Success Stories
We measure the success of our tax department in two separate ways. First, we strive to prepare complete and accurate tax returns free of any “red flags” that might draw the attention of the IRS. We want to accomplish this quality of work for a fair and reasonable fee within our local economic environment.
The second way we measure success is in income tax savings we can achieve for our clients (or on behalf our clients). To accomplish this goal, our firm spends approximately $12,000 per year for reliable, up-to-date, and comprehensive library resources. We utilize both resources available on the internet and by monthly professional journals. The tax laws, court decisions, IRS Regulations, Revenue Rulings and Procedures, and other various information available from our internet resources are just as current as for any firm, no matter how large they may be. Thus, our research capabilities are on par with the large national accounting firms
The following are some examples of how we have utilized our personal knowledge and experience along with our library resources to save significant amounts of income tax for some of our clients.
Change in Taxable Entity
During one tax year, we recommended that a new client convert their operating company from an S Corporation to limited partnership. This conversion allowed the client to save approximately $45,000 in state franchise tax for the following year.
Saving for Retirement
At the end of 2002, a new client was referred to us that had received practically no tax planning services. Both husband and wife were professionals in the same line of work. They had always practiced their profession as a sole proprietor filing a Schedule C. The wife was employed by the husband who was the sole proprietor. The previous tax preparer merely prepared their Form 1040 each year. These high-income, self employed professionals expressed to us that they wanted to retire in five to six years (while they were still in their fifties) and up to this point all he and his wife had used for a tax deferred retirement accumulation was their two IRA accounts. First, we helped our client select several new entities, which would provide some legal liability protection, to conduct their future business operations. However, we also advised them to establish a defined benefit retirement plan that would be effective for the 2002 tax year. This produced a tax deductible contribution to the plan for their 2002 tax year in excess of $160,000, given the short amount of time before they planned to retire.
Tax Free Gain on Sale of Undeveloped Land
We helped a real estate developer who had filed for bankruptcy two years earlier to achieve a tax free gain from selling some undeveloped land he owned. He had been fortunate enough to reacquire this parcel of land from a local bank. This was the same bank to which he had conveyed this property to offset some to his obligation (prior to his filing for bankruptcy protection). However, the bank did not transfer title into their name immediately as one would expect them to do. Ownership of the land had been in limbo for the intervening three or four years since the conveyance but our client continued to receive the property tax bills for the property even though he had previously conveyed the property to the bank. He finally became curious and inquired of the bank why they were not paying the property tax. He was informed by bank officials that their attorneys had recommended that the bank not take title to the property because of the potential for the bank to be held liable for unpaid taxes assessed by an adjacent Road District.
With a relatively small loan from a friend, our client had purchased the undeveloped land for a price that was far below what he had previously paid for it (before he got into financial trouble). Just over a year later, he was able to sell the land to some investors from Canada for a nice profit of $500,000. When he informed us of this transaction, he asked us what could be done to minimize the tax bite since he needed as much of the profit as possible to try and start over after bankruptcy.
Whenever one goes through bankruptcy, they have to relinquish all of their tax attributes to the trustee of the bankruptcy estate in return for all of the debts being forgiven. Normally, forgiveness of debt generates taxable income for the individual being forgiven. Tax attributes are such things as net operating loss carryover, general business credit carryover, capital loss carryover, and investment interest carryover among others. Such items can be used to reduce income tax in future tax years. However, in the case of bankruptcy, the trustee gets these tax attributes to use to offset taxable gains on the sale of assets by the bankruptcy estate. This helps the trustee maximize the amount of cash received from selling the properties, which in turn means more money is available to repay creditors of the bankrupt individual.
Upon investigation, we learned that our client’s bankruptcy estate had never filed a tax return. The return had never been filed because the trustee filed an affidavit with the bankruptcy court, asserting this was a no asset estate (i.e., unpaid liabilities far exceeded asset values). From our tax research, we learned that whenever the bankruptcy estate does not completely exhaust all of the tax attributes in offsetting taxable gains, the bankrupt individual can reclaim the tax attributes from the bankruptcy estate. However, there was no clear precedent regarding what happens when the bankruptcy estate never files a tax return. We decided to take those attributes back anyway based on the logical premise that all of the attributes must have remained intact because no return was ever filed. Our client had relinquished over $650,000 of investment interest carryover to the bankruptcy estate.
