So you want to get married?

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In a somewhat remarkable ruling the 9th Circuit ruled in the case of Sophy v. Commissioner that unmarried couples living together and both owning the same residence, each get to deduct the entire amount of mortgage interest not one-half. So, let’s say that you have a $1 Million mortgage and the interest was $30,000 for the year. Inhabitant #1 gets to deduct $30,000. Inhabitant #2 gets to deduct $30,000. Now by failing to get married, each would be taxed at single filer rates and there would be no multiplication of exemptions. So, you have to run the numbers to see if this works for your situation. Further, the IRS acquiesced in the decision in AOD 2016-02. Obviously you would lose other benefits in estate taxes, social security survivor benefits, IRA rollovers and otherwise by not being married. Additionally those living in the 7 jurisdictions which adhere to common law marriages, still have to tread carefully that you are not deemed to be married.

That said, the marriage “penalty” just got worse.

Virginia Sales and Use Tax Penalties

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Be alert. The Virginia Department of Taxation has taken the position that if at the end of an audit there is a tax owed a penalty will be assessed under Section 58.1-635. There is a problem with the Department’s logic. The statute reads as follows:

“A. When any dealer fails to make any return and pay the full amount of the tax required by this chapter, there shall be imposed, in addition to other penalties provided herein, a specific penalty to be added to the tax in the amount of six percent if the failure is for not more than one month, with an additional six percent for each additional month, or fraction thereof, during which the failure continues, not to exceed thirty percent in the aggregate.”

This has the conjunctive word “and”. That means that a penalty can only be assessed if the dealer fails to file any return and fails to pay the full tax.

Therefore, the penalty should not be assessed under this section in a situation where a return is filed, is audited, and a tax is deficiency is found. However, the Commissioner has viewed it another way.

What if you won the $1.5 Billion Powerball

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So, you take the cash option of $930 Million. What do you do now?
Let’s say you want to put some into a business, some into investment (including say buying your own tropic island). After taxes state and federal you will have approximately $490 Million left. So, let’s say you invest $400 Million. Assume an average 5% return on investment. At the end of 20 years you’d have $660 Million to play with after taxes.

If instead you took the money and put 1/2 into a Foundation that you controlled, the other half kept, you’d have about $245,000,000 left to invest, etc. However, if you were planning on giving to charity anyway, this allows you to use the money for charitable purposes and it grows tax free which allows more money to go to charity than using aftertax money to make gifts later. At the end of 20 years assuming a modest 5% growth rate, the charitable funds would be worth approximately $930 Million. The $245 Million which you’ve invested would be worth about $392 Million due to taxes on your investment income.

The moral is that if you are charitably minded do it at the beginning. That way, you have instead of $660,000 to give away over time, you have $1.17 Billion to control and of that $930,000 is available to charity.

Hidden Tax Bomb when Selling Your Business

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Let’s say in 2011, your accountant suggested it might be good to elect S Corporation treatment for your business which has been a C corporation for 5 years. You’ve got the hottest bar in town. Its worth $1 Million and you only invested $100,000 which is fully depreciated, but there are good years and bad years and you like the fact that you can deduct losses and avoid double taxation of income by using S. Fast forward to 2015. Porky comes by and wants to buy your name, assets. He’s offering $1.2 Million. You are so excited. Selling these assets would yield a gain at capital gains rates what could be better. Then you talk to your tax lawyer. He says wait. Under Section 1374 of the Internal Revenue Code there is a built in gains tax that looks back 10 years. Thus, if at the time of your S Election in 2011, your business was worth $1 Million, it must recognize that $1 Million at ordinary corporate rates. Thus, instead of the tax being $250,000 on the gain it is $565,000 give or take. A huge difference.

SPIN OFFS

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Suppose you own a corporation MYTABLES, Inc. that manufactures tables. Your company has an opportunity to go into the desk market, but wants to limit its exposure. So, it sets up a subsidiary, DESKO, LTD. MYTABLES, INC., owns all of the stock of DESKO. People love the desks. The Company needs capital to hire more people to make desks. The owners go on the Barracuda Tank and Cube Markan offers to give $1 Million for 18% of the Company, but wants DESKO separated from MYTABLES. So, how do you separate out DESKO from MYTABLES. Under Section 355 of the IRS Code you can do what is known as a spin-off and so long as the DESKO has a different line of business from MYTABLES (they do) and so long as the shareholders of MYTABLES still own 80% of the stock of DESKO, then you can spin off, so long as DESKO and MYTABLES continue in business. There are lots of technical rules under Section 355, but that is the gist of it.