Cut Costs With A Business Accountant

Small business owner filing 1040 tax paperwork with money saved lining the side

Going into business for yourself can be a lucrative and rewarding venture. However, as anyone who has run a small business knows, it can also be costly. Running a small business comes with a wide array of expenses, not the least of which come from managing the finances. While you may believe that you can save by handling the money yourself, what this will really end up doing is taking up a large amount of your time that could be better spent handling other aspects of your business operations. The more time you spend trying to handle your company’s finances, the less time you can spend on other things; your time is valuable, and you’re trying to cut costs!

Once you are close to having your business up and running, it’s time to consider hiring a small business accountant. Many business owners balk at this idea, due to the fact that hiring an accountant seems like a costly step that they can avoid. However, if you take a step back and look at the grand scheme of things, you’ll find that securing the services of a small business accountant can actually save you quite a bit.
Here are a few ways you’ll save your business money by hiring an accountant:

When Starting The Business

A small business accountant can start saving you money right from the very beginning. One thing you’ll need to consider is your business structure. Will your business be best served by filing for sole proprietorship? Or are you looking for a partnership, or even to start a corporation? Choosing the right business structure for your particular line of work can be critical to saving money in the long run, and a qualified accountant can help you with this.

Once your business gets going, you will of course need to start a business bank account. As with choosing a business structure, you’ll have several options to choose from and your company’s financial future could be at stake. A credible, experienced accountant can give you a lot of help in this area.

Once Your Business Is Up and Running

After your small business accountant has helped you get your business up and running, it’s time to start thinking about managing the day to day finances. Choosing the right finance software can save you a lot of headaches when it comes to keeping track of your income and expenses; this is another thing your accountant can help you with. They can also help train you how to file taxes properly; for example, if your business makes use of independent contractors (as opposed to full on employees), they will need to be classified as such with the IRS. Having a qualified small business accountant can make tax season much less of a nightmare, and help you save money on unnecessary tax expenditures!

As Your Business Grows

Eventually, when all of your hard work pays off and your business begins to grow, you will still find yourself saving money with the help of a small business accountant. If your goal is to reach a certain amount of growth for the year, you will need to budget for that and your accountant will be there to help you create that budget. As your business grows, your costs will go up as you find yourself needing to hire more employees and buy or lease more equipment. Once again, a qualified accountant can be invaluable during this process, helping you to avoid spending any money that you don’t need to.

Hiring an Accountant

With all of the benefits that come along with hiring a small business accountant, now is a great time to start looking for one! Choosing the right accountant, however, can be the true challenge. You will want to vet any potential candidates carefully, making sure they have plenty of experience and all of the proper certifications for your area. Don’t forget to ask for references; you will want to speak to other small business owners who have successfully made use of your potential accountant’s services. Good luck with your future business endeavors!

Why Do I Need A CPA For My Small Business?

Business owner distracted from work with tax forms

As a small business owner, there is a lot you have to take into consideration. The day to day running of your business requires a lot of planning, from licensing and permits to leasing your location and registering all of your company trademarks. Needless to say, a huge part of running any business is the financial aspect, and many business owners find themselves asking the question, “Do I need a CPA for my small business?” Hiring an accountant might seem like something only bigger businesses do, but it’s something you should seriously consider no matter where you are in the growth of your company. Here are a few reasons why:

You Will Save Money

Of course, hiring a CPA isn’t cheap; it can be one of the bigger expenses you incur when you go into business. Even so, securing the services of a good accountant will ultimately pay for itself. First, consider how much time you will spend poring over the finances for your business. Every minute you spend trying to balance your books is a minute that you can no longer devote to other crucial aspects of running a business. If you’re spending hours each day working on tax forms, you aren’t bringing money in. Not only that, you can rest easy knowing that you have a financial expert working to save your company as much money as possible. Even if you yourself are financially savvy, you might find yourself spread too thin as a result of taking on every other job a business owner must deal with.

A CPA Can Help You Deal With The Unexpected

Running a business always come with an element of unpredictability. Especially as your business grows, you may find yourself dealing with problems you never considered. As your business grows, and you hire more employees, contract out more work, order more equipment, and generate more income, a talented accountant will help you to get it all under control. They will also help you deal with any unexpected financial curve balls that may come your way and threaten your business.

