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Making a Section 444 Election

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The IRS has established various rules regarding required tax years in order to prevent excess deferral of taxes by partnerships, S corporations, and personal service corporations. In certain circumstances, however, under Internal Revenue Code Section 444, partnerships, S corporations, and personal service corporations may elect to use a tax year other than their required tax year, subject to certain limitations. This article will explain the basics of Section 444 elections. It is not intended to constitute tax or legal advice.

Partnership, S Corporation and personal service corporation taxation can involve many complex tax and legal issues, so it may be advisable to seek an experienced attorney in these matters. Sherayzen Law Office, PLLC can assist you in all of your tax and legal needs.

Requirements

In general, a partnership, S corporation, or personal service corporation can make a section 444 election provided that it meets the following requirements: (1) it is not a member of a “tiered structure” (defined below), (2) it has not previously made a section 444 election, and (3) it elects a tax year that meets IRS deferral period requirements.

A tiered structure is defined in 26 C.F.R. § 1.444-2T: “—(1) In general. A partnership, S corporation, or personal service corporation is considered a member of a tiered structure if— (i) The partnership, S corporation, or personal service corporation directly owns any portion of a deferral entity, or (ii) A deferral entity directly owns any portion of the partnership, S corporation, or personal service corporation.”

Determination of the Deferral Period

The deferral period is determined by whether a partnership, S corporation, or personal service corporation is adopting or changing its tax year by making a section 444 election, or whether it is retaining its tax year.

For partnerships, S corporations, or personal service corporations adopting or changing to a tax year other than its required year, the deferral period is the number of months after the end of the new elected tax year to the end of the required tax year.

If a partnership, S corporation, or personal service corporation makes a Section 444 election to retain its tax year, the deferral period must be three months or less, determined by the number of months from the start of the tax year to be retained and the end of the first required tax year.

Making a Section 444 Election

Form 8716 must be filed in order to make a Section 444 election. In general, the form must be filed by the earlier of the due date (not including extensions) of the elected tax year or the 15th day of the 6th month of the tax year for which the Section 444 election will go into effect. Form 8716 should be attached to Form 1065, Form 1120S, or Form 1120 for the first elected tax year. A Section 444 election will remain in effect until terminated.Required Payments

A partnership or an S corporation making a Section 444 election must also file Form 8752, “Required Payment or Refund Under Section 7519” for every year that the election is in effect. If the required payment is greater than $500, the payment must be made when the form is filed. A personal service corporation must distribute required amounts to its employee-owners by December 31st of each elected Section 444 tax year.

Contact Sherayzen Law Office for Help with Section 444 election.

 

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this answer was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

Deductible Expenses for a Newly-Formed Partnership

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Are you planning on starting a partnership for business purposes? Usually, partnerships will incur various costs while forming a partnership. Some of these costs may be deductible or amortizable, others will not. This article will examine the deductibility of the most common costs in the formation of a partnership.

Partnerships often involve complex legal and tax issues, so it may be advisable to obtain legal counsel when forming a partnership. Sherayzen Law Office, Ltd. can assist you in all of your tax and legal needs.

Syndication Costs

Often, the formation of a partnership will involve various costs associated with marketing and selling partnership interests to prospective partners. These fees are termed “syndication” costs. Unfortunately for taxpayers, such costs are neither deductible nor amortizable under Internal Revenue Code Section 709. This will be the case regardless of whether the costs were incurred or actually paid.

Organizational Expenses

Unlike syndication costs, however, certain organization costs connected with forming a partnership may be deductible or amortizable. Under IRC Section 709, organizational costs include expenses that are: “(1) are incident to the creation of the partnership; (2) are chargeable to a capital account; and (3) would be amortized over the life of the partnership if they were incurred for a partnership having a fixed life.” Organizational costs may include certain legal and accounting fees associated with the formation of a partnership.

