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Posts on Jan 1970

Jury Duty Scam

In a recent post we talked about the new Paso Robles Courthouse and the state of the art facilities it provides for jurors who are called, in large part, from the North County.  Jury duty is a civic responsibility and avoiding this duty presents the potential for serious consequences.  Playing on people's sense of civic duty, and always looking for a new way to scam people, identity thieves have recently increased the use of a scam in which they make phone calls posing as court officers, claiming that people have failed to appear for jury duty and face the potential for arrest.  When concerned citizens legitimately protest that they never received a jury summons, the scammers ask for personal information including birthdates and social security numbers for "verification" purposes.  Provide this information and you've become a victim of identity theft.  Here is an FBI warning from a few years ago about the scam.  Do not give out your personal information to anyone unless you are certain you are dealing with someone with a legitimate need for the information who will keep it confidential.

– Posted by Michael M. McMahon, Attorney at Law

mmcmahon@carnaclaw.com

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Business Enity Choice in California

Under California and Federal taxing statutes, which business entity offers the greatest flexibility, and possibly the greatest tax savings?

Short Answer

            Obviously there are numerous issues presented to businesses, not the least of which is how to maximize tax savings. One must always weigh all issues presented in choosing a given business entity form. With that in mind, this memorandum will highlight the benefits offered through use of an S corporation and LLC, taking into consideration California Taxes, Federal Self Employment taxes, and formerly proposed regulations concerning limited partnership treatment for certain non-participating members of an LLC with respect to such self employment taxes.

S Corporation v. Limited Liability Company

California Taxes

            Limited Liability Company:

·        A California operated limited liability company and S Corporation are subject to an annual franchise tax of $800.00. (However, please note that an S corporation is not required to pay the $800.00 fee in its year of incorporation where an LLC must pay the $800.00 in its year of organization)

·        In addition, LLC’s taxed as partnerships (Generally, any multi member LLC reports as a partnership) must pay an additional entity level tax based on the total income reportable to California for the tax year. Cal. Rev. Tax Code § 17942.

o   Total income is measured by taking the LLC’s worldwide gross income and adding the costs of goods sold, paid or incurred in connection with the business, otherwise known as gross receipts. Cal. Rev. Tax Code § 24271 (Referencing IRC § 61 as controlling). Such tax or fee ranges from $900 – $11,790 as indicated in the following table:

 

Total Income from all sources    

 Fee

Over $250,000, but less than $499,999

$900

$500,000 or more, but less than $999,999  

$2,500

$1,000,000 or more, but less than $4,999,999

$6,000

$5,000,000 or more    

$11,790

            What does this mean? Basically, it means that a California LLC is taxed on its GROSS RECEIPTS in the manner provided in the table above.   

            S Corporations:

In order to make an election to be treated as an S corporation, the following requirements must be met:

*  1. Must be an eligible entity (a domestic corporation, or a limited liability company).

*  2. Must not have more than 100 shareholders.

*  Spouses are automatically treated as a single shareholder. Families, defined as individuals descended from a common ancestor, plus spouses and former spouses of either the common ancestor or anyone lineally descended from that person, are considered a single shareholder as long as any family member elects such treatment.

*  3. Shareholders must be U.S. citizens or residents, and must be physical entities (a person), so corporate shareholders and partnerships are to be excluded. However, certain tax-exempt corporations, notably 501(c)(3) corporations, are permitted to be shareholders.

*  4. Must have only one class of stock.

*  5. Profits and losses must be allocated to shareholders proportionately to each one's interest in the business.

If a corporation meets the foregoing requirements and wishes to be taxed under Subchapter S, its shareholders may file Form 2553: "Election by a Small Business Corporation" with the Internal Revenue Service (IRS). The Form 2553 must be signed by all of the corporation's shareholders. If a shareholder resides in a community property state, the shareholder's spouse generally must also sign the 2553.

The S corporation election must typically be made by the fifteenth day of the third month of the tax year for which the election is intended to be effective, or at any time during the year immediately preceding the tax year. Congress has directed the IRS to show leniency with regard to late S elections. Accordingly, often, the IRS will accept a late S election.

Some states such as New York require a separate state-level S election in order for the corporation to be treated, for state tax purposes, as an S corporation.

If a corporation that has elected to be treated as an S corporation ceases to meet the requirements (for example, if as a result of stock transfers, the number of shareholders exceeds 100 or an ineligible shareholder such as a nonresident alien acquires a share), the corporation will lose its S corporation status and revert to being a regular C corporation

Taxation of S Corporation:

·        Subject to a California tax of 1.5% net income.

·        Net income is generally defined as gross income less any and all costs of doing business.

EXAMPLE: As you may imagine, the $500,000.00 in gross receipts results in substantially less net income. Assume for every $500,000.00 in gross receipts, the company nets $200,000.00 of income. The Company would than owe the state of California 1.5% of the $200,000.00 or $3,000.00.

