What Does An Accountant Do With Taxes?

Accountant's desk riddled with forms, calculator, glasses and a sticky note saying tax time

Tax laws are constantly changing and quite frankly trying to keep up with all of these changes can be a complex tax. Tax accountants help companies and also individuals make sure they remain in alignment with tax laws by making sure they file their federal and state income returns. In fact, some tax accountants are even willing to offer tax planning advice to help businesses save more money in taxes.

While this may not be the path that all accountants choose to take it’s important to know that there is still some value in hiring a tax accountant because the wide array of services they tend to offer businesses both large and small.

Tax Return Preparation

Do you find yourself often dreading tax return season? That’s one of the great assets of having a tax accountant. Tax accountants primary responsibility is to meet with clients to help them assess their financial needs. This includes but is not limited to gathering needed documentation, such as pay stubs, investment income statements and other financial documents.

Tax Planning

Every corporate business decision leads to tax ramifications, which is complex in general. Companies who typically do business outside of the United States typically experience complexities much more than other businesses do. In most cases, this leads could lead to a growing need for tax professionals.  

Many tax accountants choose to specialize in tax planning because it helps them develop strategy around their client’s financial situation to minimize income tax. Most companies hire internal and external tax accountants to help them develop long term plans that will ultimately help them save money.

Real Estate or Taxable Investment Dealings

Do you own a rental property? If you do it will be in your best interest to hire a tax accountant. Owning a rental company creates a lot of special tax situations that you’ll want to be sure you are taking advantage of and making sure you aren’t making any mistakes.

The same thoughts can also apply when you are buying and selling a home in addition to other real estate. While these laws are straightforward, it’s important to make sure you are doing things properly.

Help You File Your Taxes

For obvious reasons a tax accountant can help you file your taxes. This does not mean that you shouldn’t know what’s going on with your personal and business taxes.; however, it does mean that you must be willing to admit that you need some additional help as it relates to filing your taxes.

You Don’t Have To Do It On Your Own

It doesn’t matter how long you have been in business, it’s important for you to remember that you don’t have to do everything on your own. When necessary and possible make sure you are delegating anything that you aren’t able to do on your own.  By having someone help you with your taxes along the way you are insuring your businesses success even before the success comes. There is also a great deal of methodology around the idea that says that you shouldn’t wait until you need help to implore the help of a professional.

What Tax Documents Should You Bring To Your Accountant?

Man running from a tidal wave of tax documents

If you are anything like most people and specifically business owners, the idea of having to even do your taxes can be incredibly stressful. In most cases it’s because many are afraid that they don’t know what they are doing and may make numerous errors and in most cases these people are probably right. Not everyone should be managing their own accounting needs especially as a business owner. Because of this many must consider hiring an accountant and if they do here are just a few things you should bring with you.

Your Social Security Card

This is probably unnecessary if you have used the same accountant year after year; however, if the accountant you are meeting with is new you’ll want to make sure you bring in your social security card for identification purposes. Your accountant will want to verify the spelling of your name and bringing your social security card will help with that. You will also want to bring the insurance cards for your spouse and dependents as well. If for some reason you don’t have access to your social security card, it might be worth stopping by your local Social Security Administration Office in order to get a replacement card.

Income Related Documents

Depending on what kind of worker you are you will want to make sure you are bringing in plenty of income related documents. A list  of these documents include but are not limited to:

  • Form W-2 (wage and salary income)
  • Form W-2G (gambling winnings)
  • Form 1099-A (foreclosure of a home)
  • Form 1099-B (sales of stock, bonds, or other invest-ments)
  • Form 1099-C (canceled debts)
  • Form 1099-DIV (dividends)
  • Form 1099-G (state tax refunds and unemployment compensation)
  • Form 1099-INT (interest income)
  • Form 1099-K (business or rental income processed by third-party networks)
  • Form 1099-LTC (benefits received from a long-term care policy)
  • Form 1099-MISC (self-employment and other various types of income)
  • Form 1099-OID (original issue discount on bonds)
  • Form 1099-PATR (patronage dividends)
  • Form 1099-Q (distributions from an education savings plan)
  • Form 1099-QA (distributions from an ABLE account)
  • Form 1099-R (distributions from individual retirement ac-counts, 401(k) plans, and other types of retirement savings plans)
  • Form 1099-S (proceeds from the sale of real estate)
  • Form 1099-SA (distributions from health savings accounts)
  • Form SSA-1099 (Social Security benefits)
  • Form RRB-1099 (Railroad retirement benefits)
  • Schedule K-1 (income from partnerships, S corporations, estates, or trusts)

