A Pass-through Entity must obtain an exemption certificate, Form PTE-EX, from every member who claims exemption from withholding. The following are eligible to claim exemption:

• Massachusetts residents;
• Non-resident individuals who agree to file Massachusetts non-resident income tax returns or to participate in a composite return prepared by the Pass-through Entity;
• Organizations exempt from Federal income tax but only if their share of Pass-through Entity’s income does not constitute unrelated business taxable income;
• Corporations which file a Massachusetts corporate excise return; and
• Certain Pass-through entities that are members of lower tier pass-through entities.

 For any member from whom it has not obtained an exemption certificate, the Pass-through Entity is required to withhold and electronically remit Massachusetts income tax on a quarterly basis.

Exemption certificates must be obtained annually by the end of the first month of the Pass-through Entity’s taxable year and retained among the entity’s records for inspection upon request.  Thus, calendar year entities must obtain these certificates by January 31, 2009.

Entities which are exempt from these requirements include:

• A partnership whose income consists mostly of interest, dividends and capital gains and substantially all of whose assets consist of investment securities and deposits, provided that the entity is not engaged in a trade or business in Massachusetts; 
• A publicly traded partnership; 
• An upper-tier entity whose only Massachusetts-source income comes from one or more lower tier Pass-through Entities which have withheld tax; and 
• A trust or estate for which tax is due at the entity level or which is required to withhold under another Massachusetts provision. 

The information provided above is intended to be general in nature and does not constitute tax advice. Please contact Richard Bienvenue at (508) 255-2240 if you have questions or would like to further discuss your situation.

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

1. Your selling your business - Upon the sale or distribution of corporate assets or business, tax is paid at both the corporate and shareholder level. If you are thinking of retiring or selling your small business in the future, you should seriously consider the advantages of making an S-election.

2. Unreasonably high compensation issues - C-Corporations have to worry about paying unreasonably high compensation. In order to get money out of a C-Corporation most taxpayers take out cash in the form of compensation bonuses. On an IRS examination, agents consider these unreasonable high compensation issues to determine if taxpayers are trying to avoid paying a corporate level tax and tax at the individual level for the receipt of dividends. If raised during examination the service will hit you for the tax and for substantial penalties. This issue doesn’t exist for the S-Corp, as all the corporate income flows through to the shareholder and is taxed only at that level.

3. Accumulated Earnings - O.K. if you avoid the unreasonable compensation issue noted in number 2 above, perhaps you will run into too high a level of accumulated earnings. In this scenario, the IRS may try to assert that the C-Corporation is not paying this cash out because of a desire on the part of the taxpayer to avoid paying taxes on the dividends. Again, this issue just doesn’t apply to the S-Corp, because all income flows through each year.

4. Personal expenses - lets face it many taxpayers try to funnel personal expenses through the business, or perhaps something that every body thought was legitimately a business expense is disallowed upon IRS examination. In a C-Corporation environment this could be disaster. Most likely the IRS will consider the payment of the personal expenses a dividend - so the taxpayer has to pickup the tax on that. In addition, now that the corporation loses the expense, its taxable income is increased and the corporation has to pickup the tax on its level. Add on penalties and something as innocuos as disallowed auto expenses totaling, lets say $10,000, will now cost the taxpayer an additional $7,000 - $9,000 in tax and penalties. Lets hope tax preparers out there are encouraging their clients to play it straight when it comes to personal expenses - especially with their C-Corp clients.

5. Utilization of losses - As a C-corporation any losses generated by the business, stay with the corporation, but may be carried forward. This is nice, but isn’t particularly useful if you are generating income otherwise (other businesses, earned compensation, etc.) The S-Corp allows losses to flow through to the shareholders, which can then utilize these losses to offset other income.

6. Save on payroll taxes - As noted in number 2 above, many taxpayers pay themselves a salary higher than they normally would in order to get the cash out of their C-Corporation and to avoid having to pay the corporate level tax. In this scenario, the taxpayer is paying 12.4% (6.2 employee, 6.2 employer) for social security on approximately the first $95,000 of wages plus 2.9% medicare on the total wages paid. If you were an S-Corp you might pay yourself a more reasonable wage, say comparable what you might pay an outsider and save yourself up to 15.3% in employment taxes by taking the resulting corporate profits as flow through income.

7. Keep the cash basis of accounting - C-Corporations that exceed $5million when applying the average annual gross receipts test (Is your accountant monitoring this every year for you?) are required to convert to the accrual basis of accounting. This could result in a huge change in taxable income, expecially in the first year. In this scenario, an S-election could save you and the use of the cash basis of accounting, particularly in light of IRS Revenue Procedure 2002-28, which provides for safe harbor provisions.

8. Is your C-Corporation a QPSC or a PSC? If so an S-Corp may be for you.

In many small businesses TLB has found that the S-Corporation is the preferred corporate entity and just seems to make the most sense. Of course there may be reasons one would want to operate as a C-Corporation - sounds like a future post. As always, please consult with TLB on any and all of these issues, before taking action, to determine the ramifications of an “S” election (i.e. the built in gains tax) and to plan accordingly.

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.