As we move into 2007 it is always a good idea to learn from other peoples' tax mistakes of 2006. Last Year Tax Courts and the Internal Revenue Service shed light on a number of tax regulations that could help small businesses be more meticulous. Some of the cases include helping land owners save, and a reminder to be extremely thorough when considering a business deal.
The rulings for small businesses in 2006 were significant because they reminded people of common problems and things they needed to be versed on.
Most recent examples:
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After increasing problems with people convincing appraisers to raise their estimated worth of charitable donations for tax deduction purposes, the IRS wants people to think twice about getting greedy with their charitable giving, or those who file returns with inflated appraisals will be penalized under Congress legislation.
The IRS is giving a bird-eye view to appraisals and if there are any reasons for them to challenge it, they will.
Another common problem relates to IRS rules concerning estates. Under IRS rules, if 35 percent or more of a decedent's estate value is tied up in business ventures, its beneficiaries would no longer have to worry about paying it all at once, but instead they can pay it over a ten year period.
One illustration:
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Now, just because a piece of property brings in cash, does not mean it qualifies as a business venture.
In order to qualify, the land must be an active trader business. That means you have to be a property manager as well as an owner.
A family-owned corporation got into trouble with the IRS when it neglected to pay taxes on what the IRS considered transfers of equity. The family shareholders made occasional transfers of money or property to the corporation, but because of poor record keeping, it was unclear whether those transfers were loans or gifts. The transfers would only be tax free if they were loans.
Usually, when the shareholders needed money, the corporation would occasionally make payments to the shareholders on those transactions. The IRS said that that indicated the original transfers were equity, not debt.
The tax court sided with the IRS, but on appeal, a higher court concurred with the corporation saying that despite poor record keeping, it looked like debt.
In addition, to continue to retain their small business status, corporations with earnings cannot, for more than 2 years in a row, have passive income that exceeds 25 percent of its income. That passive income could include royalties, rent from property the corporation or its interest lease out, or deposits from tenants if the corporation is not active in managing the properties. That is not a good thing because you'll then be taxed on two levels instead of one.
It is advisable that if you have an S Corporation (designated small business) that you become acutely aware of what type of entities you're acquiring and what type of business you're doing, because it could become a tax fiasco.
There is a bright spot, however: if you've fallen into a more passive form of income, time is usually on your side, so you can act reasonably to maintain your status.
It is advisable to consult a tax professional before making drastic decisions. Consulting a qualified tax expert before considering a business transaction of any kind can save you time, money and trouble in the future.
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