Side By Side Comparison of S Corporation v. LLC

EXAMPLE 2: Instead of using the above 40% profit margin, let’s determine California tax owed for both an LLC and an S corporation based on a more realistic 15% profit margin Comparison (please remember, LLC franchise tax of $800.00 is in addition to the amounts shown below):

Gross Sales 

Net Income  

LLC Tax

S Corporation Tax

$200,000

$30,000

$0   

$450

$275,000

$41,250  

$900 

$618.75

$600,000

$90,000 

$2,500 

$1350

$900,000 

$135,000 

$2,500 

$2025

$1,200,000

$180,000

$6,000

$2700

$6,000,000

$900,000

$11,790

$13,500

  • Clearly, for smaller businesses, there is a distinct advantage to using the S Corporation from a California Tax perspective.

  • Please note, however, that as sales increase, the LLC Tax owed to California is capped at $11,790.00. While such amount is assumedly raised pursuant to inflation on a regular basis, the tax owed by an LLC will always be capped, that is never subjecting the gross receipts to a percentage tax.

  • By contrast, there is no cap on the amount of net income subject to the 1.5% California S corporation tax.

Treatment of Self Employment Taxes

            The self employment tax is an additional tax of 15.3% levied on income up to $94,200.00 and 2.9% on all income in excess of $94,200.00. In general, the measure of tax is all income derived from a trade or business. When dealing with pass through entities, however, such distinction is blurred, and the tax code does little to clarify.

S Corporations

            An S corporation is a pass through entity. Consequently, all income of the corporation is passed through to the shareholders on their K1’s and reportable on their respective individual returns. When, however, the shareholder is actively involved in the trade or business producing the income, some portion of that income is subject to self-employment tax.

            Under the rules governing S Corporations, only amounts received as compensation for services rendered are subject to the self-employment tax. Accordingly, only those amounts specifically paid as a salary are subject to self-employment tax, leaving all other income passed through free from self employment tax liability. 

            After abuses were discovered, the IRS began to closely scrutinize salaries paid to S Corporation Shareholders to determine whether they were reasonable. Generally the facts and circumstances surrounding the business control; however, some guidelines are:

  • Salaries generally paid for comparable positions; and

  • Amount of retained earnings that are passing through to the shareholder as a “dividend;”

Once a S corporation shareholder receives his/her “reasonable salary,” all other amounts (referred to as both dividends and distributions) are reportable on his or her individual return as ordinary income, and subject only to federal and state income tax rates. Clearly an S Corporation with substantial earnings could save a tremendous amount of tax dollars by paying only a “reasonable salary.” 

Limited Liability Companies

            The self employment tax treatment of members of LLC’s is a gray area of tax law. One generally accepted rule states:

  • Managing members are taxed like general partners, that is his or her entire distributive share is subject to self-employment tax, not just amounts received as compensation for services;

The treatment of non-managing members, however, is ambiguous at best.

            In 1997, the IRS issued proposed treasury regulation 1.1402(a)-2. During this time, there was disagreement as to the treatment of Limited partners in partnerships; therefore, Congress refused to allow the IRS to finalize any rules regarding non-managing members of LLC’s believing it was within Congress’s purview to issue such rules.

            As is generally the case, Congress failed to issue guidelines, and the proposed regulation was obviously never codified. However, it does offer the only administrative guidance regarding treatment of non-managing members for self employment tax purposes.

            Basically, Treas. Reg. 1.1402(a)-2 treated members of an LLC as limited partners unless they met one of the following tests:

  1. They have personal liability for debts or claims against the partnership or LLC;
    1. Obviously this effectively removes professionals from garnering beneficial self employment treatment;
  2. They have authority to contract on behalf of the partnership, or LLC; or
  3. They participate in the partnership’s trade or business for more than 500 hours during the partnership’s tax year.

Consequently, while not entirely clear, a non-managing member not meeting any of the above criteria could receive his or her distributive share free from self employment tax liability.

Possible Safe Harbors for Failing one of the Above Conditions:

If an LLC member fails the limited partner test because that member participates in a nonprofessional LLC for more than 500 hours during the tax year, Proposed Treasury Regulations section 1.1402(a)-2(h)(4) allowed that member to be taxed as a limited partner/non-managing member for self employment tax purposes if he or she:

 (1) owns only one class of interest; and

(2) if, immediately after acquiring the interest, the member has rights and obligations identical to those of the other members who are already classified as limited partners and who own a substantial (i.e., at least 20%) continuing interest in that class of interest.

In addition, Proposed Treasury Regulations section 1.1402(a)-2(h)(3) allowed an LLC member of a nonprofessional LLC who fails one or more of the limited partner tests, but who holds more than one class of interest, to be treated as a limited partner with respect to a particular class of interest if, immediately after acquiring the interest, the member has rights and obligations identical to those of the other members who are already classified as limited partners and who own a substantial (i.e., at least 20%) continuing interest in that class of interest.

All references researched seemed to indicate substantial confidence in taking the positions stated above when filing a return for a non-managing member of an LLC. However, there exists no clear guidance on how the IRS will treat such positions if audited. So, taxpayer must still be advised of possible risks.