An Accountant Will Help With The Legal Aspects

Depending on a number of factors, including your location and the type of business you are running, the laws that govern your company can vary widely. For example, the tax laws you are bound to will depend on what type of business structure you have. Will you be the sole proprietor? Or an LLC? Are you working from home? Or do you operate out of a storefront? But even if you are the sole proprietor of the business, a CPA can help you navigate the tangled web that is local business law. Ultimately, you will need the assistance of someone who is experienced in dealing with businesses of all types and sizes. They can also assist you should you face the unfortunate situation of a lawsuit being filed against your company.

When To Hire A CPA

As a CPA can charge up to several hundred dollars an hour, it’s important to be responsible when securing the services of one. Make sure to thoroughly research anyone you are considering hiring, and ensure that they have all of the proper certifications that a CPA requires. While many small business owners worry that hiring an accountant will be an expense they can’t afford, or force them to relinquish control of certain aspects of their business, the truth is that having a great CPA can increase your savings and your profits while also offering you greater freedom to manage the other aspects of running a business. With all of these considerations in mind, the answer to the question, “Do I need a CPA for my small business?” is almost always YES!

A Primer on Disregarded Entities

Disregarded Entity Tax Reporting Ownership
Disregarded Entities

If you spend a substantial amount of time around tax professionals, there’s a decent chance you will encounter the phrase “disregarded entity” at one point or another. This phrase, fear-inspiring though it sounds, is a fairly straightforward concept which has relevance in a variety of contexts. In this article, we will introduce disregarded entities and explain why you and other HTW readers should be familiar with this concept.

Tax Reporting

Not all business entities are the same. As we have discussed in our webcast on the topic, businesspeople can select between a number of distinct corporate entities depending on which entity best suits their particular situation. Once an entity has been selected, one of the remaining steps is for the owner to determine whether that entity will be “disregarded” for tax reporting purposes. In simple terms, if an entity be disregarded, then it will not file its own separate tax return to the IRS; it is disregarded to whomever is the current owner, and so the current owner will include the financial data of the entity within his or her own return. Disregarded entities, therefore, can be thought of as assets which are fully traceable to the owner, rather than wholly distinct entities.

Only certain corporate entities may be disregarded. For instance, a single member LLC is typically disregarded to the single member unless the single owner specifically elects to treat the LLC as regarded. And so income generated by such an LLC would be included on the owner’s tax return rather than a tax return prepared and owned by the entity itself.

Certain corporate entities can never be disregarded. S Corps, C Corps, and multi-member LLCs in which the two members are not husband and wife in a community property state cannot ever be disregarded and must report income independently.

1031 Exchange Context

Another context in which disregarded entities may show up as an important concept is the 1031 exchange industry. The tax code requires that whichever entity owns the relinquished property in a 1031 exchange must also acquire title to the replacement property. As I’m sure our readers are aware, title to real estate can be held by corporate entities, and so if a regarded corporate entity hold title to real property then this preexisting ownership must kept consistent throughout the exchange. If the entity doesn’t remain consistent then a valid tax-deferred exchange cannot occur.

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Delaware Statutory Trusts Increasingly Popular as Real Estate Investment Opportunities

DST Trust Investment Real Estate Property
Delaware Statutory Trusts

There is a number of ways to hold title to real property. Perhaps the most common way is to hold full title – or “fee” simple title – as an individual or married couple. Title to real property can also be held jointly by multiple corporate or individual persons. One increasingly common means to jointly hold title to an investment property is to use a so-called Delaware Statutory Trust. DSTs are trusts which have been established under the state laws of Delaware and which permit multiple investors to co-own a property and still maintain the ability to freely sell their ownership interest. In a DST ownership arrangement, investors acquire an “undivided fractional interest” in the real property and they are able to dispose of this interest without obtaining the prior approval or cooperation from the other investors. In other words, DST interests are freely alienable, and for this and several other reasons DSTs have become used more and more frequently in tax deferred real estate exchanges under IRC Section 1031.

Benefits of DSTs

Delaware statutory trusts offer several significant benefits over other co-ownership arrangements. For one, DSTs are able to accommodate large numbers of investors – much larger than TIC arrangements – and so DSTs provide a reasonable avenue for investors to acquire interests in highly expensive developments. Investors can achieve a level of diversification with DSTs which would ordinarily be unattainable; with DSTs, investors can obtain reasonably priced fractional interests in properties which would normally be outside their list of prospects.

Investors who prefer passive investments may also gravitate to DSTs. Typically, DSTs are managed by a central sponsor, and so investors usually take on very few (if any) managerial responsibilities when they acquire an interest in a DST.

