Capital Gain Deferrals with Installment Sales

Preface: Installment sales, when convenient and permissible, can defer payments on capital gains tax. Talk with your CPA if you are selling property that qualifies for an installment sale to determine if it is right tax plan for the deal.

Capital Gain Deferrals with Installment Sales

Credit: Donald J. Sauder, CPA | CVA

Thinking of selling property with owner financing? Maybe you’re optimized tax plan is an installment sale–a sale of property that occurs when one or more payments occur after the tax year of ownership transfer, and gain is deferred. Deferral is the key word here. If a sale qualifies for an installment sale gain recognition, the deferred gain must be reported with installment sale methods unless your tax accountant elects out of the installment method on the sale in the initial year of filing.

Here’s how an installment works. Suppose Marvin sold his Selingsgrove farmland to Will for $2 million, to be paid in equal installments over 10 years, plus interest. Let’s say Marvin’s basis in the farmland was $1 million, and the deed was mortgage free. Marvin would receive a payment for $200,000 in the first year of sale and prorate his capital gain over the 10-year payment period. This would therefore result in stretching the deferral of tax payments on capital gains of $1 million ($2 million sale price minus $1 million basis). Marvin would report the sale of property on IRS Form 6252 with the following parameters: on IRS Form 6252, Marvin’s CPA would report the sale with a description of the property and selling price, and calculate the gross profit with the contract price ratio for the gain percentage on the installment sale (50% = $2 million/$1 million). In this example, would report $100,000 (50% of $200,000) of capital gain on his tax return in the first year of sale, versus $1 million. This would reduce his tax burden from $250,000 of capital gains tax in the year of sale to say only $25,000.

Now let’s look at depreciation recapture if the property had a $1 million building. All depreciable installments sales must report the depreciation recapture in the year of sale. If Marvin sold the farmland with a building with Section 1250 Property, buildings such as a barn or house, and the depreciation accumulated on the building was $200,000, Marvin would need to pay tax on the entire depreciation recapture of $200,000 in the year of sale. This is income recapture reported on IRS Form 4797.

Special caution: if you sell property with payment from an irrevocable escrow fund for the remaining payments, the gain must be reported and capital gains tax paid in the year of sale because payment is guaranteed.  Installment sales to related parties with depreciable property is permitted only under the exception that no benefit will be derived from the sale.

In certain instances, partnership interests can be sold with the installment sale methods as a single capital asset. The gain or loss on accounts receivable and inventory will be deferred, but the ordinary income or loss and depreciation recapture will be taxed in the year of sale. The capital assets such as goodwill can be sold on the installment basis with deferred gain. To optimize tax planning, talk with your CPA before beginning to sell your business.

Installment sales cannot be used for sales of inventory, dealer sales, stock or securities traded on an exchange or installment obligations, such as a purchaser’s obligation to make future payments that can be in form of notes, mortgages, or other evidence of debt.

In summary, installment sales, when convenient and permissible, can defer payments on capital gains tax. Talk with your CPA if you are selling property that qualifies for an installment sale to determine if it is right for the deal.


Professional Employer Organizations and Your Business

Preface:  Professional employer organizations permit an option for businesses to outsource the human resource functions of their business. Read further to learn why a professional employer organization benefits certain enterprises. 

Professional Employer Organizations and Your Business

Credit: Donald J. Sauder, CPA | CVA 

As an employer, you understand the various responsibilities of hiring, keeping, and managing your workforce. The human resource responsibilities can require more time than many business owners should give. Professional employer organizations are co-employer organizations that perform the human resource function for businesses; they are an outsourcing of the responsibilities of human resources.

Professional employer organizations rules differ from state to state, but are similar. There are more than 800 professional employer organizations in the United States, with more than two million employees participating.

With a professional employer organization your business has no responsibility for payroll filings, benefit packages, and tax reporting of forms 941 or W-2. Professional employer organizations can often obtain better rates than a mid-size employer when shopping for benefits packages. Professional employer organizations also keep your business in compliance with federal workplace legislation.

Some states recognize professional employer organizations as co-employers, assuming responsibilities for legal rights and duties of employees at the employees’ working location. These states also make your business responsible for any unpaid payroll taxes not funded to the IRS. So if you use a professional employer organization, check them out thoroughly. Request their audited financial statement to assess the financial strength of the organization and interview management to gain the level of trust necessary for a good outsourcing relationship.

