Kornfeld v. Commissioner and the Step Transaction Doctrine

Step Transaction Doctrine Legal Theory Tax Deduction

The Step Transaction Doctrine

We will look at one more case before returning to our article series on the sixteenth amendment. This is a case every HTW reader should become very well acquainted with: Kornfeld v. Commissioner (1998). Though it’s primarily an income tax case, it contains a plethora of other important topics and subtopics, and it presents a message which every HTW reader should commit to memory.

In the past, we’ve learned that whether a transaction be taxable is dependent on its substance, and that courts apply the “substance over form” doctrine to determine the true nature of a business transaction. The substance over form doctrine is not the only tool utilized by courts to review a transaction, however; the so-called “step transaction doctrine” is another tool commonly used by courts to clarify the nature of a transaction for tax purposes. Under the step transaction doctrine, multiple “steps” may be classed together and regarded as a single transaction; in this way, steps which may have been taken simply for the specific goal of altering tax liability can be overturned. The step transaction doctrine does not exist to create tax liabilities where none should exist, but to assess tax liability properly by viewing a transaction with the greatest level of accuracy.

In other words, the step transaction doctrine imposes a sort of coherence to a multistep transaction so that it can be properly adjudicated. This is very common in law: legal theories often condense or codify reality so that it can be interpreted using preexisting categories. But the rationale for theories such as the step transaction doctrine is not only about simplicity; there is also the aim of viewing a matter according to its true nature. Even though the step transaction doctrine may “condense” things for the sake of simplicity, many contend that this theory (and other similar theories) portrays matters in a more accurate way, that it provides a clearer sense of what actually occurred. Let’s look at the details of the Kornfeld case to get a better sense of this doctrine and its rationale.

Facts

The facts of this case are a bit complicated. Kornfeld, a highly experienced tax attorney, established a revocable trust which he intended to use to purchase bonds. He entered into an agreement with his daughters in order to claim an amortization deduction on the bonds; the agreement was that Kornfeld would transfer funds (from the trust) to the bond issuing institution equal to the value of a life estate in the bonds and then the daughters would pay the balance on the bonds. The agreement also held that Kornfeld would deliver checks to the daughters for the exact amount which they paid to cover the balance.

Kornfeld and his daughters executed this initial agreement and Kornfeld obtained the bonds. Subsequently, the tax code was changed so that the amortization deduction sought by Kornfeld was made unavailable in situations involving related parties. In response, Kornfeld and his daughters made another agreement which included Kornfeld’s secretary; the second agreement held that the daughters would take a second life estate interest in the bonds following Kornfeld’s death, and that the secretary would have the final remainder interest upon the death of the daughters. Importantly, Kornfeld used IRS valuation tables to create his estimates for the value of his life estate interest. Kornfeld claimed amortization deductions on the bonds and then the IRS assessed a deficiency after they declared that the transaction had failed to produce a genuine life estate in the bonds.

Law

Under U.S. code – specifically section 167 – taxpayers may claim a depreciation deduction of a reasonable amount based on wear and tear for property held primarily for the production of income (such as a bond). IRC subsection 167(d) pertains to life tenants and beneficiaries of trusts. Under these rules, life estate interests in bonds – or “term interests” or limited interests – are considered amortizable (or depreciable) and thus taxpayers may claim a deduction for such an interest. Also see 26 CFR 1.167(a)-1.

Ruling

Applying the step transaction doctrine, the court rejected the argument made by Kornfeld that the payments made to his daughters (and secretary) had no real connection to the bond transaction, and that a genuine life estate interest had been created for tax purposes. The court based its decision on the fact that the seemingly disparate actions of the case were patently interdependent and all served to produce a single, underlying purpose. Kornfeld thought that he had devised a near foolproof scheme to completely avoid any tax liability on the bond transaction, but the court realized that a genuine limited interest had not been created and that Kornfeld had acquired total ownership of the bonds.