Potential Issues

Because of their structure, DSTs are likely to be an excellent option for veteran investors who want steady, reliable returns from investment property with relatively low risk; they will be less ideal for newer investors, or for investors who are looking to grow their wealth at a rapid pace.

Obtaining an interest in a DST is a bit tougher than doing the same with another investment vehicle; DSTs have barriers to entry, and so investors who acquire DSTs typically hold these interests longer than they hold interests in other investments. This means that investors should think carefully about whether investing in a DST be a good decision for them, because DSTs generally demand greater levels of commitment from investors.

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Combining Sections 121 & 1031 for Optimal Tax Treatment

Real Estate Residence Tax Capital Gain Investment
Sections 121 & 1031

As we’ve noted before on HTW, Section 1031 of the IRC applies specifically and exclusively to real property used for business or investment purposes. Section 121, on the other hand, applies to primary residences, and can be utilized to eliminate substantial capital gain upon the sale of one’s property (up to $250,000 for single filers and $500,000 for married filing jointly). Though no taxpayer can use 1031 to exchange his primary residence, the tax code allows taxpayers to simultaneously utilize both of these sections in cases involving mixed use or dual use properties. In the 1031 industry, combining Section 121 and Section 1031 in this manner is commonly referred to as “split treatment.” In this article, we will discuss how this process of combining 121 and 1031 can be achieved.

Combining on the Sale

If a taxpayer has been living in a portion of the property he or she wishes to sell as part of a like-kind 1031 exchange, then the taxpayer may utilize 121 and 1031 on the sale. Suppose that the taxpayer owns a four-unit rental property and lives in one of the units; in this scenario, the taxpayer could sell the property, exclude up to 25 percent of the gain through the exclusion conferred by Section 121 and then defer recognition of up to 75 percent of the remaining gain by acquiring suitable replacement property as part of a 1031 exchange. Hence, in this example, the taxpayer would only be deferring whatever portion of the property is considered used for investment purposes.

Combining after a Conversion

Suppose a taxpayer acquires like-kind replacement property as part of an exchange but then wishes to convert the replacement property into a primary residence. Then, let’s further suppose that the taxpayer wished to sell the property outright after this conversion to a primary residence. In this scenario, the taxpayer would have benefitted initially from Section 1031 on the acquisition, but they would also be able to utilize Section 121 to exclude realized gain on the sale. Current regulations on converted property state that a taxpayer must own a property for a minimum of 5 years after completing a 1031 exchange in order to be eligible to use Section 121; what’s more, taxpayers must also live in the property as their primary residence for at least 2 years during that 5 year period.

Let’s illustrate this: suppose that a taxpayer exchanges into an investment property through a 1031 exchange and then moves into the property 2 years later. Suppose that the taxpayer lives in the property for 3 years and then decide to sell the property. The taxpayer could use Section 121 to potentially exclude up to $250,000 (if filing single), but he would only be able to exclude 3/5 of whatever gain is recognized on the sale. Even though the property would be classifiable as a “primary residence” at the time of sale, Section 121 could only offset a portion of the gain equal to the percentage of time spent living in the property.

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Bitcoin, Taxes & Statehood

bitcoin currency state taxation tax
Bitcoin: Stateless Currency

In our earlier post about the taxation of bitcoin, we pointed out the fact that bitcoin taxation brings up a number of potentially problematic, complicating issues. For one, we mentioned that there could be issues with bitcoin’s basic classification as “investment property” given that it is a digital currency. There could be many, many other issues presented by the taxation of bitcoin, some superficial and some fundamental. One of the most important – and most interesting – fundamental issues with bitcoin taxation is related to its status as a stateless currency. As discussed before, bitcoin is essentially a self-perpetuating currency system based on complex verification processes which are managed by bitcoin users; and because bitcoin verification processes are so difficult and its structure is so finely developed, there is no need for bitcoin to be managed by a central authority. What we have is a truly independent medium of exchange which is capable of operating freely outside and over traditional boundaries of nation and state.

But the stateless aspect of bitcoin brings up a critical question: given that taxation is essentially forcible compliance with the financial demands of a state, how does bitcoin factor into the taxation paradigm? Let’s put the matter this way: how can property be taxed if it’s derived from a system which is designed to avoid taxation? Bitcoin and the U.S. dollar are based on two totally dissimilar value systems, and simply retroactively applying preexisting tax laws to bitcoin fails to address this basic discrepancy. If bitcoin continues to rise in market value – and many reputable financial experts predict that this will happen – it seems likely that this fundamental issue will receive more and more attention. At some point, those who seek to tax (or otherwise control) bitcoin may be forced to ask the question: why are so many people flocking to this digital currency in the first place?

