Monthly Archives: May 2015

Lending Money to Family Members Could be Taxing

Lending to family members dates back to the creation of money. The IRS entered the mix a great deal later, but it now looms large in the equation. Tax problems can arise when you first lend money, as you’re being repaid, or if you’re not repaid. The issues usually involve: imputed income, gift tax, or bad debts.

Imputed Income

Imputed income is revenue presumed earned but neither recognized nor received by the alleged recipient. The IRS may impute interest on a loan at the “applicable federal rate” (AFR) when a lower rate (or no interest) is charged. The agency then assesses tax on the excess of the imputed interest over the amount required by the terms of the loan.

Gift tax issue

When the IRS imputes phantom interest, it also creates phantom taxable gifts. The imputed interest is treated as though the borrower actually paid it to the lender, whereupon the lender returned it to the borrower as a gift. Since the lender “constructively received” the additional interest, he or she owes income tax on it. Since the lender then presumably gave the interest back to the borrower, he or she also owes gift tax on it, unless an exclusion or credit applies.

Bad Debt Deduction

Normally, a loan that goes bad is deductible, either against ordinary income (if made for a business purpose) or as a short-term capital loss. However, when the defaulting party is related, the IRS may demand clear and convincing evidence that the original loan was not actually a gift. Once a loan is recharacterized as a gift, no bad debt deduction will be allowed if the loan isn’t repaid, and the lender also may owe gift tax on the principal unless an exclusion or credit applies.

Interest need not be charged and will not be imputed on a family loan of $10,000 or less unless the loan directly relates to purchasing or carrying income-producing assets. Without a written document imposing interest at the applicable federal rate (AFR) or higher, the loan probably will be considered a gift and thus will not be deductible if not repaid.
Interest will be imputed on a family loan over $10,000 if the stated rate is below the AFR. However, unless the principal exceeds $100,000, imputed interest will be limited to the borrower’s annual net investment income, and no interest will be imputed if that income is $1,000 or less.

Obviously, lending to relatives can create unintended tax consequences. You should always have a written loan agreement on family loans to document the transaction for the IRS.
Please contact us for guidance before you make any family loans.

Factors For Non Residents to Consider Before Incorporating in the US

As a non-U.S. citizen, incorporating a business in the United States is generally similar to the procedure required for a U.S. resident. Because U.S. citizenship and residency are not necessary, non-U.S. citizens are welcome to start or expand on American soil without jumping through any more hoops than a U.S.-born business owner.

However, companies owned by foreign nationals who want to do business in the United States must weigh the options of whether or not to form a corporation or limited liability company (LLC) and whether they plan to maintain a presence in the United States with offices and employees. There are a host of other details to factor into the equation — including differences in language and business practices— but following are the main ones to consider when crossing borders and oceans.

Do you need to incorporate in the United States?

If you only plan to sell goods, perhaps through the Internet or wholesaling to U.S. companies, it may not be necessary to form a U.S. company. Other variables to take into account in making your decision to incorporate in the United States include: differences in individual state tax laws, transportation costs, tariff/trade regulations, size and scope of your company, leases, employees and much more.

You may also give some forethought to the fact that some U.S. consumers are more likely to purchase things over the Web from a U.S. company rather than overseas, so it may be desirable for marketing purposes to incorporate in the United States as well.

How do you incorporate in the United States?

Company incorporation in the United States is administered at the state level —not the federal level — for both foreign nationals and U.S. citizens. The process will differ from state to state but is generally comprised of two steps: 1.) applying to register in that specific state and 2.) establishing a registered agent with a valid, physical address in the selected state. A registered agent can be either the business owner or another designated person who is authorized to receive legal documents on behalf of the business during standard business hours.

To incorporate a company as an LLC or corporation, formation documents must be filed with the appropriate state agency, which is most often the Secretary of State. Required filing fees must also be paid. A corporation’s formation document is typically referenced as the Articles of Incorporation or Certificate of Incorporation, depending on the state. The Articles of Organization or Certificate of Organization often refer to the LLC’s formation document. Formation paperwork is used to advise the state and the public of specific details relating to the company. Formation documents serve as a formal record of reference of the corporation’s or LLC’s existence.

LLCs and corporations must offer certain information in their formation documents. The mandatory disclosures vary minimally by state.

U.S. residents will likely need a Federal Tax Identification Number (EIN) to start their business. This process requires a Social Security number. For foreign businesses, an Individual Taxpayer Identification Number (ITIN) may satisfy the requirement. The Internal Revenue Service (IRS) issues these tax processing numbers to individuals who have to pay U.S. taxes but are not eligible for a Social Security number. Residents and non-resident aliens as well as foreign nationals fall into this category.

To obtain an ITIN from the IRS, complete and mail IRS Form W-7. You can get started by printing Form W-7 and the associated instruction sheet.

Which business type should you choose?

Comparable in title and operation to businesses in other countries, the primary business formation structures are sole proprietorships, partnerships, corporations and LLCs.

