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A Couple of S Corporations, A Couple of Rental Arrangements, A Couple of Taxpayer Losses

Recently, two Circuit Courts shot down the taxpayers in two cases involving rents and S Corporations.

In the Estate of Stuller, the Seventh Circuit Court of Appeals addressed a Tennessee Walking Horse breeding operation held in an S Corporation. Surprise! The IRS, the District Court, and the Seventh Circuit found that the breeding operation was a hobby.  Among other facts not in the favor of the taxpayer was that the operation lost money for 15 of 16 years.  It made a whopping $1,500 profit one year.  The breeding activity was not conducted in a business-like manner.  No real surprise, so far.

The Stullers’ S Corporation rented property from Mr. and Mrs. Stuller, the rents from which apparently they reported as income. After the Stullers were found by the courts to have a non-deductible hobby in the S Corporation, they sought for the courts to hold that they did not have to report as income the rental payments that they received from the hobby-bearing S Corporation.  They were rebuffed. The S corporation is separate from the owners.  They organized the arrangement and it did not turn out like they wanted.   Tough luck. They picked their poison.

In Williams v. Commissioner, the Fifth Circuit addressed a case where an S corporation rented realty to a C corporation. The Williamses owned all of the stock in both companies.  Mr. Williams materially participated in the business of the C corporation.  The arrangement appeared to be arms’- length and there is no indication that the IRS had a problem with the economics of the deal.  The Williamses reported the rental income in the S corporation as passive income, which, conveniently, was offset by losses in other passive activities.

The Williamses got it all wrong. While the “self-rental rule” is a bit obscure, it is aimed squarely at what the Williamses were doing.  The IRS, the Tax Court and the Fifth Circuit all agreed that under the self-rental rule, they had to classify the rent income as nonpassive income and their passive losses could not offset the related-party rental income.

In both cases, it appears that the taxpayers tried to be a little bit too clever in structuring their activities for tax purposes. In both cases, they got bad results.

VKM

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Make Compensation Tax-Free: The IRS Tells You How

Well, my headline may overstate a little bit the subject matter of a new publication by the Internal Revenue Service. Recently, the IRS issued Publication 15-B, Employer’s Tax Guide to Fringe Benefits. (Click here for full publication).  It is a handy summary of fringe benefits, focusing primarily on twenty types of fringe benefits (and variations thereunder) that are wholly, or partially, excluded from the income from most employees.  Generally, the “excluded” benefits are exempt from income tax and, in most cases, are exempt from Social Security Tax, Medicare Tax and Federal Unemployment Tax.  Table 2-1 on page 6 gives you a concise summary of the primary fringe benefits and the tax treatments.

What fringe benefits, under the appropriate circumstances, might be excluded from the employees’ income? Some of these are pretty well known.  Quickly coming to mind are accident and health benefits; health savings accounts; limited moving expense reimbursements: up to $50,000 of group term life insurance;  and de minimis benefits, such as holiday parties, low value holiday gifts (other than cash), occasional personal use of the copying machine or printer, and occasional meals (within limits).

Some excludable fringe benefits may not be as obvious or as widely provided, but can be quite valuable to employees. Some examples include educational assistance, adoption assistance, dependent care assistance, athletic facilities, retirement planning assistance, commuting benefits, and employer-provided cell phones.

Other excludable fringe benefits are a bit more employer-type specific, such as lodging on business premises, employee discounts, and no-additional-cost services (think airline and hotel employees).

Some employees are not eligible for all of types of tax free benefits. In many cases of these fringe benefits, “2% shareholders” of S corporations and highly compensated employees are limited in their ability to exclude all or part of many of the fringe benefits.  Partners aren’t employees, so they often do not benefit from the exclusions.

Publication 15-B is comprehensive and references many other IRS publications for further guidance.  It is a good read for employers.  It is also a good read for employees who want to convince their employers to help them turn some of their taxable compensation into tax-free compensation.

VKM

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