The Kornfeld case is a prime example of the step transaction doctrine at work. All HTW readers need to be aware of how the step transaction can affect their tax liabilities; if you aim to acquire a particular kind of tax treatment, you need to understand that your actions preceding any given transaction, as well as your actions which occur after a given transaction, can impact the tax treatment you ultimately receive. In the future – after a few more installments on the sixteenth amendment – we will look at a few more examples of how the step transaction doctrine has been used to alter the tax classification of a series of events.

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The Tax Benefits of the Legal Profession

Law Profession Tax Tips

Tax Tips for Lawyers

Few occupations receive as much attention as the legal profession. Lawyers hold a high position on the occupational totem pole and are regularly portrayed as characters in a variety of media – films, television shows, books and others. Historically, the legal profession has possessed a considerable amount of prestige and many of our most talented citizens aspire to work in law in one capacity or another. Along with prestige, the legal profession has also been regarded as one of the surest routes to financial success. As it turns out, there are a variety of tax benefits lawyers may utilize to strengthen their financial condition. In this article we will discuss several of these benefits.

In order to develop their practice, lawyers regularly conduct formal business discussions with prospective clients and other professionals. Occasionally, these discussions occur just before or after some form of entertainment (such as a show, sporting event, etc.). Fortunately for lawyers, these entertainment expenses are deductible. However, under section 274 of the Internal Revenue Code, lawyers must comply with multiple requirements in order to deduct these expenses: they must be able to thoroughly substantiate the expenses (i.e. who was entertained, when did the entertainment occur, etc.), and they must also prove that there was a clear association between the entertainment and the business discussion.

Travel expenses incurred by lawyers are also deductible. As with entertainment expenses, travel expenses must be fully substantiated. The IRS is quite strict about these types of deductions and so it is imperative that lawyers keep excellent records of every individual expense.

Lawyers have to conduct a lot of research throughout the course of their practice and as a consequence they spend considerable sums on books, periodical and research software. The cost for books and subscription services which have a useful life greater than one year may be depreciated over a five year period; software is not considered depreciable and must be amortized over a three year straight line period. If a lawyer purchases books, periodicals or software on an annual subscription basis – thus making these materials accessible for one year at a time – then these expenses would be deductible in the normal fashion.

Another tax issue which lawyers must be aware of relates to client based expenses. It is not uncommon for lawyers to advance money to clients or to incur expenses on direct behalf of clients. If money is advanced to the client, this is treated as a loan for tax purposes and so it cannot be deducted. However, there is an important exception to this rule: if a lawyer incurs expenses on behalf of a client as part of normal operating procedure and then fails to receive reimbursement then these expenses become deductible. An example of this would be expenses such as postage and photocopies. These expenses are supposed to be charged to clients, but if a lawyer is somehow unable to collect payment for them then they may be written-off as “bad debts.”

These are just a few of the tax perks available to lawyers. In addition to these benefits, lawyers also need contemplate other tax related issues such as entity selection (or business structure), client trust funds, client-related expenses, accounting methods and others as well.

To learn more, view the presentation given by our CPA Lance Hulbert.

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For more information please view the following video presentation

Tax Deductions for Engineers, Architects & Construction Professionals

Engineer Architect Construction Tax Tips

Engineer

Careers in engineering, architecture and construction all have the potential to be extremely rewarding. Though these professions may emphasize different skill sets, they are similar in one very important dimension: all of these fields involve building new things from scratch. There is a creative process inherent to these fields which attracts workers who are not merely bright but also driven to see theoretical projects transmitted into physical reality. Professionals in engineering, architecture and construction play a vital role in our society as they develop and maintain the infrastructure which allows our economy to function successfully. Given their important role in our society, it is not surprising that there are a variety of tax deductions available to professionals in these fields. In this article we will cover two of these deductions.