Certain business structures limit whether non-U.S. citizens can be owners of a business incorporated in the United States. With LLCs, there are no limitations on the number of investors who can own interests in the business and no restriction on non-U.S. citizens assuming roles as members (owners). By contrast, if the corporation distributes profits to the shareholders in the form of dividends, shareholders pay income tax on those distributions; thus, C corporations are often criticized for imposing “double taxation.”

Under U.S. tax law, a non-U.S. citizen may own shares in a C corporation, but may not retain shares in an S corporation. S corporations allow shareholders (owners) to report their portion of business income and expenses on their personal income tax returns and avoid corporate level taxation. The U.S. tax rules dictate that non-U.S. citizens cannot be shareholders of S corporations. For these reasons, many non-U.S. citizens operating businesses in the United States choose to incorporate their business as an LLC.Do you need a U.S. address to incorporate a business in the United States?

You will need to name a registered agent in your state of incorporation, and the registered agent must have a physical address in your state of incorporation. The registered agent is responsible for important legal and tax documents on behalf of incorporated companies, such as:

  • Service of Process – sometimes called Notice of Litigation – which initiates a lawsuit
  • Important state mail, such as annual reports or statements
  • Tax documents sent by the state’s department of taxation.

In addition to having a physical address in the state of incorporation, the registered agent must be available at that designated address during normal business hours.

You cannot use the registered agent address as your legal address. The registered agent address is intended for receipt of official documents only – generally related to taxes and lawsuits. The legal address of your company has to be your home or office in your country.

How do you determine your resident status?

If you are a non-resident, you are taxed in the United States only on U.S. source income (for example, your share of the LLC’s income). If you are a U.S. resident, you are taxed on your worldwide income.

Resident status is not limited to those having a green card. Resident status also applies to those with a physical presence in the United States. For example, for 2009, a person is treated as a resident if he or she is in the United States for at least 31 days and at least 183 days during 2007, 2008 and 2009 (counting all the days in 2009, but only 1/3 of the days in 2008 and 1/6 of the days in 2007). Even if this residency test is satisfied, you can still be treated as a non-resident in certain situations (for details on determining residency and tax obligations, see IRS Publication 519, U.S. Tax Guide for Aliens, at Non-U.S. businesses that do not operate in the United States (for example, do not have any income from U.S. sources), do not owe any federal income taxes; however, there may be annual state charges or fees for maintaining the LLC or corporation.

Non-U.S. companies that do not want to form a business here but merely wish to import their products to the United States should explore import rules by navigating the Commercial Importing Procedures and Requirements.

What to Do if You Haven’t Filed a Tax Return Yet

Filing a past due return may not be as difficult as you think.

Taxpayers should file all tax returns that are due, regardless of whether full payment can be made with the return. Depending on an individual’s circumstances, a taxpayer filing late may qualify for a payment plan. It is important, however, to know that full payment of taxes upfront saves you money.

Here’s What to Do When Your Return Is Late
Gather Past Due Return Information

Gather return information and come see us. You should bring any and all information related to income and deductions for the tax years for which a return is required to be filed.

Payment Options – Ways to Make a Payment

There are several different ways to make a payment on your taxes. Payments can be made by credit card, electronic funds transfer, check, money order, cashier’s check, or cash.

Payment Options – For Those Who Can’t Pay in Full

Taxpayers unable to pay all taxes due on the bill are encouraged to pay as much as possible. By paying as much as possible now, the amount of interest and penalties owed will be lessened. Based on the circumstances, a taxpayer could qualify for an extension of time to pay, an installment agreement, a temporary delay, or an offer in compromise.

Taxpayers who need more time to pay can set up either a short-term payment extension or a monthly payment plan.

A short-term extension gives a taxpayer an additional 60 to 120 days to pay. No fee is charged, but the late-payment penalty plus interest will apply. Generally taxpayers will pay less in penalties and interest than if the debt were repaid through an installment agreement over a greater period of time.

A monthly payment plan or installment agreement gives a taxpayer more time to pay. However, penalties and interest will continue to be charged on the unpaid portion of the debt throughout the duration of the installment agreement/payment plan. Taxpayers who owe $25,000 or less in combined tax, penalties and interest can apply for and receive immediate notification of approval through an IRS web-based application. Balances over $25,000 require taxpayers to complete a financial statement to determine the monthly payment amount for an installment plan.
When it comes to paying your tax bill, it is important to review all your options; the interest rate on a loan or credit card may be lower than the combination of penalties and interest imposed by the Internal Revenue Code. You should pay as much as possible before entering into an installment agreement.

You can also pay your Federal taxes using a major credit card or debit card. There is no IRS fee for credit or debit card payments, but the processing companies charge a convenience fee or flat fee.

A user fee will also be charged if the installment agreement is approved. The fee, normally $120, is reduced to $52 if taxpayers agree to make their monthly payments electronically through electronic funds withdrawal. The fee is $43 for eligible low-and-moderate-income taxpayers.