Expense-Related Documents

  • Form 1097-BTC (bond tax credit)
  • Form 1098 (mortgage interest)
  • Form 1098-C (charitable contribution of vehicles)
  • Form 1098-E (student loan interest)
  • Form 1098-MA (homeowner mortgage payments)
  • Form 1098-T (tuition for higher education)
  • Business expenses (summarized by type and amount)
  • Child care expenses (summarized by provider and amount)
  • Gambling losses
  • Medical expenses
  • Moving expenses
  • Personal property tax, such as car registration paid
  • Real estate tax bills
  • Realized gain/loss report for any stocks, bonds, mutual funds and other capital investments sold during the year
  • Receipts or acknowledgment letters for gifts to charity
  • Rental expenses (summarized by property, type, and amount)

What If I’m Missing a Document?

If you’re missing a document, you can ask your employer to give you a new copy. If you’re missing 1099 contact your client.

Do Self Employers Have To Pay Quarterly Taxes?

A self employed person filling out paperwork with CPA for quarterly taxes

Before one can truly answer the question about do you have to pay quarterly taxes as a small business you must understand what is identified as a self employer. According to the IRS the following things must apply to you:

  • You carry on a trade or business as a sole proprietor or an independent contractor.
  • You are a member of a partnership that carries on a trade or business.
  • You are otherwise in business for yourself (including a part-time business)

What Obligations Do Self Employers Have?

As someone who is self-employed it is often times required that you file an annual return and also pay a tax quarterly fee that is estimated.

Under federal law, the self employed must pay what is referred to as an SE tax in addition to income tax. SE tax is required because it is identified as the social security and medicare tax for individuals who work for themselves. It is often compared to the taxes that are withheld from the pay of wage earners for social security and medicare.  In most cases when you hear someone refer to self employment tax they are primarily talking about social security and medicare taxes.

Before you can decide whether or not you must pay self employment tax and income tax it is important for you to identify your net profit and or net loss.  You can do this by subtracting your business expenses from your business income. If your expenses are less than your income, the difference is net profit and becomes part of your income. If your expenses are more than your income, the difference is a net loss. You usually can deduct your loss from gross income.

Once you are able to determine whether or not you are self employed and how much you must pay in quarterly taxes you are now ready to start marking quarterly payments but now you’re probably wondering how. If you head on over to the IRS website you will be able to identify a form that is called Form 1040-ES. It is used to help you figure out your quarterly taxes. It also contains a worksheet that you will fill out  that can help you estimate how much you should be paying in taxes.

After you determine your quarterly taxes it’s now time for you to start focusing on  how to file your annual return. In order to file your return you will need to use Schedule C.  Schedule C is used to report your income loss from a business you operated or a profession you once practiced. In most cases a Schedule C is used for employees and businesses who have expenses that are less than $5,000.  

Another popular question that is often asked is are you required to file an information return and the answer is yes. If you have made or received a payment as a small business or as a self employer you are required to file an information return which is defined as a mandatory tax document that businesses must use to notify the IRS about such transactions. (For example, IRS Forms 1097, 1098, 1099, 3921, 3922, 5498, and W-2 are all information returns.) Informing the agency about reported transactions is mandatory.

At the end of the day it is important that you know the law in your state. By understanding your tax law you will understand which tax forms you need to fill out, what taxes you’re required to pay and most importantly you will be able to identify how the IRS views your business.

Can You Claim Expenses Before A Business Starts?

Glasses on a business expense claim form

When starting a new business most startup founders have to spend a large amount of their own personal money to start the business. While that may be stressful there is good news, you can now take a start up deduction to limit your tax bill. Here’s how:

What Can I Write Off As a Startup Founder?

