Start-up Costs or Write-off Right Away?

[Maria]

Hello,

I need help again!

This file has been here forever. I found it "sticky." The client submitted excel file with home office info, such as home telepone, internet, supplies, mortgage interest, home repair, yard work, and auto expenses etc. However, I have to help him to split all expenses between the Schedule C, which is an existing business, and a LLC which was set up on 12/13/06. The expenses were more than $30,000. The gross receipt for the Schedule C was only $2550, and the LLC did not have any sales.

Since the client feels that the LLC is a more "ligitimate" business, he would like to allocate most expenses to the LLC, however, those expenses incurred throughout the year and the LLC was set up in mid December, can he deduct all thoses expenses or capitalize and amortize for 5 years on the LLC return?

Thanks very much for your help.

Maria

[joanmcq]

This question should be 'is it a legit business?' With only $2550 of income and $30,000 of expenses, I'd question the expenses and whether his is really a hobby.

[LTS]

$30000

just for my own curiosity. has the 30k already been limited by say the 10% area of office in home to total area of house? and i don't think house repairs and yard work are allocated unless related to OIH.

[Golden Rocket]

Reality Check

Maria - assuming this guy is credible, and this massive hemorrhaging of money is simply the result of getting started, I think the question is "SHOULD he maximize deductions this year?" He will need the deductions later, when he turns a profit.

If he intends to operate a proprietorship concurrently with this LLC, then there needs to be a clear cause-and-effect assignment of expenses to each entity, also allocation of common expenses. The LLC is the entity which logistically would be deferring more expenses.

I would look at this tag-team of LLC and proprietorship with a jaded eye. If the client makes a statement that he feels the "LLC is the more legitimate company" what does that tell you? I would tell this guy that I would have to analyze all transfers of funds between these two entities as an integral part of preparing his taxes. He won't like this, but remember he is the creator of this mess.

[Luis Mopeo]

Is the LLC a single-member? Was there an election to be taxed as a corporation?

Single-member LLC, disregarded entity, no allocation, all on Schedule C.

Setting up an LLC late in the year then wanting to allocate a bunch of expenses to it sounds very much like someone who wants you to help them cook the books. Why wouldn't they form the LLC January 1?

There's the business income limitation for business use of the home, so there won't be any allowable deductions for 06 other than mortgage interest and property taxes.

$30,000 sounds like a massive figure for business use of the home expenses. Unless the house is a mansion owned by a very wealthy individual. In that circumstance, the "business" the person is getting into would have to have huge profit potential to have any air of legitimacy. A person with a mansion isn't going to start a business with a profit potential that resembles a regular person's wages.

I'm also skeptical of the "more legitimate" comment. Who's the client trying to impress? True, sometimes there is a business reason to be an LLC or a corporation. If the client is trying to impress the IRS, that's a different story.

If there's no election to be taxed as a corporation, there's no room for manipulation, even if the figures are legitimate. If there was an election to be taxed as a corporation, you have an even worse can of worms on your hands.

You said the return was "sticky." Did you get a bad feeling about it from the start? Sometimes it's good to trust your instincts.

I'd put in writing the information you're looking for and why and send it to the client. Let the client know you're going to prepare the return based on what you believe is legitimate and you're going to decide whether any or all of the deductions are allowable. Whatever you do, don't take a position on a return that you're uncomfortable with simply because the client asked you to.

[Maria]

Single Member LLC

Hi,

Thanks for all input.

The $30,000 include fees paid to his two kids for contract work of the LLC. We have tried to convince him to treat those as "gift." But it seems he is not very happy to do that.

We have also tried to ask him to make the LLC "effective" Jan 2007. However, he paid LLC fee to the state for 06.

Not my favorite task to do - I have to also split the home office between the schedule C and LLC(disregarded entity).

Thanks,

Maria

[Luis Mopeo]

Hi,

Thanks for all input.

The $30,000 include fees paid to his two kids for contract work of the LLC. We have tried to convince him to treat those as "gift." But it seems he is not very happy to do that.

We have also tried to ask him to make the LLC "effective" Jan 2007. However, he paid LLC fee to the state for 06.

Not my favorite task to do - I have to also split the home office between the schedule C and LLC(disregarded entity).

Thanks,

Maria

I don't know all the details, but so much seems wrong with this picture.

You said the Schedule C was an existing business. Did the sole proprietorship shut down? Is the LLC a completely new business operation?

A disregarded entity is just that. It never happened as far as the IRS is concerned. Unless your state laws treat it differently, it's all sole proprietorship(s).

You can't get around a single Schedule C for tax purposes unless one business shut down and a completely different business started in 06. The only way you'll be able to push those expenses forward into the second Schedule C (LLC disregarded entity), is as start-up costs. Those services could not be connected to the existing business. The new business would have to really be a new business, not just paperwork to make it look like that.

It sounds like the guy hired his kids to work in his business, then later decided he wanted to make it look like they'd been working for an LLC that didn't yet exist (for whatever reason). You can't do that.

Assuming the expenses are legitimate business expenses (I'll be honest and say I'm skeptical), you can't wait until the end of the year and say "Let's pretend these expenses were incurred by this business, and we'll pretend these other expenses were incurred by that business." The expenses were incurred by whatever business they were incurred by.

I'd be asking these questions.

1. Is there a real profit motive?
2. What activities in the home gave rise to the home office deduction? Are all the tests met including exclusive use?
3. Did one business go out of business and another one start up in 2006? Or was it the continuation of the same business? (Filing for a single-member LLC will not change this answer). If it was the same business, the only allocations would be for management purposes. Allocations would be irrelevant from a tax standpoint.
4. What services did the kids perform? Were the wages (oops, contractor payments) reasonable? Which business were they working for? Were they employees but incorrectly paid as independent contractors?
5. Where is this guy getting all these wacky ideas about tax planning?

This seems to have all the charm of someone who heard a radio talk show, or attended a seminar, or watched a late-night infomercial where they give out bad advice about how to save on taxes. He decided to do all these clever things like forming an LLC, claiming expenses for business use of the home, hiring the kids, so he can be smart and take "legitimate" deductions that would otherwise not be allowable. He obviously didn't consult you before he did these things. Did he consult a professional before doing any of these things, or did he get all these bright ideas all on his own?

I've had similar clients. They get themselves into tax messes, but don't understand enough to know how big a mess it is. They don't understand why you can't stand on one foot, wave your magic calculator, press 'Control-Alt-P' on your keyboard, and make the desired tax returns showing the desired results pop out. After all, the guy on the radio says smart taxpayers do this stuff all the time. And they usually add the caveat, "Don't be surprised if your tax preparer doesn't understand this brilliant strategy. It's too sophisticated."

When I have clients who do this kind of stuff without consulting me, I find out who told them to do it, then tell the client to have that person prepare their returns. "I just don't understand this kind of thing." If they did all this without consulting a professional, you're being asked to bail them out of a huge mess whether they know it or not.

Be careful.

[Maria]

Thanks for the Advice

Hello,

The existing Schedule C is a cartoon design business, the new LLC is a business venture to invest in real estate, buying and selling houses. (so, my guess is there will not be profit for years considering the current real estate market). Up to now, as far as we know, no house is purchased yet.

I have emailed my boss that I am not comfortable helping to split expenses.

Thanks again,

Maria