Nov 16th 2011
Speaking of federal tax changes, “This year has brought us some real doozies,” says Vern Hoven, CPA, EA and CPE Link instructor, who specializes in demystifying tax legislation.
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In the continuing Tax Update Adventures, our hero, Super Tax Preparer snatches a businessman with more than 50 businesses from the jaws of tax disaster! How? By helping him take advantage of the tax relief provisions provided under the passive loss regulations.
Our businessman, let’s call him Mr. Benjamin, owns or partially owns real estate investment properties; interests in convenience stores, gas stations, and restaurants; gasoline-hauling trailers; and an airplane. He purchases and develops properties and leases them to Benjamin Management, Inc., which manages the day-to-day business operations through on-site managers. Benjamin is a 44.9% shareholder, and president, of Benjamin Management. If Benjamin elects to treat each separate business as a single activity, he will create extensive taxable rental income for himself as a landlord while simultaneously creating large nondeductible passive losses as the tenant! Both ways, he loses and the IRS wins. Benjamin’s use of multiple entities in which to operate his various businesses is very common but, as “Super” knows, it can lead to a disastrous tax result.
The worst case scenario: all his businesses that are profitable create “active” income and all his businesses that are generating losses create nondeductible losses, with no offsetting between the activities allowed!
What can Benjamin do? To avoid the passive loss rules, he’d have to “materially participate” in each activity to the tune of 500 hours at each of his 50 businesses. An impossible feat! OR he may aggregate, for passive loss purposes, two or more activities reported separately elsewhere on his tax return, into a single business activity.
“Super” knows that taxpayers now must annually report their groupings and regroupings of business activities to the IRS. But deciding how many different businesses to report on the Passive Activity Form 8582 is critical. “Defining separate activities too narrowly, or too broadly, can either lead to evasion of the passive loss rules or, more tragically, make it impossible for taxpayers to take advantage of the relief provisions available to them,” says Hoven.
There are about 140 million tax filers in the United States and this has been just one more of their stories.
Next, in Episode III of The Tax Update Adventures, Super Tax Preparer tackles Business Tax changes, Federal Payroll changes and Business Retirement Plans.