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Tuesday, July 28, 2015

Tax Consequences of Distributions in a Business

Tax Consequences of Distributions in a Business



When you decide to start a business venture, there are a myriad of things to consider.  We regularly assist small business owners, especially start-up businesses, walking them through the steps that need to be taken in order to make the business official and legal.  There are many ways a business can be organized and there are both non-tax and tax factors as well as state and local statutory requirements that need to be taken into consideration when embarking on this exciting journey of starting a business.

I previously wrote an article regarding the non-tax factors that should be considered when starting a business.  This article is one of a series of articles that focuses on the tax implications of certain business activities and things you should consider when choosing your business entity.  The most prominent federal tax considerations in choosing a business entity include:



This article will focus on the tax consequences of distributions in a business.

Team work, business conceptA liquidating or nonliquidating distribution from a partnership to a partner generally is treated as a nontaxable return of the partner’s capital.  The partner recognizes no gain until he receives cash exceeding the basis of his partnership interest.  On non-cash property distributions, a partner does not recognize any gain, but defers any gain not recognized when the distribution occurs and recognizes it when he subsequently disposes of the distributed property.  Gain or loss may be recognized under §751(b) of the Internal Revenue Code if the distribution changes the partner's share of certain partnership ordinary income property.  A partner may recognize a loss on a liquidating distribution if the only property he receives consists of cash, unrealized receivables, or inventory.  These rules also apply to LLCs.

Cash distributions from an S corporation generally are considered a nontaxable return of capital up to the shareholder's basis for his stock.  The excess is considered capital gain.  Certain cash distributions may be taxable if they are attributable to earnings and profits accumulated under Subchapter C before the corporation elected to be taxed under Subchapter S.  An S corporation is deemed to sell any distributed property to the shareholder, and the corporation recognizes any gain or loss inherent in the property when the distribution occurs.  That gain passes through to the shareholders and is taxable to them in the year the distribution occurs.  Gain "built-in" to corporate assets when it converts from a C to an S corporation is taxable at the corporate level.

Cash distributions from C corporations are taxable to shareholders as dividends to the extent of the corporation's earnings and profits.  Corporate earnings are subject to double taxation: they are taxable for the corporation when earned, and taxable again for the shareholder when distributed.  A similar double tax is imposed when a C corporation distributes appreciated property; the transaction is treated as if the corporation sold the property for its value and distributed the cash proceeds to the shareholder.

For a complete analysis of the tax implications of C Corporations, Partnerships, and S Corporations click here for the Joint Committee on Taxation's publication entitled "Choice of Business Entity: Present Law and Data Relating to C Corporations, Partnerships, and S Corporations."

Attorney Angel Oliver / McGrath and Spielberger, PLLC assists clients with all sorts of tax matters, both federal and state (including but not limited to North Carolina and South Carolina). Click here to contact Ms. Oliver about your tax matter.

Basis Limitations and the Deductibility of Losses for a Business under the Internal Revenue Code

Basis Limitations and the Deductibility of Losses for a Business under the Internal Revenue Code



When you decide to start a business venture, there are a myriad of things to consider.  We regularly assist small business owners, especially start-up businesses, walking them through the steps that need to be taken in order to make the business official and legal.  There are many ways a business can be organized and there are both non-tax and tax factors as well as state and local statutory requirements that need to be taken into consideration when embarking on this exciting journey of starting a business.

I previously wrote an article regarding the non-tax factors that should be considered when starting a business.  This article is one of a series of articles that focuses on the tax implications of certain business activities and things you should consider when choosing your business entity.  The most prominent federal tax considerations in choosing a business entity include:



This article considers the limitations on the deductibility of losses in a business.



Taxpayers who wish to use losses from a business or investment activity to offset their income from other sources must structure the venture to be taxable as a partnership, LLC, or S corporation.  A partner may generally deduct his share of losses up to the basis of his partnership interest and an S corporation shareholder may deduct losses up to the basis for his stock.  Losses of a C corporation do not pass through to shareholders; they must be carried back or carried over to offset future corporate income.