In general, a partnership may be allowed a $5,000 initial deduction for the organizational costs it incurs in its first year of business. However, if organization costs amount to more than $50,000, the $5,000 deduction will be reduced by any amount that exceeds the $50,000 threshold. Organization costs that are not deductible because of the threshold may be amortizable over a period of not less than 180 months, beginning with the month that the partnership begins operating its business. Note, special rules that are not covered in this article apply to partnerships formed before October 22, 2004.

It is important to also note that not all initial costs a partnership may incur or pay will be treated as organizational costs. Besides syndication costs (covered above), costs associated with acquiring and transferring assets to the new partnership, admitting or removing partners after the initial formation of a partnership, and various other costs may not be treated as organizational costs under these rules.

Startup Costs

Startup Costs are amounts that are paid or incurred after a business is formed, but before business operations actually start. In general, startup costs include pre-operation costs associated with employee training, advertising, promotion and market surveys, and related expenses. Costs associated with investigating the purchase of a partnership interest of a partnership may also be treated as startup costs by partners, provided certain rules are met.

A partnership may deduct $5,000 of startup costs in its initial year of operations. Startup costs that exceed $50,000 will reduce this amount, similar to operating expenses (explained above). A partnership may elect to amortize startup costs that have been reduced by the $50,000 limit over a period of 180 months, beginning with the month the partnership commences its operations. If a business is acquired, the period of amortization will begin the month after the business is purchased.

Contact Sherayzen Law Office for Partnership Organization and Tax Planning

If you are thinking about starting a partnership or your existing partnership is need of a sound tax plan, contact Sherayzen Law Office. Our experienced business and tax law firm will thoroughly analyze your current situation and create a customized plan to move your business toward achieving your business and tax goals.

Cash and Property Contributions to Partnerships and Their Affect on a Partnership Interest

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A partnership is defined to mean the relationship between two or more persons to carry on a trade or business, with each person contributing money, property, labor, or skill, and each expecting to share in profits and losses.  This article will provide a broad overview of some of the tax consequences of cash and property contributions to a partnership (whether upon formation or additional contributions later), the basis of partnership interests received by partners, the basis of contributed property to the partnership, and some other helpful information.

Basis of a Partner’s Interest

The basis of a partnership interest is the cash contributed by a partner, increased by the adjusted basis of any property contributed by a partner. In general, no gain or loss will be recognized when property is contributed by a partner in exchange for an interest in a partnership; however, in certain circumstances (explained further in this article), a partner must recognize gain, and if so, this gain is included in the basis of his or her partnership interest.

Special rules apply to a partner’s contribution to the partnership in the form of assumption of a partnership’s liabilities.

Basis of Contributed Property to the Partnership (Transferred Basis)

For the partnership, the basis of contributed property (for the purpose of determining depreciation, depletion, gain, or loss for the property) will be the same as the partner’s adjusted basis for the property as of the date it was contributed, increased by any gain that must be recognized by the partner.

Contribution of Property- Top Three Exceptions to General Recognition Rules

As mentioned above, usually no gain or loss will be recognized by either a partner or partnership when property is contributed to a partnership in exchange for an interest in the partnership. This general rule applies to both situations where a partnership is being formed and already existing partnerships.

However, there are some exceptions to this rule, three of which are explained below.

1) Property Subject to a Liability

If a partner contributes property that is subject to a liability, or if a partner’s liabilities are assumed by the partnership, that partner’s basis interest will usually be reduced (but never below zero) by the amount of the liability assumed by the other partners. The partner’s basis should be reduced because the assumption of the liability is treated as a distribution of cash to that partner; the other partners’ assumption of the liability is likely to be treated as a cash contribution by them to the partnership.

In most circumstances, a partner must recognize gain when property is contributed which is subject to a liability, and the resulting decrease in the partner’s individual liability exceeds the partner’s partnership basis.

2) Partnership Would be an Investment Company if Incorporated

Gain will be recognized when property is contributed in exchange for a partnership interest if the partnership would be treated as an investment company, if it were incorporated .