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Floral Arrangements 6-15-09

DSCN2316 DSCN2320 DSCN2309 DSCN2313 DSCN2318 DSCN0713  DSCN0708 DSCN0707 DSCN0704 DSCN0701 DSCN0699
 
– Posted by Timothy J. Carmel, Attorney at Law

tcarmel@carnaclaw.com

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The Paso Courthouse Update

The Paso Robles Courthouse opened amid speeches by state, local, and court officials in November, 2008.  As some of those officials noted at the opening, the beautiful new facility replaced a dated facility that was stretched beyond its limits from the day it opened.  The new courthouse is the product of years of dreaming, planning, and the hard work of obtaining funding.  It is a facility that reflects the rapid growth of the North County, intended to serve the interests of North County residents and business people.

Paso Courthouse Overview

As a firm that devotes a substantial portion of its practice to civil litigation, we were happy to learn that the court decided to devote the other Paso department to the civil calendar.  New North County cases are to be filed at the Paso Robles Courthouse, while North County cases filed before the opening of the new courthouse have frequently been reassigned to the Paso Courthouse in connection with case management proceedings.  Judge Roger Picquet currently sits in the civil department in the Paso Courthouse.

From a personal perspective, we were pleased to learn that one courtroom in the Paso Courthouse was to be devoted to family law.  Family law proceedings can be particularly emotional for those involved and frequently require parties, including children, to appear in court.  With proceedings taking place during regular business hours, these appearances can be difficult for those who work or attend school during court hours.  Although the presence of the Paso Courthouse does not eliminate the need for such appearances, it does make attending easier for North County participants who work or attend school north of the Cuesta Grade.  The family law department is run by Judge Burke, who long held the family law assignment in San Luis Obispo.

In addition to two courtrooms, the Paso Courthouse is equipped with a clerk's office for filing and review of court papers, conference rooms, space for a mediator and family law facilitator, and a third hearing room that doubles as a jury assembly area.

Civil Operations to Date

With the courthouse having been open long enough to allow some of the kinks to be worked out, we were curious about the court's perspective on whether the Paso Courthouse has so far met expectations.  We were also anxious to find out what has been happening in the civil division of courthouse on a daily basis since its opening and decided the best place to start was with Judge Picquet.

Having served as City Attorney for Paso Robles while in private practice, Judge Picquet is no stranger to the North County and welcomed the opportunity to visit Paso Robles for something other than a nighttime city council meeting.  We asked Judge Picquet for his observations on the types of cases he hears at the new courthouse and the experience of working in a brand-new state-of-the-art facility.

Judge Picquet finds the new facility to be well-designed and an appropriate setting for court proceedings.  Attorneys, witnesses, and jurors have commented favorably on the new courtroom, which is equipped with monitors and other equipment that allows for easy display of exhibits.

Jurors for the Paso Robles Courthouse are selected not only from the North County but also the North Coast and San Luis Obispo.  However, jurors for the Paso Robles Courthouse are not selected from the South County.

Judge Picquet has presided over one jury trial (a personal injury action) and numerous court trials.  A substantial portion of the civil calendar is occupied by commercial and residential unlawful detainer (eviction) proceedings. In what Judge Picquet sees as a reflection of the North County economy, a substantial number of these unlawful detainer proceedings involve owner-occupied residences.  Also reflecting the time and place are numerous cases involving former hard money lenders such as Estate Financial and 21st Century Financial.

According to Judge Picquet, the North County caseload is increasing rapidly because of the way cases have been assigned to the Paso Robles Courthouse.  Although the SLO Courthouse had many existing North County cases, only cases filed since 2008 were reassigned to the new courthouse.  Since the opening of the civil department at the beginning of 2009, North County cases are immediately assigned to the Paso Courthouse.  For this reason, Judge Picquet expects the Paso civil department to catch up quickly with SLO.

Conclusion

Considering the poor conditions of many courthouses throughout the state, we in the North County are truly fortunate to have this beautiful yet functional new facility.  We encourage anyone who has not seen the new courthouse to take some time to visit.  Meanwhile, we will keep posting occasionally about developments at the courthouse.

– Posted by Michael M. McMahon, Attorney at Law

mmcmahon@carnaclaw.com

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Taxing your healthcare benefits in order to fund healthcare. Sounds circular to me.

Apparently, Congress has put forth the “stellar” idea to remove the tax exemptions that are synonmous with employer provided healthcare (Article).
Although there is a long history of taxing benefits that do not result in cash in hand, this proposition is absurd at its inception. Next Congress might try and determine how much money a person saves on an FSA and tax him or her on that as well.

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Pursuant to IRS Circular 230, the Internal Revenue Service requires us to inform you that any tax advice included herein is not intended or written to be used, and it cannot be used by any taxpayer for the purpose of avoiding penalties that may be imposed by the IRS on the taxpayer. That said, please do not hesitate to contact us if you have any further questions regarding this matter.

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