For ventures that use significant amounts of borrowed funds, a partnership or LLC structure is the preferred organization form because the basis of a partner's interest increases by his share of the partnership's liabilities.  Each partner is treated as if he personally borrowed his share of the partnership's obligations and contributed that amount of cash to the partnership, even if the partnership debt is nonrecourse (i.e., no partner is personally liable for repayment of the debt).  The resulting basis increase enables partners to deduct losses attributable to funds the partnership borrows.



A shareholder's basis for stock in an S corporation does not include corporate liabilities, other than loans the shareholder makes directly to the corporation; therefore, corporate obligations to third parties do not increase a shareholder's basis.  A shareholder can increase the basis of his stock by borrowing funds personally and lending or contributing the proceeds to the corporation.  When the loan must be directly secured by corporate assets, however, this transaction is not possible in practice.



Highly leveraged ventures usually are organized as limited partnerships or LLCs because partners can deduct significant greater losses than S corporation shareholders who make the same out of pocket investment.



Passive Loss Limitations



Losses attributable to nonrecourse liabilities may be restricted under §465 of the Internal Revenue Code (IRC).  Section 465 limits a taxpayer's deductions for losses to the amount he has at risk in the activity at the end of the tax year (i.e., his capital contribution plus liabilities for which he bears personal liability).  This limitation does not apply to qualified nonrecourse financing used in real estate activities.  These rules apply to certain closely held C corporations.



Under §469 of the IRC, certain taxpayers may not deduct losses incurred in passive activities that exceed their income from other passive activities.  This section applies to individuals, estates, trusts, closely held C corporations, and personal service corporations.  An activity is passive if it is a trade or business in which the taxpayer does not materially participate.



These passive loss rules are also applied to partners, LLC members, and S corporation shareholders in a similar fashion.  Each partner or shareholder separately determines whether his income or loss from the activity is passive based on his participation in the activity.  With some important exceptions, a limited partner's share of all partnership income or loss is passive.



The passive loss rules are modified to apply to closely held C corporations in which it may not use passive losses and credits to offset portfolio income but may use them to offset income from an active business.  A closely held C corporation when there are five or less owners that directly or indirectly own more than 50% of the value of the stock for at least the last half of the tax year.



The passive loss limitations apply fully to personal service corporations (a corporation in which its principal activity is performing personal services that employee-owners substantially perform and all of the employee-owners collectively own more than 10% of the value of the corporation's stock).



For a complete analysis of the tax implications of C Corporations, Partnerships, and S Corporations click here for the Joint Committee on Taxation's publication entitled "Choice of Business Entity: Present Law and Data Relating to C Corporations, Partnerships, and S Corporations."



Attorney Angel Oliver / McGrath and Spielberger, PLLC assists clients with all sorts of tax matters, both federal and state (including but not limited to North Carolina and South Carolina). Click here to contact Ms. Oliver about your tax matter.

Wednesday, July 22, 2015

The Tax Implications of Allocations of Income or Loss Items in a Business

The Tax Implications of Allocations of Income or Loss Items in a Business



When you decide to start a business venture, there are a myriad of things to consider.  We regularly assist small business owners, especially start-up businesses, walking them through the steps that need to be taken in order to make the business official and legal.  There are many ways a business can be organized and there are both non-tax and tax factors as well as state and local statutory requirements that need to be taken into consideration when embarking on this exciting journey of starting a business.

I previously wrote an article regarding the non-tax factors that should be considered when starting a business.  This article is one of a series of articles that focuses on the tax implications of certain business activities and things you should consider when choosing your business entity.  The most prominent federal tax considerations in choosing a business entity include:



This article addresses how income and losses are allocated in the different types of businesses.



The owners of a partnership or LLC may establish their shares of each partnership or LLC item through provisions in their partnership or operating agreement.  An allocation provided for in the agreement is respected for tax purposes unless under the tests contained in the Internal Revenue Code Regulations determine that it lacks substantial economic effect.  If you have your operating or partnership agreement carefully drafted by a professional the agreements will ordinarily satisfy these tests making most allocations of partnership or LLC tax items valid.



Investors in a C corporation can create some flexibility for allocating income and capital appreciation among themselves by issuing different classes of common and preferred stock as well as sophisticated debt instruments.