Specifically, professional employer organizations handle only the human resource function– payroll, tax and workplace compliance, and record keeping. The client company is still in charge of managing employee responsibilities, on-site supervision, and tools for employees; the employees are outsourced for human resource management only. Professional employer organizations permit your business to have a professional human resources department even if you are only a small business, but you will pay a premium on your leased labor for this benefit. Businesses that contract with professional employee organizations think this additional cost is a wise expense. The main difference to your employees is the name on the W-2 for tax filings.

One specific benefit of professional employee leasing organizations is in specialty employment tax areas, such as FICA taxes. Employees who are exempt from social security tax for religious reasons may be subject to FICA taxes if working for an employer. A specialty professional employee leasing organization structured for this exemption from FICA tax may permit the employer to save the FICA payment to the IRS and permit the employee to keep the savings, too. This can be a combined tax savings of 15.2% per year on wages up to the social security tax limit. The cost to involve a qualifying professional employer organization is small compared to the combined benefit to the employer and employee.

If you think a professional employer organization may be a fit for your company’s human resource management, talk with your trusted tax advisor. Compare the additional expenses and the dollar savings on reduced administrative burdens.

In summary, professional employer organizations permit an option for businesses to outsource the human resource functions of their business. These organizations handle payroll filings, tax compliance, record keeping, and compliance with federal workplace rules. Some businesses can benefit from professional employer organizations. Talk with your tax advisor if you have interest in this option for your business.

Where Will Ideas Lead Your Marketplace?

Preface: Most good ideals are the result of building on existing ideas or working together via collaboration to develop ideas. Good ideas take time and energy to develop. Good ideals lead to great ideas.

Where Will Ideas Lead Your Marketplace?

Credit: Donald J. Sauder, CPA | CVA

Innovation will always be with us. Insights leading to extraordinary developments in civilization have been occurring before the day a group of men built a truly preposterous boat called the Ark. The Ark was a fabulously good idea in its time, but so innovative that it drew ridicule towards the one in charge of building it. The first lesson to learn from history–when someone has an idea you think is preposterous, don’t ridicule them. Instead, say something like, “That is a unique idea.”

Good ideas take time to become great ideas. In 1799 Sir George Cayley presented the first design for a fixed-wing aircraft. Numerous attempts were made to implement Sir George Cayley’s idea during the next century. On December 17, 1903 in Kitty Hawk, North Carolina, Wilbur and Orville Wright made the first controlled, sustained power flight. This led to the development of aircraft into a useful means of transportation.

Airplanes have developed significantly since 1903. Today billionaires fly in private Boeing 757s with a $100 million price tag. If that isn’t surprising, consider Saudi Prince Al-Waleed Bin Talal’s “Flying Palace,” a specially-designed luxury Airbus A380 for $500 million. Sir George Cayley’s idea in 1799 has followed a path of incredible innovation to today. Where will innovation lead in the next century for your marketplace?

Let’s bring this to a practical level. Most good ideas are the result of building on other ideas or working together to develop ideas. Good ideas take time and energy to develop. Good ideas lead to great ideas. The idea for the Ark came to Noah for a reason, and he put all his energy into implementing that idea, just like Wilbur and Orville Wright put all their energy into their building and flying an airplane.

Microsoft isn’t a business developed from a flash of insight. Years of tinkering with mainframe computers in high school led Paul Allen and Bill Gates to see what computers could do in a developing world. A vision developed over time–a computer on every desk and in every home, with Microsoft software, of course. Microsoft was incorporated on April 4, 1975.

In 1977, Ken Olsen is famously quoted, “There is no reason for any individual to have a computer in his home.” An engineer who co-founded Digital Equipment Corporation in 1957, Ken helped build computerized flight simulators and was an accomplished pilot, a very intelligent entrepreneur and engineer. Ken was named by Fortune magazine as America’s most successful entrepreneur in 1986. Avoiding fancy trappings, he kept a simple office in an old mill building, and when his staff built a modern and lavish office he refused to use it. In 2011 he was listed as #6 on the list of top 150 innovators and ideas from MIT. When you think about innovators in the computer industry, however, Olsen probably isn’t a name that comes to mind. But his ideas were key to developing the technology innovation that spurred Microsoft’s vision.