Engineers, architects and construction professionals may take advantage of the so-called “meals and entertainment” deduction. This deduction is designed to stimulate business activity and also promote productivity while on the job. With this perk, professionals from these fields may deduct 50% of their meals and entertainment costs on their tax return. However, there is one exception to this rule: if an employer provides a meal to his employees as a matter of convenience, then the cost is 100% deductible. This exception may come up if there are no eating establishments nearby a job site and the boss does not wish to risk his employees returning late from a meal break.

This deduction may be utilized when professionals engage in business discussions during the course of a meal. However, people who wish to use the deduction in this manner must be able to provide specific information regarding the occasion (i.e. who was entertained, where and when did the meal occur, why did the meal occur, what was the cost, and so forth).

Another perk available to professionals in these fields is the Domestic Production Activities Deduction (or the Section 199 Deduction). The DPAD is a very significant tax break which incentivizes professionals to operate on projects within the United States. With this perk, entities may take a 9% (as of the current year) deduction on net profit derived from engineering, architectural and construction services performed within the U.S. However, the amount of this deduction may not exceed 50% of W-2 wages, and this includes wages paid to the owner.

These are just two of the deductions currently available to engineering, architecture and construction professionals. To learn more about these and other deductions for professionals in these fields, be sure to read the transcript of the webcast by our CPA Jessica Chisholm.

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To learn more please view the following video

The Tax Benefits of Real Estate Ownership

Real Estate Property Owners Tax

Real Estate

Most people — even those among the so-called millennial generation — would like to own property at some point in their lives. Since it relates to both our drive for prosperity as well as our abundance of space, there is something about real estate ownership which gives off a thoroughly American impression. As Americans, material success has always been among our primary concerns, and home ownership is a clear indication of such success. What’s more, home ownership also has symbolic value as it represents stability. And in a land of such frenzied activity having a sense of stability can be a source of great pleasure.

What not all Americans realize, however, is that real estate ownership offers a number of important tax benefits which are unavailable to renters. And among those who have some sense of the benefits of home ownership very few are aware of exactly how advantageous these benefits can be. As it turns out, there is a whole range of perks available to those who own property. Property owners who take advantage of these perks can save a great deal of money.

For instance, property owners are able to deduct a number of items on Schedule A of their personal 1040. Individuals are able to deduct mortgage interest (on the first $1 million of home acquisition debt and the first $100,000 of home improvement debt), qualified mortgage insurance, real estate taxes, and the points paid when purchasing or refinancing. Individuals who sell their home may be able to exclude up to $250,000 ($500,000 if married and filing jointly) provided they meet the requirements of the Principal Residence Exclusion.

People who own rental property are able to take deductions for a variety of expenses which they may incur throughout the course of ownership. Advertising, cleaning bills, utilities (when the rental property does not have a tenant or when utilities are included in rental price), mortgage interest, homeowners insurance and property taxes are all deductible. Repairs to rental property are deductible as well, while improvements to rental subject must be capitalized and then depreciated over their useful life.

There are many other benefits which may be derived from real estate ownership. For more information, view the resources from our webcast here.

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Check out this video to learn more

Tax Write-Offs for Freelancers

Here are five major tax write-offs freelancers shouldn’t ignore when they are getting ready to pay taxes.

Home Office

This should be the most obvious since most freelancers work out of their home. The IRS allows freelancers to deduct a portion of their mortgage or rent, provided that this space is not used for anything else. It must be designated for work purposes only.FreelancerPic

Home Utilities

You can deduct the cost of utilities which have been used specifically for work purposes. All you need to do is determine the percentage of space your office occupies in your home and then calculate that against things like gas, electricity, heating, air conditioning, and even phone service.

Unpaid Invoices

Clients who don’t pay their bills are a pain, but the IRS helps freelancers with this burden by allowing the unpaid invoices to be written-off as a loss. While it’s never a good experience for bills to go unpaid, you won’t have to worry about it at tax time.

