TLB has issued a year-end tax letter for individuals covering recent changes in tax rules and regulations and covering simple strategies for minimizing your 2007 tax obligation.

The IRS has issued final regulations (T.D. 9356) on employment and excise taxes for disregarded entities, including single member LLC’s, and Qualified Subchapter S Subsidiaries (QSUB’s). These final regulations provide that a disregarded entity is treated as a separate entity (a corporation) for purposes of employment taxes and the related reporting requirements. The new regulations were effective August 16, 2007 and are applicable to wages paid on or after January 1, 2009.

Practically speaking these regulations mean that the business entity is responsible for filing and paying for employment taxes, as opposed to the owner at the individual level. With this treatment, owners of single member LLC’s are not responsible for the employment tax obligations of the entity. However, TLB cautions the owner may still have exposure under other rules, such as the responsible party provisions.

The IRS will still allow a single member LLC to calculate, report and pay all employment tax obligations as though the employees of the LLC were employed directly by the owner – and under the owner’s name and taxpayer identification number.

Alternatively, the single member LLC may calculate, report and pay all employment tax obligations under the entities name and taxpayer identification number.

Effective January 1, 2009, those who report employment taxes under the owner method are required to continue to use this method ongoing unless and until otherwise permitted by the IRS Commissioner. However, a taxpayer may take the opportunity now to convert from the owner method to the entity method of reporting without seeking permission – as long as it is done before January 1, 2009. Taxpayers who switch methods may consider wages paid by the owner to employees during the calendar year of the switch as having been paid by the entity for purposes of determining the various wage and benefit bases used in calculating employment taxes.

Please contact TLB if we can help you evaluate which option is the best for your facts and circumstances. Posted by Rich Bienvenue

Real estate agents, developers and investors must be careful in how they report income from the sale of subdivided real property. Many taxpayers and preparers assume the sale of real estate is eligible for capital gains treatment (capital gains are currently taxed at 15% for federal purposes) as opposed to ordinary income (current maximum federal rate of 35%). Needless to say an IRS adjustment relating to these issues and the addition of penalties and interest oftentimes results in a large liability that perhaps could have been minimized or avoided with proper planning.

In determining the proper tax treatment on the sale of subdivided property one has to consider whether the property constitutes investment property, which is eligible for capital gains treatment, or property held primarily for sale in the ordinary course of the taxpayers trade or business (taxpayer is deemed a dealer in property), which is treated as ordinary income. Of course, most disputes between a taxpayer and the IRS relate to the determination and definition of a trade or business and therefore whether a property is an investment activity or held primarily for sale.

Whether property is held primarily for sale in the ordinary course of business or for investment depends upon the facts and circumstances present. Perhaps the circumstances indicate a property is held primarily for sale, but other facts and circumstances may indicate the taxpayer is not engaged in a trade or business. Some of the relevant facts considered by the IRS and Courts include:

1. The nature and purpose of the acquisition of the property and the duration of ownership;2. The extent and nature of sales efforts;3. The number, continuity, and regularity of sales;4. The extent to which the taxpayer attempts to increase sale by improving the property and advertising;5. The use of a business office to facilitate sales; and 6. The time and effort devoted to sales by the taxpayer.

The purpose for which the taxpayer acquired the property is an important consideration in determining the characterization of the property. However, it is not uncommon for property acquired for investment to later be characterized as property held for sale, if the facts and circumstances of the scenario change, sometimes over the course of many years.

The extent and nature of sales efforts is another consideration in properly characterizing these types of transactions. If the taxpayer engages in advertising, hires agents, maintains a sales office, has a real estate license or represents to the public himself as a dealer in property, it is likely the IRS would consider the taxpayer a dealer.

Another significant consideration is the number, continuity, and regularity of sales. Obviously, the more sales the taxpayer engages in , the greater the chance the IRS would consider the taxpayer a dealer. In addition, substantial development or improvement of a property, such as land improvements, grading, subdividing and installing roads or utilities indicate the taxpayer is a dealer.

In considering these factors it is important to note that not any one consideration is a determining factor – all considerations need to be weighed together in order to support a proper determination. In addition, the Internal Revenue Code provides for safe harbor provisions that allow investors to subdivide unimproved land into parcels and to sell the parcels without being deemed to have held the property primarily for sale in the ordinary course of a trade or business. However, these safe harbor provisions are limited and are not applicable if the taxpayer makes improvements to the property that substantially increase its value. Also, the safe harbor provisions are not available to dealers in real estate who hold property primarily for sale in the ordinary course of their trade or business.

Sorry lottery fans – except for the fact that you just hit the big one – you just can’t win, at least not with the IRS. As you probably know if you ever do hit the big one and win $100 million – you don’t always actually receive $100 million. Instead, you receive an annual annuity from the lottery commission, which I might add isn’t chump change, but after paying for taxes, lawyers, investment management, not to mention the new house, new spouse and an Escalade (I would get a Bentley – it holds its value better), a couple million a year just doesn’t go as far as it used to.One option available to lottery winners from outside third parties is to exchange your newly won stream of payments for a lump-sum payment that you could totally blow – I mean invest – now. As you might suspect, the IRS has treated these lump-sum payments as ordinary income, and therefore subject to the individual income tax rates (probably at the current top rate of 35%) and not at capital gain rates (15%). So not only did you cash out your winnings at less than 100 cents on the dollar, 35% of whatever is left is gone to the federal government (we haven’t even mentioned the state).The Second Circuit recently upheld the IRS position in this regard, which was previously upheld by the Third, Ninth and Tenth Circuits and by the Tax Court in Prebola v. Comissioner, (No. 05-6953-ag – 3/27/2007). In upholding the IRS position the courts have been applying the “substitute for income doctrine,” which holds that lump-sum payments received in exchange for what would otherwise be received as ordinary income are treated as ordinary income.Sorry Ms. Prebola.