Software Club 210: Light Red/Club_Software_210_Light_Red_Micro_Star_1997.iso/sba/f309.sbe

Text File | 1997-01-01 | 20KB | 559 lines

@Q01
                ┌────────────────────────────────────┐
                │ ARE LOSSES INCURRED BY MY BUSINESS │
                │ LIMITED BY THE PASSIVE LOSS RULES? │
                └────────────────────────────────────┘

As a general rule, tax losses and tax credits generated by a
business may be used to offset other income of the owner(s)
of the business, in the case of a sole proprietorship,
partnership, of S corporation.  Or, in the case of a C
corporation, such losses or credits may, in many cases, be
used to offset other income of the corporation, such as
portfolio income or active business income.

However, if the losses or credits are considered to be from
"passive activities," there are severe limits on the use of
such losses or credits to offset current income other than
income from "passive activities."

  QUESTION:  Is your business set up as a "C corporation"?
@YN
01\Q02
02\Q11

@Q02

CONCLUSION:  Then you will not be able to offset losses or
credits generated by your corporation against your personal
income.  This is always true in the case of a C corporation,
whether or not the losses or credits it incurs are "passive"
in nature.  The key questions in your case are (1) Whether
your corporation has any "passive" losses or credits and (2)
whether your corporation is considered to be a "personal
service corporation" or a "closely-held C corporation."

(Note:  A "passive" activity, for purposes of the question
below, is a trade or business carried on by a corporation,
where the major shareholders do not "materially participate"
in the activity.  If any one or more shareholders owning
more than 50% of the stock "materially participate" in the
activity, it is not considered a "passive activity.")  (Most
rental activities are automatically "passive.")

  QUESTION:  Does your C corporation generate any losses or
             credits that are from "passive activities"?
@YN
01\Q04
02\Q03

@Q03

CONCLUSION:  Then you do not need to be concerned about
the usability of "passive" losses or credits, since your
corporation does not have any such losses or credits.
Therefore, any losses or credits your corporation generates
from a trade or business should, in general, be allowable as
an offset against income from any other trades or businesses
it carries on, or against "portfolio income" such as taxable
interest or dividend income.

@STOP

@Q04

TENTATIVE CONCLUSION:  Then your C corporation may be
limited, under the passive activity loss rules, in its
ability to currently utilize such losses or credits, IF it
is either:  (a) a "personal service corporation"; or (b) a
"closely-held C corporation."

For a C corporation to be a "personal service corporation,"
the corporation's principal activity must consist of the
performance of personal services.  Personal services would
cover a wide range of activities, including professional
services such as law, medicine, dentistry, accounting,
architectural and engineering services, actuarial sciences,
and the like.  It would also cover areas such as consulting
services, the incorporated professional athlete or
entertainer, and miscellaneous other service businesses,
such as an incorporated salesperson.

  QUESTION:  Does your corporation perform personal
             services as its principal activity?
@YN
01\Q08
02\Q05

@Q05

CONCLUSION:  Your company is not a "personal service
corporation" for purposes of the passive loss rules, and
thus is not fully subject to the passive activity loss
limitations.

However, your company may be a "closely held C corporation"
that is partially subject to the passive loss rules,
depending on its stock ownership.  (See below)

 QUESTION:  Did 5 or fewer individuals (directly or
            indirectly) own more than 50% (in value)
            of the stock of the corporation during
            the last half of the tax year?

@YN
01\Q06
02\Q07

@Q06

FURTHER CONCLUSION:  While your corporation is not considered
a "personal service corporation," and thus is not fully
subject to the passive loss restrictions, it is considered
to be a "closely held C corporation," and thus is partially
subject to the passive loss rules.  That is, it may offset
passive activity losses against its "net active income,"
but not against its "portfolio income."

@STOP

@Q07

FURTHER CONCLUSION:  Your C corporation is not a "personal
service corporation" (within the meaning of the passive loss
rules), and is also not considered a "closely held C
corporation."  This means, if the above conclusions are
both correct, that your corporation is not subject to ANY
of the passive loss restrictions.  Thus, losses incurred by
your corporation on passive activity investments should be
fully available to offset against either portfolio income
or other income ("net active income") of the corporation,
without restriction.

@STOP

@Q08

SERVICES MUST BE "SUBSTANTIALLY PERFORMED" BY SHAREHOLDER
EMPLOYEES:  To be deemed a "personal service corporation,"
the personal services performed by the corporation must be
"substantially performed" by employees who own stock in the
corporation.  To determine whether the services to customers
and clients are "substantially" performed by employee-owners,
the Income Tax Regulations say that more than 20% of the
corporation's compensation expense attributable to its
service activities have to be attributable to personal
services performed by its employee-owners.  If it is clear
that over 20% of the cost of performing services (of the
types described in the previous question) are attributable
to services performed by owners, you should answer "Y"
("YES") to the following question.  If it is clear that less
than 20% of such compensation costs are attributable to
services rendered by employee-owners, then answer "N" ("NO").

QUESTION:  Are the services rendered by the corporation
"substantially" performed by its employee-owners?
@YN
01\Q09
02\Q05

@Q09

STOCK OWNERSHIP REQUIREMENT:  A corporation cannot be
treated as a "PSC" for tax purposes unless employees own
more than 10% of its stock (by value), directly or
indirectly.

  QUESTION:  Do employee-owners own (directly or indirectly)
             more than 10% of the stock of your corporation,
             by value?

@YN
01\Q10
02\Q05

@Q10

CONCLUSION:  It appears from your responses that your C
corporation may be a "personal service corporation" under
the definitions used in the passive activity loss rules
and for determining whether a C corporation is restricted
in its choice of a fiscal tax year.

If so, this means that if your corporation has losses from
"passive activities," it may not generally offset those
losses against its "net active income" (business income,
generally) or against its "portfolio income" (income from
dividends, interest, annuities, certain royalties, etc.).

However, such losses (or credits) can be used to offset
other passive income of your corporation.  Also, when you
finally dispose of a passive activity (by selling off such
a business, for instance), the corporation should than be
allowed to deduct any "suspended" passive losses related to
that activity which it had accumulated over the years, but
had not been able to utilize because of the passive loss
limitations.

@STOP

@Q11

"Passive" losses or credits of unincorporated businesses,
or of S corporations, generally cannot  be used to offset
income of the owners of the business to whom such business
losses are allocated, unless there is passive income against
which such losses can be offset.

Note:  A "passive" activity,  is a trade or business that
is carried on by a business, where you, as sole proprietor,
partner, or S corporation shareholder, do not "materially
participate" in such activity. However, if you, individually,
are considered to "materially participate" in the activity
in question, it is not a passive activity with regard to YOU
(even if it is so, for your fellow partners or S corporation
shareholders).  (Note also that