A partnership will usually be treated as an investment company if over 80% of the value of its assets is held for investment, and it consists of certain readily marketable items, such as money, stocks and other equity interests, real estate investment trusts, and interests in regulated investment companies. Whether a partnership will be treated as an investment company or not, is typically determined immediately after the contribution of property.

3) Partnership Capital in Exchange for Services Rendered

In most circumstances, if a partner receives a partnership interest in exchange for services rendered, that partner must recognize compensation income.

Partnership’s Holding Period for Contributed Property

Usually, the partnership’s holding period for contributed property includes the partner’s holding period.

Partner’s Holding Period for Partnership Interest

A partner’s holding period for a partnership interest usually includes the holding period of the property contributed (if the property was a capital asset or Section 1231 asset to the contributing partner).

Treatment of Built-In Gain/Loss to the Partnership

In general, if a partner contributes (non-depreciable) property, and the partnership eventually sells or exchanges the property and recognizes gain or loss, the built-in gain or loss must be allocated to the contributing partner. (If the property is depreciable, detailed rules apply to allocation procedures).

Partner’s Basis Increases/Decreases

A partner’s basis will usually increase by any additional contributions by a partner to a partnership (including an increased share of, or assumption of, a partnership’s liabilities), a partner’s distributive share of taxable and nontaxable partnership income, and in general, a partner’s distributive share of the excess of the deductions for depletion over the basis of depletable property.

In general, a partner’s basis will decrease (but not below zero) by any money (including a decreased share of partnership liabilities, or an assumption of the partner’s individual liabilities by the partnership) and adjusted basis of property distributed by a partnership to a partner, a partner’s distributive share of partnership losses, and a partner’s distributive share of nondeductible partnership expenses that are not capital expenditures (including a partner’s share of any section 179 expenses).

Contact Sherayzen Law Office For Legal and Tax Help Regarding Partnerships

The contribution of property to partnerships and various partnership-partner taxation matters can involve complex issues, and this article only attempts to provide a very general background information that should not be relied upon in forming a partnership, contributing property to the partnership or any other specific taxation aspects. Rather, you should contact Sherayzen Law Office for legal help with this issue. Our experienced business tax firm will guide you through the complex web of rules concerning U.S. partnership formation and taxation matters and help you with your specific needs.

IRS Issues Guidance on Tax Treatment of Cell Phones

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On September 14, 2011, the Internal Revenue Service issued guidance designed to clarify the tax treatment of employer-provided cell phones.

The guidance relates to Section 2043 of the Small Business Jobs Act of 2010, Pub.L.No. 111-240 (enacted last fall) that removed cell phones from the definition of listed property, a category under tax law that normally requires additional recordkeeping by taxpayers.

Generally, a fringe benefit provided by an employer to an employee is presumed to be income to the employee unless it is specifically excluded from gross income by another section of the Code. (See Income Tax Regulations § 1.61-21(a)).

Pursuant to Notice 2011-72, the employer- provided cell phones are treated as an excludible fringe benefit. The Notice further provides that when an employer provides an employee with a cell phone primarily for noncompensatory business reasons, the business and personal use of the cell phone is generally nontaxable to the employee. The IRS will not require recordkeeping of business use in order to receive this tax-free treatment.

Simultaneously with the Notice, the IRS announced in a memo to its examiners a similar administrative approach that applies with respect to arrangements common to small businesses that provide cash allowances and reimbursements for work-related use of personally-owned cell phones. Under this approach, employers that require employees, primarily for noncompensatory business reasons, to use their personal cell phones for business purposes may treat reimbursements of the employees’ expenses for reasonable cell phone coverage as nontaxable. This treatment does not apply to reimbursements of unusual or excessive expenses or to reimbursements made as a substitute for a portion of the employee’s regular wages.