Historically, populations have depended on currency as a medium of exchange because currency allows large quantities of value to be shifted much more easily. And states have imposed taxes on their populations because they’ve had the means to do so, and also because states have had a hand in establishing the legitimacy of a currency. We have faith in the U.S. dollar because it comes with the imprimatur of the U.S. government; it is “secured” by its affiliation with the state. And of course the U.S. dollar and other currencies around the globe benefit from various efforts to ensure that any digital transfer of currency be guarded by the most advanced cryptographic processes available. But bitcoin is a system unto itself because it is originally based upon and perpetuates itself through its own highly sophisticated cryptographic verification system. It does not have the “legitimacy” of statehood because it has no need for it. It exists outside, above and around statehood, rather than coexisting side by side.

What if many of the issues associated with bitcoin are unsolvable because they’re not really meant to be solved? What if the fundamental issue with bitcoin is the fact that it’s not intended to fit into any existing state system, no matter how much force is used to make it otherwise?

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A Basic Introduction to Reverse Section 1031 Tax Deferred Exchanges

Here on HTW, we’ve spent considerable time and effort exploring the complexities of Section 1031 tax deferred exchanges. And this is for good reason: if performed correctly, a 1031 like-kind exchange can be an extremely useful wealth maximization tool. Like-kind exchanges not only allow taxpayers to defer the capital gain taxes which would normally be owed, they also allow more capital to be reinvested in the newly acquired property, and this leads to even greater returns. In other words, Section 1031 doesn’t just permit tax deferral, it allows your capital to work more effectively on your behalf. The clear financial benefits of Section 1031 explain the impressive rise in popularity of these transactions in recent years.

As if the existing complexity of 1031 were insufficient, it turns out that there are variations on the standard like-kind exchange which taxpayers may choose to conduct. One of these variations is known as a “reverse exchange.” Given the advantages which this variation can confer in certain contexts, reverse exchanges have become increasingly common. Let’s look more closely at the mechanics of reverse exchanges and then discuss some of the unique benefits of this type of transaction.

Basic Mechanics

In a standard – or “delayed” – exchange, the original property owned by the taxpayer is disposed of prior to the acquisition of the replacement property. In a reverse exchange, the order is flipped, and the replacement property is acquired first and the original property (the “relinquished property”) is sold subsequent to the acquisition of the replacement property. Superficially, this process seems simple, but other aspects of this variation make it considerably more complicated than a standard exchange.

Under current tax law, taxpayers are not permitted to simultaneously hold title to both the relinquished property and the replacement property. This makes intuitive sense, because simultaneous ownership of both properties would conflict with the basic exchange concept. In order to solve this problem, the entity facilitating the exchange for the taxpayer – referred to as the “qualified intermediary” – develops a separate corporate entity which exists solely to temporarily hold title to the replacement property prior to the disposition of the relinquished property. In 1031 nomenclature, the replacement property is “parked” in the entity and then title to the replacement property is transferred to the taxpayer after the relinquished property is sold. This parking arrangement has been approved by the IRS; in fact, the IRS has issued specific guidelines regarding the mechanics of these transactions.

Reverse exchanges also require more documentation and preparatory work compared to standard exchanges. The fees for these transactions are typically much higher given the additional complexity involved.

Unique Benefits

Reverse exchanges carry unique benefits for investors. Perhaps the most important of these benefits is the timing of the acquisition of the replacement property. The impetus for a reverse exchange usually relates to the desirability of the replacement property; the investor needs to close on the replacement property immediately, or else face the possibility of either losing it to another investor or receiving inferior financing. In some cases, investors know exactly which replacement property they want to acquire and simply haven’t arranged a buyer for their replacement property; but in many other cases, reverse exchanges are a response to market trends.

Another key benefit of reverse exchanges is the effective elimination of the identification requirement. In standard exchanges, replacement property ordinarily must be identified within 45 days after the closing of the relinquished property; reverse exchanges solve this issue from the outset because the replacement property is acquired first. Though it may seem like an easy enough rule to comply with, more than a few exchanges have failed simply because the investor could not properly identify a new property within the specific time window.

There’s much, much more to reverse exchanges, but this serves as a good introduction. In the future, we will go over the structure of reverse exchanges in greater detail and discuss further why they are uniquely beneficial for investors in many cases.