What Happens If You Don’t File a Past Due Return or Contact the IRS?
It’s important to understand the ramifications of not filing a past due return and the steps that the IRS will take. Taxpayers who continue to not file a required return and fail to respond to IRS requests for a return may be considered for a variety of enforcement actions.

If you haven’t filed a tax return yet, please contact the office for assistance.

Spring Newsletter

Spring has officially sprung and we’re working like busy bees on client tax returns these next few weeks before April 15th, and I would like to say: if you have not yet done so, we need to get your information to complete your return as soon as possible.

This has been a very busy season … so as much as you can enable us to do our work on your behalf, the better.

Give us a call: 561-629-4026

You need someone on your side who can fight for you.

More and more municipalities (states, cities, the federal government) are looking into every corner possible for additional cash, and not just those who are facing bankruptcy.

And one way they do so is to scrutinize … you.

Joe Espinosa Reveals 6 Common Tax Preparation Mistakes That Could Get You Audited

“What is once well done is done forever.” – Henry David Thoreau

Sometimes clients come to us from other professionals because they have gotten themselves in hot water with the IRS, and they’re facing the withering gaze of the auditors.

We don’t want that to happen for you — so here are 6 common tax preparation mistakes we watch out for when preparing and submitting your tax returns…

1. Indefensible claims

There are so many old wives’ tales saying that certain items trigger an audit: home office deductions, passive losses, schedule C (sole proprietorship) activities, etc. But you really can’t predict the trigger (and you can drive yourself crazy trying), but you *can* adopt the “be reasonable” mantra about every item on your return, including these. So if you don’t have a decent claim for a home office, don’t claim it. If your money-losing sole proprietorship is really more of a fun hobby, treat it as such.

Look–don’t be scared to take deductions and losses you’re entitled to, but don’t take tax positions you aren’t comfortable defending. If you take reasonable tax positions, you’ll likely find you won’t end up needing to defend them. And if you do face an audit, it will likely be far easier.

2. It doesn’t all add up.

This seems like it should go without saying, but make sure you add, subtract and multiply accurately. Check your numbers through each step and do some simple math checks when you finish. If you do make a math mistake, you are likely to get a math correction notice from the IRS. This isn’t an audit. But your goal is to minimize your interaction with the IRS bureaucracy, which, ah… isn’t known for the best mail handling practices.

3. Lost 1099

This can be confusing, because the Form 1099 comes in many varieties, including 1099-INT for interest, 1099-DIV for dividends, 1099-G for tax refunds, 1099-R for pensions and 1099-MISC for miscellaneous income. These forms are sent by payers of such funds to both you and the IRS.

So regardless of how many 1099s you receive, make sure they all are accounted for on your return. There are also Forms 1098 which lenders send (to you and the IRS) recording how much interest you paid. The IRS matches your return against the 1098s and 1099s. So one sure way to guarantee an IRS query is to fail to account for something! If a Form 1099 is wrong–say it reports more income than you had–you can explain or deduct it on the return, but you need to first report it.

4. Suspicious OVER-reporting

I’m not talking about under-reporting income, or holding necessary information back. But you’d be surprised how many professionals and amateurs alike try to submit too much *supporting* information. True, if your return is complex, you may need to add explanations or disclosures in footnotes. Be concise, truthful and accurate, but don’t provide copies of sales agreements, settlement agreements, bank statements, etc., unless you are later asked by the IRS to do so.

Disclosures can be made on regular paper or special IRS forms. A Form 8275 “Disclosure Statement” on plain paper can be used any time you need to disclose something that can’t be adequately disclosed on the forms. Form 8275-R “Regulation Disclosure Statement,” is for disclosing positions that are contrary to IRS Regulations or other authority. You shouldn’t be filing a Form 8275-R–or taking a tax return position that would require it–without professional help.

5. Fighting unnecessary fights.

If you take reasonable tax positions, and complete your return accurately, checking your math, why should you pay a bill if the IRS sends you one?

Frankly, it’s simply a matter of practicality (and wisdom) rather than principle. It just doesn’t pay to fight with the IRS on small matters. So don’t get into the bureaucratic system and risk bigger problems for a few dollars. Just pay it and move on.

6. Ticky-Tack Prior Year Amending

Here’s the reverse situation of my previous point: amended returns are reviewed much more regularly than initial returns. So if you forgot a deduction or otherwise think you can get a small amount back by amending, think twice before amending your return (i.e. — consult with a pro). Consider whether you might have bigger problems if other matters on your return, unrelated to the amendment, are reviewed. Yes, you can win a battle … and lose a larger one.

And a last word: No matter how careful you are to avoid tax preparation mistakes, there’s no way to guarantee you’ll never have a tax controversy. Sometimes your number just comes up.

And if your number is called, well, we’re here to walk with you …

(But we’ll do everything in our power to make sure it’s NOT called!)


Joe Espinosa
Sunshine Consulting Solutions Corp