IRS Announces Increase in De Minimis Safe Harbor Rule for Small Business Capital Expenses

It is a common decision for a small business to not keep audited financial statements, which means they do not get some of the tax benefits given to companies that have “applicable financial statements.” One such tax provision is the amount a company can claim under the de minimis safe harbor for capital items.

The de minimis safe harbor is designed to reduce paperwork and recordkeeping requirements, but still allow business to deduct expenses for improvement in tangible property that would normally qualify as a capital item. Under the previous Internal Revenue Service (IRS) regulation, the small business not keeping applicable financial statements were limited to $500, while those with audited financial statements were allowed up to $5,000. Starting with the 2016 tax year, the small business not keeping audited financial statements will be able to deduct up to $2,500 per invoice under the de minimis safe harbor for expenses to improve tangible property.

What this means for many small business owners is that expenses for the “acquisition or production of new property or for the improvement of existing property” may be deducted if the expenditure is less than $2,500 per invoice. This should ease accounting burdens and paperwork requirements for small business that sought to deduct these types of expenses under the previous rule.

© 2015 Houghton Vandenack Williams
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New Proposed Regulations Issued on Debt Basis Planning

Debt basis planning is a tool often used by shareholders of S corporations to allow them to use S corporation losses at the shareholder level. The amount of losses that a shareholder can use is limited to her adjusted basis in the S corporation’s stock. When a shareholder loans a corporation money, that loan may in some cases increase her basis in the stock. Loaning an S corporation money, therefore, can in some circumstances increase the amount of losses that a shareholder can use. However, debt basis planning has been a frequent subject of audit and litigation by the IRS, and such planning can be very uncertain.

The IRS has recently issued proposed regulations which may clarify the requirements for debt basis planning. Under the new proposed regulation, indebtedness of an S corporation to a shareholder will increase that shareholder’s basis if it is “bona fide indebtedness.” Some of the factors that might indicate bona fide indebtedness include a legally enforceable written note, appropriate provisions relating to interest, reporting of loans on financial statements, and timely payments on the loan. S corporation shareholders should be aware that debt basis tax planning should be undertaken carefully. However, the proposed regulations indicate that the opportunity to make use of this planning technique to increase the amount of usable losses may be less uncertain than in prior years.

© 2012 Parsonage Vandenack Williams LLC

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S corporation Under-compensation

The IRS continues to attack S corporation distributions as a method of avoiding payment of employment taxes and has been successful in a recent case.  The IRS succeeded in reclassifying distributions as salary resulting in underpayment by the corporation of employment taxes.  See Watson, P.C. v U.S. 109 AFTR 2d

© 2012 Parsonage Vandenack Williams LLC

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Benefits of Making an S Corporation Election

In an S Corporation, all income and losses are divided and passed through to its shareholders.  The shareholders then report the income or loss of the corporation on their own individual income tax returns.  A corporation can elect to be treated as an S Corporation by filing Form 2553.  Eligibility restrictions to make the election include not having more than 100 shareholders, all shareholders must be individuals, estates, exempt organizations, or certain types of trusts (note: cannot be another corporation), there can only be one class of stock, and no shareholder can be a nonresident alien.

The main benefit of an S corporation versus its C corporation counterpart is that S Corporations do not pay federal income taxes and accordingly there is only one level of taxation.  In contrast, a C corporation has a double level taxation: It pays a corporate income tax and then shareholders pay tax on most received distributions.  Also unlike a C corporation, an S corporation is not subject to the corporate alternative minimum tax.

Another benefit is how corporate losses can be deducted on the shareholders individual income tax return.  This is especially useful for start-up companies that typically will have losses in its early years.

If you are planning on starting a new corporation that may have early losses or minimal profits, you should consider making an S Corporation election.  If you do, then also consider adopting a shareholder restriction agreement to ensure that you do not accidentally lose eligibility by transferring stock to a non-qualified shareholder.

© 2012 Parsonage Vandenack Williams LLC

For more information, contact info@pvwlaw.com