Once you launch your business the cost of all business expenses become deductible. These business startup costs are capital expenses. These are the costs that you incur to get an asset (a business) that will benefit you for more than one year.

In most cases you are unable to deduct expenses unless you sell or dispose of the business; however, there is a tax rule that will allow you to deduct up to $5,000 in start up expenses a year then after that you can deduct the remainder over the course of 15 years.

Here are examples of start up costs you can write off:

  • Legal and accounting fees
  • Licenses, permit, and other fees
  • The cost of investigating what it would take to create a successful
    business, including research on potential markets or products
  • Advertising costs, including advertising for your business opening and creating a business website
  • Office rent and utilities paid before the business begins operating
  • Rental of business equipment such as computers and office supplies
  • Costs for employee training before the business opens, and
  • Expenses related to obtaining financing, suppliers, customers, or
    distributors.

Can A Small Business Deduct The Cost Of A Computer?

Yes and no which means it depends on the situation. If you purchase a computer for your business and you use that computer exclusively for your business you can deduct the entire cost. If you use it for more than half of the time for your business you can also deduct the cost.

Additionally, you have to take into consideration your personal time. If you use a computer only 60 percent of the time, you can only deduct 60 percent of the expense.

Are There Exceptions to Start Up Cost Deduction?

There are exceptions to start up cost deduction because some costs related to opening a business may not be considered a start up expenses.  A few of these exceptions could include the following:

  • Inventory
  • Mile Tracking
  • Long-Term Assets
  • Research and Development Costs
  • Organizational Costs

When Can You Deduct Business Startup Costs?

Expenses that began as start up expenses are now operating expenses once your business fully launches. An example of this could include supplies such as paper, pens, printers, computers, etc.  These operating costs are the things that keep your business going on a day to day basis.

For Tax Purposes, When Does My New Business Begin?

Many people often ask when does your new business begin and according to tax purposes the IRS says that a venture becomes a business once it acquires all the assets necessary to perform its intended functions. You must also put those assets to work. The moment you start doing business is when you start doing business even if you aren’t yet earning money.

For example, If you have business that provides therapy to customer or clients your business begins when you first take the initiative to offer your services to other people. According to the IRS nobody has to hire you before you can become a full business you just have prove you are available to be hired.

In what ways can you claim expenses before a business starts? We’re always open to new thoughts, leave your comments below.

Small Business Coaching: Tax Basics

small business person accounting their taxes

The best and worst thing about running a small business is that you’re responsible for everything. While there’s a certain freedom that comes with this, there’s also an often overwhelming level of responsibility. Everything from finances, to staffing, to advertising, will fall squarely on your shoulders. You’ll have to be willing to accept the many challenges that come with running your own small business. For entrepreneurs all over America, these challenges are well worth the rewards that come with being your own boss. However, what many small business owners continue to be daunted by is the prospect of handling their company’s taxes. Needless to say, dealing with taxes for a business is a lot more complicated than just filing your personal taxes! We’re here with some of the tax basics for small business to make the task a little bit less stressful.

What Do I Have To Pay? 

Businesses have to pay a variety of taxes, rather than a simple blanket income tax. You’ll be taxed on a variety of aspects of your company; for example, you’ll have to pay unemployment taxes if you have hired people to work for your small business. If you are selling items, such as through a storefront, you’ll also need to calculate the sales tax that you owe. Payroll taxes, Social Security, and Medicare (FICA) will also be required.

In addition to these, there are a few other forms you’ll need to file for your business. First, you’ll want to fill out an SS-4 form to receive an Employer Identification Number, or EIN. You’ll use this number on most of the other forms that you fill out. You’ll fill out a Form 1040-ES to calculate your income tax, form 940 for Federal Unemployment Tax, and you’ll be required to withhold federal income taxes from the wages of your employees.

Who Are My Employees? 