Little flexibility is available to S corporations as an S corporation is permitted to have only one class of common stock.  Although voting rights may differ, preferred stock cannot be used to create different interests in corporate capital and income.  Some differences in the cash flow allocated among S corporation shareholders can be effected if a portion of their capital is provided as loans rather than as capital contributions.  Because of the use of sophisticated hybrid securities may be characterized as a prohibited second class of stock, their use is precluded.



A pass-through tax regime such as a partnership, LLC, or S corporation permits losses to pass through to the owners who devote their time and energy to the business.  The ability of passive investors to deduct losses is often delayed by several Internal Revenue Code provisions designed to curtail tax shelters.  A C corporation is not able to pass through start-up losses to its shareholders, but corporations may deduct losses against their taxable income and carry any excess back or forward as net operating losses.  For start-up companies that raise capital from outside investors, these tax rules are among several factors that may weigh in favor of a C corporation.  Although start-up losses do not pass through as they are realized, most taxable investors would be unable to deduct them currently in any event.  The losses may be used more efficiently as carryforwards to shelter income earned during the early years of a C corporation’s profitability.



For a complete analysis of the tax implications of C Corporations, Partnerships, and S Corporations click here for the Joint Committee on Taxation's publication entitled "Choice of Business Entity: Present Law and Data Relating to C Corporations, Partnerships, and S Corporations."



Attorney Angel Oliver / McGrath and Spielberger, PLLC assists clients with all sorts of tax matters, both federal and state (including but not limited to North Carolina and South Carolina). Click here to contact Ms. Oliver about your tax matter.

Tuesday, July 21, 2015

The 6 Mortgage Loan Companies with the Most Complaints

The 6 Mortgage Loan Companies with the Most Complaints



Based on the Consumer Financial Protection Bureau report covering February thru April, 2015



As attorneysCustomer Service Feedback who are regularly involved in foreclosure and mortgage dispute cases, we pay close attention to large mortgage lenders and mortgage loan servicing entities and the problems which are found in that industry. We regularly file complaints with the Consumer Financial Protection Bureau on behalf of clients when the typical problems we encounter reach beyond the normal depths and reach a level of true ridiculousness. Which mortgage loan institutions are the most frequent offenders, nationally? The market leaders are no surprise, and include Bank of America, Wells Fargo, Chase, Citibank, Ocwen, and NationStar.



Bank of America had the most complaints overall of any national bank, with approximately half of thoDistressed mortgages and foreclosuresse being related to its mortgage lending and loan servicing activities. For February thru April, BoA averaged approximately 400 mortgage loan type complaints per month. On the one hand, with its hands in so many loans, it makes sense that BoA would be among the leaders in complaints; on the other hand, BoA has sold off many loans and the rights to service many loans, and thus its overall loan portfolio is significantly less than what it used to be.



Wells Fargo had fewer complaints with the CFPB overall compared to BoA, but also had approximately 400 complaints per month related to its mortgage lending and mortgage loan servicing activities. In our office, we have seen a significant increase in the number of Wells Fargo loans in distress, and a remarkably high percentage of those have required us to file complaints with the CFPB.



JP Morgan Chase had the sixth most complaints of any institution in the country between February and April. Approximately 40% of those complaints were related to mortgage lending and mortgage loan servicing, which works out to approximately 250 per month.



Although Citibank’s 507 complaints per month put it in seventh place overall, its mortgage lending and mortgage loan servicing complaints were a comparatively small portion of that. Citi averaged less than 150 complaints per month with regard to mortgage loans.



And now we come to Ocwen, wonderfully challenged Ocwen. With regard to mortgage loan complaints only, Ocwen was the national leader, with more than 425 complaints per month. This actually represented a decrease for Ocwen, which could be related to various government agencies forcing Ocwen to reduce its mortgage loan servicing portfolio, including the state of California threatening to outlaw Ocwen from that state all together. Ocwen is perhaps the most inconsistent entity that we regularly deal with in regard to mortgage loan disputes. For the most part, dealing with Ocwen is a nightmare, but once in a while we will have a case that actually works out very smoothly. The most frequent complaint we hear from new clients about their dealings with Ocwen – other than “they gave me the run around” – is that the customer service is outsourced overseas, and many borrowers complain of the customer service representatives not being able to properly understand or speak English.