Advertising

Part of the cost of doing business is getting seen. As such, the cost of flyers, business cards, and other forms of advertising and marketing expenses can be written-off. You can even deduct the cost of owning and maintaining a website.

Professional Development

To stay competitive, you have to spend money to stand out. The costs associated with doing so can add up, but you can deduct expenses related to membership dues and professional fees thanks to the IRS.

Take advantage of these tax liability reduction options.

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How to Get Credit for Your Charitable Giving During Tax Time

Not all donations can be written off on your taxes. For example, a donation to a private party or individual does not count. If you donate your time to an organization, you may not deduct the value of your time either. In this post we’ll take a closer look at what is required to receive credit for charitable donations.SalvationArmyPhoto

Qualified Organizations Only

The organization that you donate to must be a 501-3c to qualify for a tax credit. These are verified as non-profit organizations. The IRS also offers an IRS Exempt Organizations Select Check search option on the IRS.gov website so that you can see if your organization of choice is there.

Keep Receipts

Keep all of your receipts and make sure to get one. Get receipts for cash donations as well. This is proof of your donation to the organization should disputes of validity come into play.

Avoid Incentives

Any time that an organization or charity event advertises gifts for donations, the value of those gifts may offset the donation amount. In some cases, the entire donation amount can be disqualified if an incentive was received. It is important to deduct the value of the incentive received from the donation amount.

Document Values of Donated Goods

Every item has a value. Document the value of the goods being donated and have those values reflected on a receipt. You may also have an organization representative sign an itemized list of goods and their values.

It is important to be aware of the status of the organization you wish to donate to. You may think that you are helping a great organization and will receive a tax credit and end up discovering otherwise. Do your homework before making a charitable donation.

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Is Every Donation Tax Deductible?

Many believe that every donation to a charity is tax deductible. In actuality, there are charitable organizations which are not tax-exempt, and donations to these types of organizations are not tax deductible. The IRS offers a database of organizations so you can see if donating to a specific charity is tax-deductible.

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Look for 501(c)(3) Status

Whether it be money or tangible goods, in order for a donation to be tax deductible the organization to which it is given must hold 501(c) (3) status. Incorrectly writing off a deduction can result in the issuance of an audit. When organizations are tax exempt, you benefit from being allowed to deduct donations.

Time is not Deductible

Although time does have value, it is not tax deductible in terms of volunteering to work for an exempt charity. Volunteering is something done purely for charitable purposes, it has no value other than the joy of helping others. Some have attempted to deduct values based upon hours of volunteered time, but such attempts are not accepted.

Receiving a Gift for Making a Donation

Making a donation at charity events where prizes are awarded or items are raffled off are almost always non-tax deductible. This is because you receive something of value in return. So, even though your contribution seems like a charitable donation, in this instance it is actually a transaction between you and the charity.

Closing Thoughts

Prior to making donations, be sure to research the organization if tax deductibility is important to you. If it is not clearly listed in printed material that the organization in question is tax-exempt, inquire further for a definite answer. When donating items of value, always make sure that you get a receipt showing the value of the donation and what the item donated was.

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Can Lawyer Fees Be Written Off on Taxes Legally?

Legal fees are always a pain to deal with. There are a lot of complex rules on what you can deduct and what you can’t. The answer is that only certain lawyer fees can be written off on your taxes. In most circumstances, though, you will have to count them as a personal expense. When counted as such they are not deductible.LegalFeesPic

Let’s discuss how to work out whether you can write something off or not.

Is it Personal?

This is the crucial question you have to answer. Personal legal fees aren’t tax deductible and will therefore leave you in a situation where you can’t deduct them from your taxes.

A prime example of a personal lawyer fee is the fee you pay to get divorced. Also, if you have any cases for slander you would be forced to cover this out of your own pocket. The reasoning behind this is that it’s purely a personal decision and you are not strictly forced into it.

Business Lawyer Fees

If you require a lawyer for the purposes of investment, you can deduct them from tax returns. This applies to everyone from sole businesspeople to huge corporations. From a personal finance perspective, these are the best legal fees around.