The Debate to Preserve or Eliminate Section 1031

Real Estate Exchange Property 1031 Section Tax Deferred
Real Estate 1031 Exchange

As lawmakers of the federal government struggle to deal with our ever-increasing national debt, Section 1031 of the Internal Revenue Code has come under scrutiny and may face extinction. Now that Republicans control both sides of the Congress (and the White House), Section 1031 could be seriously threatened if GOP lawmakers feel that reducing or eliminating the advantages of 1031 would prove financially beneficial for the nation as a whole. Discussions have surfaced previously about eliminating Section 1031, but current discussions appear to be more serious given the dire financial situation in which the country is encased.

Not all legislators view Section 1031 as a target for elimination; some lawmakers concur with many real estate professionals that 1031 actually contributes mightily to the national economy in a variety of ways. Let’s look at both sides of the debate in greater detail.

Section 1031 as a Tax Loophole

Under Section 1031, taxpayers are able to defer capital gains tax when they exchange their business or investment property for another property of like-kind (which essentially means another business or investment property). In practice, this can mean the deferral of hundreds of thousands ? and even millions ? of dollars in capital gains tax which would otherwise be collected by the federal government.

Though no lawmaker questions the permissibility of like-kind exchanges as they have developed under current regulations, there is doubt as to whether Section 1031’s true purpose was to defer gain in this particular way. The roots of Section 1031 stretch all the way back to 1921; at that time, however, the exchanges typically consisted of neighboring farmers who wished to swap their property in order to clarify property lines. Numerous common law opinions which occurred decades later shaped the current Section 1031 industry. Though it’s clear that like-kind exchanges do confer at least some benefits to the wider economy, it would be hard for even the most fervent 1031 supporter to deny that current like-kind exchanges are conducted with the same underlying purpose as those which occurred many decades ago.

Section 1031 as an Engine of Economic Activity

On the other side, many (if not most) professionals in the real estate industry contend that Section 1031 benefits the national economy in myriad ways. For one, they claim that Section 1031 encourages economic activity beyond the exchange itself in the form of construction services, title insurance services, real estate agent services, and so forth. Curtailing or eliminating Section 1031 would simultaneously reduce this related economic activity as well.

Furthermore, at least one formal study has concluded that the vast majority of like-kind exchanges eventually result in a taxable sale. In addition to supporting claims about the general economic benefit of 1031, a study by Professors David C. Ling (of the University of Florida) and Milena Petrova (of Syracuse University) stated that as high as 88 percent of exchanges ultimately result in taxable sales.

In our financially troubled state, Section 1031 faces arguably its toughest challenges. We shall have to wait and see whether this decades-old provision will either be preserved or meet its demise.

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The (Relatively) Uncharted Territory of Bitcoin Taxation

Bitcoin Investment Property Tax Capital Currency Gain
Taxation of Bitcoin

Though still largely unfamiliar to the general public, the cryptocurrency known as “bitcoin” has received more and more attention in the last several years. This is due in part to its impressive rise in market value — as of today, bitcoin’s market value fluctuates in the low $4,300 range, but only a few years ago it was exchanged for just a fraction of that amount. Its increase in popularity also stems from its habit of drawing attention from governments across the globe: a number of countries have banned its usage, and other countries seem to be on the verge of banning it in the near future. One big issue surrounding bitcoin has to do with its taxation: given that bitcoin is a fully “digital” currency, and that it isn’t backed by any specific state or government, how do traditional tax laws apply? In this article we will briefly describe the mechanics of bitcoin and then provide a basic introduction to the issue of how it is taxed. In the future, we will examine the taxation of bitcoin in greater detail.

How Bitcoin Works

As stated, bitcoin is a “digital” currency, which means that it does not have any physical existence. There are no physical bitcoins which are physically traded or exchanged for goods or services. Possessing bitcoin means having the ability to transfer bitcoin from one “digital wallet” to another. Digital wallets can be obtained fairly easily and are designed to hold bitcoins just as a physical wallet holds physical currency.

The genius of bitcoin lies in its security as a medium of exchange. When people transact using bitcoin, their transactions are verified by parties who are outside of the transaction, and the verification process depends on complex cryptographic mathematical problem-solving. In other words, in order to verify that a transaction using bitcoin is valid, an outside party has to solve a complex problem. Once a transaction has been verified in this way, the transaction becomes logged in a public record which is viewable to anyone. In this way, bitcoin seeks to be a more transparent medium of exchange which is also more secure than traditional electronic transfer of physical currency.