Sometimes, there’s confusion as to who exactly the “employees” of a business are. The rules are different depending on if you have full fledged, W2 employees, or contractors that require a 1099 form. Each employee of your business will be required to fill out a W4 form, informing the IRS of their withholding allowances, any exemptions, and their marital status. You’ll be required to withhold their federal income taxes and pay into Social Security and Medicare. For non-employees who are being paid by your company, including independent contractors, freelancers, and consultants, you’ll have to send them IRS Form 1099 if they made more than $600 from you in any given year. In this case, you’re not required to withhold anything and the contractors themselves will have to report their own income. But how do you tell whether someone working for you is, legally speaking, an employee or a contractor? Usually, an employee is someone who is specially trained to work for your company, on your job site, and regularly receives direction from you. If they receive benefits from your company, then in the vast majority of cases they’ll be considered a W2 employee and not an independent contractor.

Deductions

Another common question is that of deductions. What, exactly, can you deduct? What even is a deduction? Well, if you write an expense off, you’re subtracting it from your total taxable income, meaning you owe the IRS less. Which costs and expenses can be written off on your taxes, and which cannot? Usually, you can deduct any business expenses that come up. What exactly constitutes a “business expense” is pretty broad; travel, equipment, raw materials, and legal fees can all be written off. However, it’s not quite as simple as simply deducting the cost of whatever you spend. You’ll usually only be able to deduct up to $5,000 in the first year for each of your startup cost. Any remaining cost will have to be paid off over the following years. We highly recommend seeking the help of a tax professional if you have complex expenses that you have questions about.

Getting Further Help

Seeking the help of a professional tax adviser is highly recommended to maximize your deductions and minimize the amount you owe, especially when you’re just starting out. A professional tax adviser will make use of the most up-to-date software, be aware of the latest laws and regulations, and be able to make educated, professional recommendations regarding your company. This will leave you free to make other critical business decisions, without spending a lot of manpower stressing over your taxes.

Process Payroll Quickly And Efficiently

Hand Writing Payroll With Blue Pen On Glass For Huddleston Tax CPAs Blog

Many businesses, in particular small businesses, waste a lot of valuable company resources as a result of mismanaged payroll. For anyone used to navigating the ins and outs of payroll, it’s not hard to understand why it can be such a challenge. However, it doesn’t have to be; an efficient, quick payroll system is certainly possible for a business of any size. Actually, it’s not only possible – it’s critical. An improperly managed payroll system can be a woeful drain on your company’s resources, in terms of both time and money. With that in mind, here are a few tips on how to process payroll quickly and efficiently:

Go Digital

In today’s modern, hi-tech world, one of the quickest and simplest ways to streamline your payroll is to simply go paperless. Paper timecards, paychecks, and pay stubs all cost money and have to be kept track of, costing time. It’s not just the cost of paper that you’ll save on; equipment such as printers, photocopiers and scanners are all expensive and you’ll be able to reduce that cost as well. Going paperless is a relatively simple process. The majority of workers you employ today will own smartphones; they can use these to clock in and out and keep track of their hours; just one example of a way you can start digitizing your payroll system. Keeping all of your financial information on paper is also a potential security risk that you can help to eliminate by switching to digital. Digitize as much of your payroll process as you can to save money, improve efficiency, and reduce waste.

Use The Most Up-To-Date Software

Whether you’ve already gone fully paperless, or are in the process of doing so, your payroll software should always be fully up-to-date. Whenever upgrades become available, you should take advantage of them in order to keep your payroll quick, efficient, and inexpensive. As your company grows, you’ll need to ensure your software keeps up; for example, you may need a program that can automatically generate 1099 forms if you employ independent contractors. The right program can do pretty much anything you’ll need; for example, many of them can streamline your HR and handle your taxes as well.

Keep Yourself, And Your Staff, Informed

Keeping yourself and your workforce properly informed is another critical step in the process of streamlining your payroll. It’s not enough to train your workforce once and decide that’s enough; as your business grows, your needs evolve, laws change, and technology improves, you’ll need to continuously update your staff. Occasionally, this will mean bringing in professionals to hold formal companywide trainings; sometimes, it will simply mean required reading material or training videos. Either way, keeping everyone in your company informed of all updates and changes is a must to maintain a quick payroll process.