Microsoft believed in ideas such as flight simulators being so commonplace that they could be used for young people’s entertainment. Microsoft developed ideas that people like Ken Olsen engineered years earlier.

Consider the innovation in the agriculture industry in the recent century, from plows to no-till drills; or communication and mobile phones; and yes, there is more innovation in science laboratories and on CAD (computer-aided design) software files for the future. Where will those ideas lead your marketplace?

In summary, have a great vision and purpose for your business. Strive to further that purpose and vision every day, because future innovative ideas are sure to take your business industry to places which today you may think are impossible.

Flagstone Crossings To Lower Taxes: What Entity is Right (Segment III)

Preface: Selecting the right entity car for optimized taxes is complex. Appropriately choosing an entity for your business, that will support a lower tax burden often requires collaboration with your tax advisor. Flipping a coin is not advised.

Flagstone Crossings To Lower Taxes: What Entity is Right (Segment III)

Credit: Donald J. Sauder, CPA | CVA

Partnership entities are an association of two or persons taxed on a Form 1065 for Federal purposes. They can be general partnerships, limited partnerships, or multi-member LLC’s. The organization is a pass-through entity that does not pay income tax at the entity level but instead passes the profit and losses through to the company’s “partners” on a Form K-1 that is filed with the individual 1040s.

Partnerships vehicles provide flexibility to the allocate income, ownership, voting rights, and provide multi-owner features without the tax incorporation features. Partners received guaranteed payments for services instead of a W-2 as from a corporation. Ordinary income from the partnership is often subject to FICA taxes on the individual partner’s 1040 if they are active in the company. For tax purposes, this is a significant tax characteristic and decision maker between an S-Corporations and multi-member LLCs.

General partnerships are easy to setup, but often not advised since there is easier affordable liability protection with a multi-member LLC. General partnerships, however, permit an increased ability to raise capital, but because both debts and liabilities are attached to partners, hold certain risks.

Multi-member LLC’s are often considered a hybrid of a partnership and corporation. Since the profits pass through to members on a Form K-1, the tax benefits are often appreciated. Also, members have limited risk with liability on debts and the investment; they can also participate in management, permit corporations and partnerships to be members, and do not have restrictions on the number of active or inactive members.

Partnership tax flexibility and conventional attributes are a commonly debated tax topic among advisors. One such feature is treating partners as employees.

Quoting from Noel Brock’s 2014 article:  Treating partners as employees: Risks to consider

This error can have many tax consequences, not the least of which is the mistaken tax treatment of the partner’s income as wages subject to Federal Insurance Contributions Act (FICA) taxes under Sec. 3101, Federal Unemployment Tax Act (FUTA) taxes under Sec. 3301, and income tax withholding under Sec. 3402 (called employment taxes in this article), instead of self-employment income subject to self-employment tax under Sec. 1401 (Self-Employment Contributions Act (SECA)), which is not subject to wage withholding.

When Congress enacted the 1954 Code, it provided that a partnership could be an aggregate of its partners or a separate entity. Where no view of partnership taxation was adopted by a given Code provision, the view that was “more in keeping with the provision” should prevail. One Code provision that treats a partnership as a separate entity from its partners that was adopted in the 1954 Code is Sec. 707(a). It provides that, if a partner engages in a transaction with his or her partnership in other than his or her capacity as a member of the partnership, the transaction will, except as otherwise provided in Sec. 707, be treated as a transaction occurring between the partnership and one who is not a partner. Sec. 707(a) introduced the possibility that, given the right circumstances, a partner may hold the dual status of partner and employee in a single partnership.

Of note, is the numerous state Departments of Revenue that are now also looking at this tax perspective of employees as partners with increased scrutiny. The risks are substantial for established partnerships. Appropriate tax counsel and awareness of any tax risk are advised.

Selecting the right entity for your business startup is a tax decision that could include unknown long-term ramifications for any business owner. Say, partnerships, LLC, Corporation or sole proprietor? Agreed, Saint John Paul the Great said it well “The future starts today, not tomorrow.” 

This blog is only a summary of the pertinent features to tax planning for entity selection. Getting it right is not as easy as it seems because tax laws are complicated. Making the best decision for your business, that will support a lower tax burden requires collaboration with your tax advisor. Flipping a coin is not advised.