Form 3115 Frame Home Builder

Technical topics regarding tax preparation.
#21
Nilodop  
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I agree with the result you outline in #16. No idea as to the 3115.
 

#22
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Just about anything would be preferable to paying taxes on the face value of the notes. Distributing or selling to a related party is a simple transaction. There is little or no expense and the numbers involved easily justify the hassle factor.

The best option would be to arrange an installment sale of the business to a controlled buyer, which would kill two birds with one stone -- solving the AMTP acceleration problem and converting much future income to LTCG. And the AMTP problem provides a reason to do the transaction!
Steve
 

#23
Nilodop  
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No one is suggesting paying taxes on the face value oft he notes. I don't even think there are notes. Just accouns receivable.
 

#24
anepcar  
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The company does create loan document for every buyer purchasing a frame home. He has tried selling and factoring these loan but had no success due to the credit rating from the borrowers.

Steve

Can you elaborate more on your best option approach, I never had any such exposure with any client.
 

#25
sjrcpa  
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If taxpayer uses the accrual method and reports the full sale price and then customer doesn't pay, he gets a bad debt deduction.
 

#26
Nilodop  
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If taxpayer uses the accrual method and reports the full sale price and then customer doesn't pay, he gets a bad debt deduction.
Or, more fully,
[i]If taxpayer uses the accrual method and reports the full sale price and then customer doesn't pay, he prepays the tax without having the cash to do so and then he gets a bad debt deduction.[/i]
Or, preferably, and OP's plan,
If taxpayer uses the cash method and, in reporting the sale price he values the note at its fmv, he only pays tax on that cash and very low fmv unless and until more cash is received (i.e., payments on the notes).
 

#27
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Assume S corp sole SHH and unrelated party (key employee, son-in-law) form NEWCO, LLC, with SHH getting less than 50%, and an S election is made. SHH is Manager with unanimous consent to remove. NEWCO buys assets for long-term, low-interest note (i.e., an LBO). Allocation of price to goodwill converts OI to LTCG via 15-year amortization (197). NEWCO could use a new method of accounting. (This transaction be structured as a stock sale with 338(h)(10) and QSSUB elections.)

The higher the price, the bigger the tax savings. The terms of the note suggest its face would be significantly greater than its FMV, thereby significantly increasing the tax savings.

If the
Steve
 

#28
Nilodop  
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I am seriously interested in following this planning technique. Probably will require several questions to be answered, and I hope others jump in. It almost sounds too good ...

What is the rest of the last sentence in gatortaxguy's post? It starts "If the" and then disappears.

I'll have to re-read OP's posts, but as I recall the whole point of the thread is getting taxpayer (Schedule C, if I recall correctly) to a cash method wherein he can value the notes he receives as payment for his product at their real value, which is way lower than their face value. That way he reports a lower sale price, lower taxable income, and can afford to pay the tax that otherwise is owed on the accrual method. (He'd also avail himself of the favorable treatment of inventory as discussed above).

Going from that to-
Sale of the business;
S corp.;
Valuing the goodwill (is there any?) based on The higher the price, the bigger the tax savings. The terms of the note suggest its face would be significantly greater than its FMV, thereby significantly increasing the tax savings. smacks of inflating beyond reality, at least to me;
Use of tax strategies, such as 338(h)(10) and creating amortizable goodwill, inputting a new owner, going corporate, whatever.

My last point, at least for now. While it does get him to the cash-method goal, it raises some complexities and some risks, which may or may not be worth it. We are not told the taxpayer's age, family situation, financial condition, sophistication, comfort with complexity, comfort with tax risks, willingness to incur initial fees and ongoing compliance costs, etc.

Let's keep the discussion going. The technique suggested has been raised several times, but we should get a better understanding of it, so we can know when and whether to use it.
 

#29
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My experience in negotiations is that cash is valued at, say, double the face value of a long-term, low interest note, especially if unsecured. The point here is that the economic reality is determined by the economic value of the note, not it's face value. In other words, the high price for tax purposes (i.e., the face value of the note) is not abusive if the economic effect is reasonable. (There is also the fact that we're talking about future prospects of the business, which gives some room for optimism, especially if there are plans to increase revenues.)

Simplified (unrealistic) example: cash value of business is five times taxable income. The business is sold in exchange for a 15-year, low-interest note with a face value of ten times taxable income, and all is allocated to goodwill. The goodwill deduction for each of the following 15 years is 2/3rds of this year's taxable income. And there is discretion on the timing of note payments.

The big reduction in taxable income eliminates the reasonable compensation issue as a practical matter -- because distributions are replaced by note payments -- and thus employment tax savings are also achievable. (Combine that with the zero rate on LTCG means the tax savings at the very low end can make a huge difference in the owner's standard of living.)

The basic transaction is a common LBO. As a practical matter it can only be attacked via some judicial doctrine. My consistent experience is that appellate conferees who think they have a slam dunk, but recognize that a judge would ultimately have to decide, will settle for reversing the transaction (or the tax benefits) and relieving the penalties because "You never know what a judge is going to do." That was my experience the first time I tried the transaction. I was trying to do it as a three year deal, which was way too aggressive. I learned my lesson and now generally recommend a 15 year deal.

The odds of success on audit are primarily a function of the story that is told as to the nontax reason for the transaction. So I tend to view myself as a playwright in planning such transactions. The bottom line regarding audit risk is that I view it as a heads-I-win, tails-we-break-even proposition.

Transition is an excellent nontax reason. Incentivizing a key employee is also excellent. If the key employee's interest is subject to a risk of forfeiture and an 83(b) election is made, it's presumably easy to get his stock back in the future, in which event the tax benefits remain, because the later tax consequences are determined by the facts at the time of the sale. That is, it's ok for the owner to later be 100% on both sides.

It's a tricky story, but I've done the transaction for estate planning purposes via declaring a trust fbo a daughter-in-law where the key employee is a son of the owner.

Note also that giving up a majority interest may never make much a difference in many situations, especially if the business is not expected to last beyond the term of the note.

I view the transaction as flexible enough as to justify considering it for just about any closely-held business. It's a matter of adjusting to fit the client's facts.
Steve
 

#30
Nilodop  
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What if any are the non-tax potential downsides to this technique?
 

#31
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The LBO itself is cookie-cutter. The nontax concerns depend on the structure used to maintain control. The planning trick is to identify the downsides up front (i.e., the "what-ifs") and structure so as to balance the remedy for any downside against the quality of the nontax reason to do the transaction. The client will naturally be skeptical, so it requires some work before the client can become comfortable with the structure.
Steve
 

#32
Nilodop  
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I'm asking what are the "what-ifs"?
 

#33
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I don't have a list of what-ifs other than audit. Each structure has its own what-ifs. And the solutions are highly fact specific. It's mostly a matter of answering the client's what-ifs. For example, if it's a key employee, what if the employee quits? If it's an estate planning nontax reason via a declared taxable trust fbo a daughter-in-law, what if they divorce?
Steve
 

#34
Nilodop  
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It's mostly a matter of answering the client's what-ifs. For example, if it's a key employee, what if the employee quits? If it's an estate planning nontax reason via a declared taxable trust fbo a daughter-in-law, what if they divorce?

Exactly what I meant by the ... non-tax potential downsides to this technique ... It's not letting the tail (tax savings) wag the dog (personal/legal issues).
 

#35
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I've rarely seen a situation where the non-tax issues cannot be satisfactorily resolved. The real problem is getting over the initial "too-good-to-be-true" reaction.
Steve
 

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