Is this really good tax planning? Is this legal?

[WhiteOleander]

New client comes in. Husband has always prepared their return. He has passed away. We look at last years's return. On Sch B, husband listed interest from promissary note of 7500.00 Below he listed nominee interest of 7500.00 and moves the interest out of their income.

We asked the wife what the nominee interest was. She doesn't know. We have no 1099 or papers to show who it went to. She says the interest is from a loan to their son. But doesn't know what the nominee even means.

She brings in papers. It looks like the son took the loan for his business from mom and dad.. There is even a life insurance policy on him so if he passed away the note would be paid. His painting company nets about 300,000. We think the dad passed the interest out to son. Son deducted on his Sch C because it was a business loan. He included the interest on Sch B. So it nets to zero taxable income. Also, the deduction on the Sch C lowers SE tax. Which at that income level, will lower mostly the medicare because the Soc Sec caps at about 102,000.

Will this fly? Are there rules as to whom and how you can nominee out income to someone else?

Any comments?

[BHoffman]

New client comes in. Husband has always prepared their return. He has passed away. We look at last years's return. On Sch B, husband listed interest from promissary note of 7500.00 Below he listed nominee interest of 7500.00 and moves the interest out of their income.

We asked the wife what the nominee interest was. She doesn't know. We have no 1099 or papers to show who it went to. She says the interest is from a loan to their son. But doesn't know what the nominee even means.

She brings in papers. It looks like the son took the loan for his business from mom and dad.. There is even a life insurance policy on him so if he passed away the note would be paid. His painting company nets about 300,000. We think the dad passed the interest out to son. Son deducted on his Sch C because it was a business loan. He included the interest on Sch B. So it nets to zero taxable income. Also, the deduction on the Sch C lowers SE tax. Which at that income level, will lower mostly the medicare because the Soc Sec caps at about 102,000.

Will this fly? Are there rules as to whom and how you can nominee out income to someone else?

Any comments?

I'm wondering the interest was reported on the cash basis or not. It almost sounds like it was not. It sounds like Son owed Dad the interest, but did not actually pay him. Is that the case? Maybe Dad didn't realize that interest is reportable as paid and not as accrued.

[WhiteOleander]

No, it appears the payments were all made on time. They are both cash basis.

I think the father could gift the interest to the son each year. But, then the son could not deduct that from his Sch C. So, it looks like no one is paying income tax on the interest and son is lowering SE.

[David1980]

I've seen similar situations.

Consider scenario with Bank, Dad, Son. Son wants loan, but bank won't give loan to son due to credit/whatever. Bank will give loan to dad. So dad gets loan from bank and gives money to son. Son pays bank directly, but 1099-int is reported to dad.

In which case what you have sounds OK.

Now if dad is the one actually loaning the money, then you have something completely different.

[WhiteOleander]

I've seen similar situations.

Consider scenario with Bank, Dad, Son. Son wants loan, but bank won't give loan to son due to credit/whatever. Bank will give loan to dad. So dad gets loan from bank and gives money to son. Son pays bank directly, but 1099-int is reported to dad.

In which case what you have sounds OK.

Now if dad is the one actually loaning the money, then you have something completely different.

Yes, Dad is the one actually loaning the money in this case.

[Gretel]

I've seen similar situations.

Consider scenario with Bank, Dad, Son. Son wants loan, but bank won't give loan to son due to credit/whatever. Bank will give loan to dad. So dad gets loan from bank and gives money to son. Son pays bank directly, but 1099-int is reported to dad.

In which case what you have sounds OK.

Now if dad is the one actually loaning the money, then you have something completely different.

What am I missing? It appears dad would have interest income from son, because - technically - sons pays him back. Dad in turn gets 1098 and deducts mortgage interest (he won't get 1099-INT from bank).

I don't see how son could deduct in your scenario when he no direct loan from dad to son.

[Burke]

Then Dad reports the interest on his return if actually paid to him. He should not "nominee" it off to the son, since it was not owed to son. If he gave it to him, it was a gift. Son gets to deduct on Sche C if it is business interest and he actually paid it.

[ChEAr$]

What you're missing

What am I missing? It appears dad would have interest income from son, because - technically - sons pays him back. Dad in turn gets 1098 and deducts mortgage interest (he won't get 1099-INT from bank).

I don't see how son could deduct in your scenario when he no direct loan from dad to son.

is there is no reference to mortgage interest anywhere. As I read OP, dad loaned son
money from his own funds, having nothing to do with mortgage on his house.

And as others have pointed out, if dad earned the interest he pays the tax on said interest,
and the concept of "nominee interest" is moot, as it didn't exist.

[erchess]

So are we saying that

this widow needs to amend her and late hubby's last how many returns and pay tax on the interest? I hope she can afford to do that if she must.

[Gretel]

is there is no reference to mortgage interest anywhere. As I read OP, dad loaned son
money from his own funds, having nothing to do with mortgage on his house.

And as others have pointed out, if dad earned the interest he pays the tax on said interest,
and the concept of "nominee interest" is moot, as it didn't exist.

I was only addressing Dave's scenario.

[David1980]

I was only addressing Dave's scenario.

I was assuming that the father was not the loan issuer, but rather an intermediary between a bank and the son. And had the wrong form listed anyway. Given the facts that parent issued loan, interest income should have been reported on the parents return.

[WhiteOleander]

is there is no reference to mortgage interest anywhere. As I read OP, dad loaned son
money from his own funds, having nothing to do with mortgage on his house.

And as others have pointed out, if dad earned the interest he pays the tax on said interest,
and the concept of "nominee interest" is moot, as it didn't exist.

That's it exactly! What are the rules for nominee interest? Can you move out interest to someone if you want to? I've never seen this scenario before. I think the father and son put their heads together and came up with this idea. Is it actually out of bounds for the law?

The son would be in a much higher tax bracket than the dad. If he were actually going to pay tax on it.

Thanks.

[ChEAr$]

Nominee interest

That's it exactly! What are the rules for nominee interest? Can you move out interest to someone if you want to? I've never seen this scenario before. I think the father and son put their heads together and came up with this idea. Is it actually out of bounds for the law?

The son would be in a much higher tax bracket than the dad. If he were actually going to pay tax on it.

Thanks.

is that which belongs to another although reported under SSN of the ... the... "nominator!"

So consider this scenario.

As you first posted, son pays dad interest on money he borrowed from dear old dad.
This is easy, son get's deduction on schedule c and dad pays tax on the interest.
Looks like case closed.

HOWever.... if dad then tried to "nominate son" as recipient and subtract it on his return
resulting in zero sum game for him, it follows that he should give a 1099int to son, so
that son can then claim it as income on his return, where it would then show up on his
schedule b. We can of course see that there is absolutely no economic reality here,
a point I'm sure IRS would take.

As for widow going back and amending to set things right, it's her decision and I pity
her and my new client this year whose deceased husband, while recommending many
new clients to me over the years, always did his own on paper using dollars and cents.
I looked at 2007 return and where he got those figures, God only knows. I just hope
IRS never audits cause she'll be in trouble. Again, it's widow's call whether or not to
amend. I did point out the excessive deductions and audit potential.

[WhiteOleander]

I think if the son wanted to keep the dad "even" he should have just reimbursed dad whatever tax was due on the interest he paid his dad. That way he had the deduction on Sch C and nothing to make the IRS crosseyed when they looked at the dad's return.