When we filed the tax return, we fully disclosed what we were doing so the IRS could challenge our position if it felt justified. Our client was advised of the risk and agreed with our tax filing position. On IRS Form 4952 – Investment Interest Expense Deduction, an election can be made on line 4e to treat a portion or as much as 100 percent of one’s net capital gain as investment income rather than as net capital gain which is currently taxed at a maximum rate of 15 percent (in this year, it was a flat 28 percent rate). Because our client had reclaimed investment interest carryover of approximately $650,000 we elected to treat the entire $500,000 taxable capital gain as investment income. In so doing, our client avoided paying even one cent of tax on his $500,000 capital gain from selling the land to the Canadian investors. This produced a tax savings of approximately $140,000.
An Alternative to a Non Business Bad Debt
In 1998, a new client came to us with the following problem – he had made several cash advances to some friends of his in Dallas over a period covering from October, 1963 to February, 1995. His friends led him to believe he was investing money in a project to develop some oil and gas property in east Texas. However, they never invested the money in that manner. When our client tried to seek repayment of the $39,237, his friends admitted that they had used the money for personal living expenses but said they would repay him as soon as they could. When he came to our firm in 1998 to have his 1997 income tax return prepared, he had not received any repayment. Over the intervening years, he had written several collection letters threatening to file suit against them, but this was to no avail.
The facts and circumstances of his case did not support his desired position of taking a business bad debt deduction that is fully deductible against ordinary income. In the court cases we reviewed, the only time the courts determined that people were in the trade or business of lending money involved making high-risk loans on a recurring basis to many different individuals. Furthermore, the lender was known in the local business community as a high-risk lender of last resort.
Our client’s loss did qualify for a non-business bad deduction; however, this was not suitable to him because only $3,000 per year could be deducted as a capital loss deduction. The remaining capital loss would have to be carried forward with only $3,000 deducted each year (unless there were capital gains to offset against the capital loss). He felt this would take too long to realize the full tax benefit.
Finally, we did find a Tax Court Case whereby the Tax Court allowed a deduction for theft loss instead of a bad debt loss. In this case, the lender had actually been swindled out of a fairly significant amount of money. However, he had considered it a loan when he filed his tax return. The following quotes come from this Tax Court Case: “IRC Section 165 allows as a deduction a theft loss sustained during the taxable year and not compensated for by insurance or otherwise.” “………A theft loss is deductible regardless of whether the alleged theft is prosecuted so long as there was an illegal taking of property under the laws of the State where the loss occurred.” “A criminal conviction is not a necessary element of the taxpayer’s proof in this Court.”
Thus, we took a casualty loss deduction of $39,237 on our client’s 1997 Form 1040.
An Often Missed Deduction for the Self-Employed
Unfortunately, taxpayers frequently conclude a significant business transaction without seeking advice from their accountant. One of the most common transactions where we see this occur has to do with the decision of whether to sell an automobile that has been partially used in the taxpayer’s business or to trade it in on a new vehicle. Whenever a business owner trades in a vehicle used in his business for a new vehicle rather than selling it, the tax basis in the new vehicle is the sum of the adjusted basis in the old vehicle plus any additional amount paid. Adjusted basis is tax terminology for the original purchase price paid minus the amount of depreciation claimed on the taxpayer’s income tax return.
For cars costing more than $15,300 (the tax law actually defines these vehicles as luxury autos), the amount of depreciation that can be claimed each year is limited to $3,060 for the first year, $4,900 for the second year, $2,950 for the third year, and $1,775 for each succeeding tax year until the cost of the vehicle is fully recovered. Thus, for a car that costs $25,000, is subject to these depreciation limits, and is used 100% for business purposes, it will take 11 years to fully depreciate the vehicle. These limits are referred to as the luxury auto depreciation limits.
Because of the method of accounting for trade-ins and the luxury auto depreciation limits, one can develop a ridiculous amount of basis in a automobile after just a couple of trade-ins. For example, after a couple trade-ins one could have a depreciable cost basis in a new car of $50,000 even though it has a purchase price of only $40,000. The difference will be even greater where the vehicle is used less than 100 percent for business.
Several times, when we have been contacted by a client prior to their trading for a new car, we have been able to help them achieve a significant tax loss by selling their car instead of trading it for a new car. The tax loss results from the fact that the economic depreciation exceeds the allowable tax depreciation for cars that were traded in along the way. This is true even though the car has been only partially used for business.
When a car used only partly for business is sold, the transaction is treated as separate sales of a business asset and a personal asset. The original purchase price and sales proceeds are allocated between the business and personal assets based on cumulative mileage. The allowable depreciation reduces the basis of the business asset. The loss on the business portion of the car is deductible as an ordinary loss; whereas, the loss on the personal portion of the car is a nondeductible personal loss.
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