Under the guidance issued today, where employers provide cell phones to their employees or where employers reimburse employees for business use of their personal cell phones, tax-free treatment is available without burdensome recordkeeping requirements. The guidance does not apply to the provision of cell phones or reimbursement for cell-phone use that is not primarily business related, as such arrangements are generally taxable.

Contact Sherayzen Law Office NOW for Legal Help Regarding Your Business Tax Issues!

If you have any questions or concerns regarding this or any other business tax issues, contact Sherayzen Law Office. Our experienced tax firm will guide you through the complex issues of business taxation, help you deal with current business transactions, as well as create a comprehensive business tax plan that allows you to take advantage of the existing Tax Code’s provision and engage in proactive tax planning.

Partnership Tax Lawyers St Paul | Partnerships: Required Taxable Year

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Under the U.S. tax laws, partnership income and expenses flow through to each partner in a partnership, at a partnership’s tax year-end. Generally, the tax year of a partnership must conform to the tax years of its partners. In some situations, however, a partner, or multiple partners, and the partnership itself may have different tax years, there is a potential for income deferral.

While legitimate income deferral is allowed under the U.S. tax laws, the IRS has rules in place to prevent excessive deferral of partnership income. These rules are explained briefly below in three successive steps. A partnership must apply each rule in chronological order, and the first tax year that meets all of the criteria in a specific rule will be the required tax year for the partnership (subject to certain exceptions allowed by the IRS).

Three-Step Analysis

1) Majority partners’ tax year

In general, if one partner owns more than 50% of the partnership capital and profits, then that partner’s taxable year will apply to the partnership. Similarly, if a group of partners have the same taxable year and own more than 50% of the partnership capital and profits, then that shared taxable year will also apply to the partnership. Majority interest is generally determined on the first day of the partnership.

2) Principal partners’ tax year

If step 1 does not yield a majority interest tax year, then the tax year the principal partners who own more than a 5% interest of capital or partnership profits, will be used if they all have the same tax year.

3) Year with smallest amount of income deferred

If steps 1 and 2 do not yield a result, then the “least aggregate deferral rule” is used to determine the weighted-average deferral of partnership income by testing the tax year-ends of the partners. The tax year required to be selected under the test will be whichever tax year-end is calculated to yield the least amount of deferral of partnership income.

Example of the Three-Step Analysis

To illustrate, assume that Adam and Bob are equal partners, each owning a 50% share. Adam’s tax year ends August 31, while Bob uses the calendar year, December 31. Step 1 would determine that there is no majority interest because neither partner owns more than 50%, and Step 2 would show that neither partners have the same tax year (even though they are both considered to be principal partners owning more than 5%). Thus, the least aggregate deferral rule would be applied in this case.
Under the least aggregate deferral rule, to determine the weighted-average product, begin by counting forward from the end of one partner’s tax year to the end of the other partner’s tax year-end, and then vice versa. For example, counting forward from the end of Adam’s tax year (August 31) to the end of Bob’s (December 31) is four months. Then, the number of months is multiplied by the partnership percentage interest, to determine a weighted-average product. Multiplying four by the partnership interest of 0.5 equals a product of two (the aggregate deferral). Counting forward from the end of Bob’s tax year to the end of Adam’s, determines that eight months will be deferred. Multiplying eight by .50 equals a product of four. Since the product of two under Adam’s August 31 tax year is less than the product of four under Bob’s December 31 tax year, Adam’s tax year-end will also be the tax year-end for the partnership itself.

Conclusion

Described above are the basic rules for determining the required tax year for partnerships. In some cases, it may be possible to be granted an exception from the general rules. These options however often depend upon persuading the IRS of the necessity of adopting a different tax year than would be available under the standard rules. Often, complex legal rules and case law are involved, so it is advisable to seek legal counsel. Furthermore , individual partners may need specific guidance relating to partnership taxation scenarios. Sherayzen Law Office can assist you with these matters.

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