The company which has come on strong in the last year with regard to mortgage loan servicing complaints is NationStar Mortgage. The number of complaints against it per month is similar to the number against both Bank of America and Wells Fargo. Because NationStar has acquired the servicing for many loans in the last few years, complaints against it are often related to inefficient transitions of loan servicing, including NationStar being unable (or unwilling) to properly service its new loans for months at a time.



Overall, complaints related to mortgage loans were the second most frequent type of complaints that the Consumer Financial Protection Bureau received during this time period. For those of you who are curious, the other four entities which had the most complaints against them during this time period (including complaints of all sorts) included Equifax, Experian, TransUnion, and Capital One. Together, with the six entities named above, these make up our current Hall of Shame.

Tuesday, July 14, 2015

Taxation of Business Income and Loss

Taxation of Business Income and Loss



When you decide to start a business venture, there are a myriad of things to consider.  We regularly assist small business owners, especially start-up businesses, walking them through the steps that need to be taken in order to make the business official and legal.  There are many ways a business can be organized and there are both non-tax and tax factors as well as state and local statutory requirements that need to be taken into consideration when embarking on this exciting journey of starting a business.

I previously wrote an article regarding the non-tax factors that should be considered when starting a business.  This article is one of a series of articles that focuses on the tax implications of certain business activities and things you should consider when choosing your business entity.  The most prominent federal tax considerations in choosing a business entity include:



This article relates to the tax considerations on how income and losses are taxed in various business forms.



tax magnifying glassA partnership or LLC is not a separate tax-paying entity.  Each partner or member is separately and individually taxable on his share of partnership or LLC profits, losses, deductions, and credits.  Each partner or member reports his share of each tax item, and each item retains the same character it had when it was earned or incurred by the partnership or LLC.  Under this pass-through tax regime, the members and partners avoid the double tax imposed on corporate income and the losses incurred by the business may offset income the partner or member has from other sources.



A C corporation is a separate, tax-paying entity.  Its income and profits are taxed at the corporate level when earned, and these amounts are subject to a second tax when they are distributed to the shareholders as dividends.  At the corporate level, dividends are taxed as ordinary income, at the shareholder level dividends are taxed under the capital gains rates.  Dividends were previously taxed to the individual shareholders at ordinary income tax rates.  Tax advisors then devised plans in which to avoid the ordinary income tax rate in preference for the lower capital gains tax rate by devising techniques referred to as "bail outs."  A "bailout" is a distribution of earnings in a transaction such as a redemption of stock, that qualifies as a "sale or exchange," enabling the shareholder to recover all or part of her stock basis and to benefit from preferential capital gains treatment on any realized gains.  In some cases, such as where the shareholder has died and the basis of her stock has been stepped up to its date of death value, the bailout may be accomplished tax free.  Congress responded to these techniques with anti-bailout provisions to ensure that distributions resembling dividends would be taxed as ordinary income.  When dividends and capital gains are taxed at the same preferential rate, the traditional incentive for a bailout almost disappears.  But if capital gains are taxed at much lower rates than dividends, a bailout becomes a viable strategy to reduce the double tax on C corporations and their shareholders.  Currently, dividends and long-term capital gains rates mirror one another, diminishing any type of motivation for bailouts.



Taxation of an S corporation is similar to the treatment of a partnership and LLC.  An S corporation is not a taxable entity; it serves as a conduit through which its income and losses passes through to shareholders.  Each shareholder reports his share of each tax item on his tax return, and these items retain the same character they had when they were earned or incurred by the S corporation.  Although a partnership is never treated as a taxable entity, an S corporation may be taxable if it once operated as a C corporation.  Corporate-level taxation may result if excessive passive-type income is generated by corporation assets or if the corporation disposes of assets that had built-in gains when the S election was made.



For a complete analysis of the tax implications of C Corporations, Partnerships, and S Corporations click here for the Joint Committee on Taxation's publication entitled "Choice of Business Entity: Present Law and Data Relating to C Corporations, Partnerships, and S Corporations."



Attorney Angel Oliver / McGrath and Spielberger, PLLC assists clients with all sorts of tax matters, both federal and state (including but not limited to North Carolina and South Carolina). Click here to contact Ms. Oliver about your tax matter.