Taxation of Bitcoin

As mentioned, the market of value of bitcoin has grown exponentially in recent years. Whether its value will rise or fall is uncertain, but what is clear is that many individuals have profited enormously due to bitcoin’s spectacular improvement. And whenever someone profits by any means, we have to expect that the taxman will soon be there to receive his cut. Thus far, the IRS has issued guidelines which have tried to classify bitcoin as “investment property” like other financial instruments such as stocks and bonds. Under this classification, someone who bought bitcoin back when its value was only a fraction of its current market value would simply pay at the familiar capital gains tax rates. And those who “mined” bitcoin — an issue to be covered in the future — would claim the bitcoin as if it were received as employment income instead.

We can commend the IRS for at least attempting to bring clarity to this novel situation; but as soon as we look deeper and consider some of the unique aspects of bitcoin, we can see that this straightforward application of preexisting tax laws becomes quite problematic. For instance, it’s all well and good to view bitcoin as investment property — after all, its value has skyrocketed lately — but remember, its primary function is as currency, and so bitcoin users regularly spend their bitcoin to acquire things just as they would spend ordinary physical currency. How will the cost basis of bitcoin be affected when bitcoin is spent as currency? Stock is regularly received as compensation, but it cannot be spent freely like currency. When we retroactively apply pre-established tax laws to bitcoin, we can see easily that the situation is very much like attempting to push a square peg into a round hole.

There are myriad other issues which add complexity to the taxation of bitcoin. In the future, we will dive into these issues in more detail. Stay tuned!

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Towne v. Eisner & the Definition of Income

Income Tax Rule Gain Financial
Income Tax

As counter-intuitive as it may seem, many of the most basic terms in tax law were being argued and debated as recently as one century ago. We tend to think of many terms in tax law – particularly very elementary terms such as “property” and “income” – as things which simply emerged with fixed definitions, presenting little or no controversy since their inception. Here at HTW, we know better: in fact, oftentimes the most elementary terms have been fraught with the greatest level of uncertainty. The average person may not realize it today, but the clarity of many of our essential tax law concepts is the result of an immense amount of mental energy on the part of our legal and political establishment.

The case of Towne v. Eisner (1918) is one example of such mental energy being expended to settle a seemingly simple term. In this case, the full breadth of the term “income” came under contention when a shareholder challenged the tax authorities on the issue of the taxability of stock dividend transactions. This case is significant for a number of reasons, but one reason for its significance stands out among others: through this case, the basic principle that income places someone in an advantageous position was firmly pinned down. This “principle of advantageous position,” to coin a phrase, is still at the heart of our definition of income today.

Let’s look at the (relatively simple) factual scenario of this case in greater detail.

Facts

After a company transferred $1.5 million in profits to its capital account, the taxpayer received a stock dividend consistent with his preexisting ownership stake in the company. The newly received stock had a value of roughly $417,450. The authorities contended that this stock dividend was income within the meaning of the tax law of 1913 – and that this construction of the term “income” within the tax law of 1913 was also consistent with the construction of the same term in the sixteenth amendment – and assessed a tax liability on the taxpayer. Though the taxpayer received additional shares, he did not take a cash dividend, and so the question before the court was whether a valid tax liability could be assessed given that the taxpayer was not actually placed in a financially superior or advantageous position following the stock dividend.

Law

The applicable law was the Revenue Act of 1913. This act contained an income tax provision which was freed from the traditional rule of apportionment present in previous eras. The taxpayer claimed that stock dividends fell outside of the definition of “income” as construed within this act.

Ruling

The court (the Supreme Court of the U.S.) ruled in favor of the taxpayer and threw out the tax liability assessed by the tax authorities. The court cited several earlier cases involving corporate stock dividends in its decision; the essential fact which decided the matter was that the taxpayer was not placed in a financially superior position by way of the transaction. What had occurred was merely a reissuing of stock certificates in order to properly reflect the proportional interests of the shareholder. The taxpayer did not actually “gain” anything from the transaction, he was not placed in a more advantageous position, and so the court ruled that it would be incorrect to say that the taxpayer had received taxable income.

As mentioned above, this basic principle has endured up to the present day and continues to inform our conception of taxable income. This principle informed the construction of the term “income” in various other contexts as well; for instance, the provisions of section 1031 of the tax code follow from the idea that gain should not be taxable if it were merely theoretical rather than actual. Again, though we may see this principle as self-evidently true today, this was not always so, and the case of Towne v. Eisner contributed mightily to the development of this principle.

Source

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