Not all tax issues are black or white. What determines the tax treatment of a transaction is its form and substance.
With proper planning, a potentially unfavorable tax outcome can become favorable by modifying the form of the transaction without altering its substance.
Planning is critical. It may seem like the tail wagging the dog, but the tax consequences of a transaction or business plan can make or break the deal.
- The deductibility of losses passing through a partnership, limited liability company, or S-Corporation is limited by your basis. Your basis may or may not include your share of the entity’s debt, depending on the entity form. You may be able to treat a portion of qualified nonrecourse debt as basis. A refinancing of qualified nonrecourse debt could trigger a loss of basis resulting in income recognition. You need to plan.
- Your accrual basis corporation may accrue but not pay compensation or bonuses to you at the end of the year. The deductibility by the corporation and taxability to you is affected by your ownership threshold. Additionally, personal service companies are subject to a different set of rules. You need to plan.
- Substantial prepayments of income to you for services to be performed in future periods may be immediately taxable or may be spread over the year of receipt and following the year of receipt. You need to plan.
- Private clubs and other not-for-profit business may jeopardize their tax exempt status if their unrelated business taxable income exceeds a certain percentage. The measurement of and recordkeeping for unrelated business income is critical. You need to plan.
Upon the formation of a business, the entity form will often determine if and how tax benefits are utilized or lost.
The bottom line, planning is preventive medicine. A review of goals and objectives, a forecast of expected operating results and the appropriate transaction or entity structure will produce the best possible outcome.