Outsource, If Necessary

While following the advice given in this article will help you save a great deal of time and money, it’s also a lot for a small business owner to have to keep in mind. In many cases, you may be better off if you choose to outsource your payroll. A reputable payroll company can handle nearly everything for you. They’ll keep track of your staff and make sure they’re paid correctly and on time. They’ll also always have access to the latest software and be educated on the latest legislation regarding payroll in your state. When it comes to compensating your workers, one of the biggest challenges is the proper handling of payroll taxes. Outsourcing means that your taxes will be in the hands of educated professionals. Of course, choosing the right company to handle your payroll isn’t always easy. Make sure that you carefully vet any potential firms you are considering. Read reviews, check references, and don’t be afraid to ask questions! If you’re unsure of anything, a great payroll company will be able to put your mind at ease.

 

 

 

 

 

Check out our Google, Yelp, and Yahoo Reviews -or- Read our Self Employed Tax Guide.

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Tips To Finding A Good Tax Adviser

Cartoon Man At Crossway With Three Arrows Pointing In Different Directions for Huddleston Tax CPAs Blog About Finding A Good Tax Advisor

 

No matter what your tax situation, tax season can be a huge headache. The more complex your financial situation is, the more difficult filing your taxes can be. This can be doubly true if you’re a business owner; trying to handle all of the credits, deductions, and various incomes for a business can be absolutely overwhelming. One of the ways you can take charge of your tax situation is to hire a tax adviser. However, there are many tax advisers out there and many of them aren’t exactly reputable. This article will offer a few tips for finding a good tax adviser for yourself or your business.

 

What Will A Good Tax Adviser Do For Me?

 Before we get too deep into offering advice, we should define what exactly it is that a tax adviser does. A tax adviser – a good tax adviser, anyway – is someone highly educated in local and federal tax laws, preferably a credentialed CPA, who will file your taxes for you and minimize your risk of audit. While there are many people, in a variety of professions, who can bring a lot of tax knowledge to the table, you should look for someone with one or more certifications. The first thing you should look for is a Preparer Tax Identification Number, or PTIN. Anyone who prepares tax returns professionally is required by the IRS to have a PTIN, so this the most basic requirement when looking for a tax adviser. You’ll want someone who has more than just this, however; find a professional who is credentialed in some way. While a CPA is the best option, an enrolled agent or licensed attorney can also be good options. 

 

Do I Need One?

 Whether you need a tax advisor or not largely depends on how complex your taxes are. If you are simply filling out a 1040EZ form, chances are you can handle it on your own pretty easily. However, if it gets much more complicated than that, you will probably benefit from making use of a tax adviser. If you’re in business for yourself, it gets more and more critical that you make use of a professional to file your taxes. Whether you own a business, are self-employed, or own property that you rent out to paying customers, your tax situation can veer towards the confusing and having your taxes filed professionally can decrease your audit risk significantly.

 

How Much Will It Cost?

 There are a lot of untrustworthy people out there claiming to be tax advisers, while in fact they’re scam artists trying to swindle you out of your money and perhaps even make off with your tax refund. You’ll have to be cautious when looking for a tax adviser; one of the things that you should keep an eye on when looking for someone to prepare your taxes is the fee. A professional CPA will usually charge an hourly rate; if a so-called “tax adviser” wants to charge you a flat rate, or take a cut of your refund, then there’s a good chance it’s a scam.

 

How Do I Find The Best Tax Adviser Out There For My Money?

 Even after you filter through all of the tax advisers that are obviously scams, you’ll still be left with a lot of people claiming that they’ll do the best job handling your taxes. Choosing the best one involves a little research, and a willingness to vet anyone you’re considering. First, look for someone who specializes in your specific needs; for example, if you’re a business owner, you’ll want to find someone who is an expert in business tax. When you find someone who has the proper credentials, make sure you read reviews online and check their references. Finding out if your prospective tax adviser has a lot of other satisfied customers will go a long way toward your own peace of mind. Make sure whoever you choose is well versed in all of the IRS laws when it comes to filing; for example, they have to provide their PTIN number when they file your taxes. They should also e-file when they submit your return; not only should this be expected of any reputable tax prep company working in the modern day, it’s also IRS law for any preparer that files more than 10 returns and receives compensation for their work.

 

 

Check out our Google, Yelp, and Yahoo Reviews -or- Read our Self Employed Tax Guide.

 

 

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.

Image credit: tolworthy

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.

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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