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PDtax
PDtax, Master's Degree
Category: Business and Finance Homework
Satisfied Customers: 1995
Experience:  MBA/CPA, Former college instructor and tutor.
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This is for PDTaxIn reference to the client memo, how did

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This is for PDTax

In reference to the client memo, how did you come to that conclusion? Which tax service did you use? Which key words did you use? I want to try to emulate your efforts. Also, did you use a citator?
Submitted: 11 months ago.
Category: Business and Finance Homework
Expert:  Lindie-mod replied 11 months ago.

Hello,

I'm Lindie, and I’m a moderator for this topic. I sent your requested professional a message to follow up with you here, when they are back online.

If I can help further, please let me know. Thank you for your continued patience.

Best,

Lindie

Customer: replied 11 months ago.

Hi Brian,

I found the following. Does this contradict what you wrote previously?

 

469(e)(2)Passive losses of certain closely held corporations may offset active income.-
Related Information -
Federal

469(e)(2)(A)In general.-

If a closely held C corporation (other than a personal service corporation) has net active income for any taxable year, the passive activity loss of such taxpayer for such
taxable year (determined without regard to this paragraph)-

469(e)(2)(A)(i)

shall be allowable as a deduction against net active income, and

469(e)(2)(A)(ii)

shall not be taken into account under subsection (a) to the extent so allowable as a
deduction.

Expert:  PDtax replied 11 months ago.
Welcome to the site. Thanks for your question.

I learned how to analyze tax scenarios during my time at one of the Big 4 firms (starts with E). The format we used then was the same I used, with an outline of the fact pattern, issues identifiable in the facts, restatement of applicable tax law, and a conclusion. We used to attach copies of any referred to documents, so the reviewer and file had everything needed.

I can remember using non-verifiable narrative, and having those answers tossed back at me to redo. That's why I still go 'to the code' whenever possible. Now, with internet authorship being pretty free, sorting the wheat from the chaff is even more important.

The fact pattern mixed several issues, including passive activity losses with active participation ($25,000 maximum loss against other income, and the losses exceeded that threshold), and the idea that you could create your own passive income from your own c corp, offset it with rental losses, from renting space in your home, and, well, there were just so many options that I started with general research regarding rental income of self-owned businesses. I also knew that self-rental would have questions about leases (I have done a few of these), and of consistent rent expense (inconsistent rents would indicate the owners were converting c corp income to rent without a lease to cut their taxes, a big no-no. The requirements I passed along came from that initial review.

I didn't use a traditional tax service. I started by googling rental income from 100% owned c corporations, and it wasn't long before the 469 passive activity rules came up.

I also read the 469(e) rules you mention above. It took me a second, too, but I believe the rules you mention require that the c corporation is the taxpayer with a passive activity. I didn't think it was appropriate to extend those rules to individuals who were the taxpayers with passive losses to offset rents. I wanted to see if the rental income they created was passive, and my research supported the idea it was not.

http://www.globaltaxlaws.com/google_tax_search/ is google's tax law search, but I have found good success with just a general google of a subject. Cases have to be citated, of course, but tax law sites from Cornell Univ. and others, narrative from other authors, and tax experience since the Reagan administration (the first one) combine for the insights I brought to your tax case.

I appreciate that you thought my tax research was worthwhile.

Brian

Customer: replied 11 months ago.

Thanks for the explanation. Are there any laws against at the Federal level against charging high rents?

Expert:  PDtax replied 11 months ago.
The arm's length relationship for rents needs to be justified. That's why a lease makes sense.

The laws are specific that only space 100% used for business is allowed for rental and expense recognition, otherwise the taxpayers could only deduct interest and property taxes attributed to that space against the rental income. The home office rules set that up a few years ago.

The rent has to have a basis in fair market value for similar space or it is at risk of dividend treatment in audit. The temptation is there for owners to move income out of their corp without payroll taxes, so rents is a popular vehicle.

As an aside, you asked earlier about where the non-passive income of shareholder rent came from. I neglected to mention the following:

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Passive-Activity-Loss-ATG---Chapter-6,-Entity-Issues is a link to the IRS Audit Techniques Guide (ATG) that touches on the non-passive issue of the rental income.From that document:

Issues on the shareholder’s individual return:
Assets owned personally by a shareholder and leased to the corporation: If the building or equipment is personally owned by the shareholder and leased to the corporation, net rental income may be non-passive (Reg. § 1.469-2(f)(6)).

Back to the high rents question. I didn't find a source to substantiate the rent amount. I can tell you it is a targeted audit issue, and I like to use fair value of a complete rental including services, like internet, utilities, etc. for what is likely a home office scenario like this. If you need me to find the basis for that practitioner position, let me know and I will look later today.

Brian

Customer: replied 11 months ago.
If you need me to find the basis for that practitioner position, let me know and I will look later today. Would you please?
Expert:  PDtax replied 11 months ago.
I have more time now, and am researching now.
Expert:  PDtax replied 11 months ago.
Sorry about not being able to devote enough time earlier. JA just buried me with work this weekend.

The tax issue is created by IRS at audit, and it is called a constructive dividend. The application is a work of tax art, as I will outline.

Tyson v. Comm'r, T.C. Memo 2009-176 (T.C. 2009) is a good Tax Court case that explains the IRS scrutiny of excessive rent, and tax treatment of rent in excess of a defendable amount to shareholders.

While I knew there was a fair market rent standard, this is not a Code-delineated item, but a tax position.

The practitioner based standard I referred to earlier is finding a rent that can be defended, to avoid the potential for constructive dividend treatment at audit. These cases create income at the corporation level, and often add accuracy penalties for both the c corp and taxpayer/shareholder.

Thanks again for asking.

Brian
PDtax, Master's Degree
Satisfied Customers: 1995
Experience: MBA/CPA, Former college instructor and tutor.
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