For example, if you require a lawyer to improve the reputation of your business, these fees would be fully tax deductible.

Conclusion

If you are unsure about any of this, speak to a tax professional. They will be able to assess whether something is deductible or not. Unsure about it? Stay on the side of caution and don’t deduct it.

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Five Tax Benefits for Sole Proprietors

Sole proprietors are in a good position when it comes to tax because they have a range of benefits exclusive to them. If you are a sole proprietor and you aren’t yet claiming these five tax benefits, you are missing out on a lot of money.HomeOfficePic

  1.      Health Insurance Deductions

The big benefit you have is you can deduct contributions to your health insurance package for you, your spouse, and any dependents. No other type of business enables you to do this. This deduction can make a substantial impact on your finances.

  1.      Business Expenses

Any business expenses, such as the cost of gas and business lunches, can be deducted from your tax return. Make sure you keep any receipts and other documentation in case you are selected for an audit at a later date, though.

  1.      Home Office Deduction

It’s still possible to claim a home office deduction from working out of your home. Many sole proprietors can use the tax deduction to cover their household bills.

Do beware of how much you claim on this deduction. The IRS is really clamping down hard on frivolous deductions on home offices.

  1.      Self-Employment Taxes

Sole proprietors have to pay these taxes for themselves. You are not having money withheld from your paycheck so you have to pay via estimated taxes throughout the year so Uncle Sam can take his cut.

  1.      Personal and Business

To the annoyance of the IRS, the biggest tax benefit is that you can blur the lines between personal and business expenses. Just make sure you keep accurate documentation, as sole proprietors are prone to heavy IRS scrutiny.

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How to Make Charitable Donations Count on Your Taxes

It’s well-known that if you make certain charitable donations you have the opportunity to claim a tax deduction and reduce the amount you pay. Nevertheless, you have to make sure it’s marked correctly on your taxes. If you don’t, you’re going to be in trouble with the IRS.SalvationArmyPic

The last thing you want is an audit!

Donate to Eligible Organizations

You can’t donate to any charity of your choice. It has to be registered with the IRS before tax deductions can count. On the IRS website, you will find a huge list of charities that count for tax deductions. Just remember that only monetary donations count. Time spent volunteering can’t be written off on your tax returns.

The Paperwork

You must have paper evidence from the charity that your donation was received. This must be an official document, so make sure it isn’t simply a number scribbled on a piece of paper. If you are audited, the IRS will trace each receipt to its point of origin.

In this event, the charity must corroborate your donation. Your receipt must contain the date, the name of the charity, and the amount that you donated at the very least.

Know the Limits

There are a number of scenarios where you can deduct a total of 20%, 30%, or 50% of your maximum income. What you can claim depends on what you are donating and the organization you are donating to. Thankfully, this doesn’t apply to most of us, but if you’re donating 20% or more of your annual income you should look up these limits.

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Huddleston Tax CPAs of Seattle & Bellevue
Certified Public Accountants Focused on Small Business

(800) 376-1785
40 Lake Bellevue Suite 100, Bellevue, WA 98005

Huddleston Tax CPAs & accountants provide tax preparation, tax planning, business coaching, Quickbooks consulting, bookkeeping, payroll and business valuation services for small business. We serve Seattle, Bellevue, Redmond, Tacoma, Everett, Kent, Kirkland, Bothell, Lynnwood, Mill Creek, Shoreline, Kenmore, Lake Forest Park, Mountlake Terrace, Renton, Tukwila, Federal Way, Burien, Seatac, Mercer Island, West Seattle, Auburn, Snohomish and Mukilteo. We have a few meeting locations. Call to meet John Huddleston, J.D., LL.M., CPA, Tawni Berg, CPA, Jennifer Zhou, CPA, Jessica Chisholm, CPA or Chuck McClure, CPA. Member WSCPA.