for Your Adviser CPA or Attorney (or inform yourself about this topic)

About the Preparation Procedures

Prepare Yourself - Become Knowledgeable About Forms, Checklists, Etc.

Financial Accounting - Bookkeeping and Financial Statements

Tools - Spreadsheets - Documents - Checklists - Organizers

Spreadsheets & Computations

Sample Forms

Checklists for Deployment

Checklist for Monitoring

pro1040 and Consulting OnLine are ©
Alert - S Corp Income Taxed Twice