By Andy Biebl
DTN Tax Columnist
In last month's column, I focused on troubles that can arise with do-it-yourself tax filings and interactions with the IRS. Here are more, but this time focusing on business transactions that can create tax havoc.
FAMILY TRANSACTIONS WITHOUT FORMALITIES
Many will rent land from neighbors on a handshake. But with unrelated parties, there's the expectation that each is protecting his or her economic interests by dealing at arm's length. When you transact with family members, however, the IRS may question the bona fides of the deal. Is it really a rent payment, or is there a gift or a payment for services built into the deal? And is the salary to Junior a payment for actual services or simply a parent supporting a child? You can bolster your position not only by keeping the economics in line but also by following formalities such as written employment agreements, regular recording of hours worked, written leases and, of course, proper 1099s and W-2s.
SUBSTANCE OVER FORM
Merely putting a label on a transaction can be nearly meaningless if the IRS finds that it doesn't match the economic realities. An example would be calling a futures account a hedge when the positions you took are not price protection but speculation. The economic realities will trump the label every time.
THOSE VACATION-RENTAL CONDOS
Most popular vacation destinations have brokers selling "The Package": Buy a vacation condo, put it in their rental pool, get a nice tax loss and enjoy the dwelling personally when it's not rented. In many cases, the economics are questionable (think high management and association fees), but the tax rules are more severe. If you exceed 14 days of personal use in a year, the tax law limits the loss to zero. And if you do keep the personal use at two weeks or less, the passive loss restrictions typically defer any rental loss.
THE SELF-DIRECTED IRA
Self-directed IRAs are great if it simply means that you're managing the mix of investments. But beware of the promoter who suggests that you can pull $500,000 out of your retirement plan to acquire business property in an IRA. The self-dealing and prohibited transaction rules are fraught with danger. A small misstep can cause the entire retirement plan to become taxable.
BUYING A "TAX SHELTER"
Buying tax deductions is so 1970s. The Tax Reform Act of 1986 created the passive loss rules. Unless you personally participate in a business activity for at least 500 hours, any tax loss must be deferred. And rental activities, such as equipment leasing, are automatically cast as passive. There are legitimate investments that can produce tax benefits, although today, it's generally in the tax credit area (low-income housing credits, certified historic rehab credits, energy credits). The same passive restrictions are often a barrier with these credits. The fees and the underlying economics of these deals also need careful examination.
EDITOR'S NOTE: Andy Biebl is a nationally recognized CPA and tax principal who specializes in agriculture with CliftonLarsonAllen LLP in Minneapolis and New Ulm, Minnesota. He writes tax columns for DTN and its sister publication, The Progressive Farmer magazine. To submit questions for future columns, email [email protected]. Subscribers can always find Biebl's columns in Town Hall, on the Farm Business page or online using the Search feature under News.
(MZT/AG)
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