Corp 1120

[Barb]

I have a client who is a Doctor - Scorp
His wife is also a doctor - separate s corp. Do not do too many scorp.

Any help would be greatly appreciated.

(a) Client bought EMR equipment on lease in Oct 2005 for a 5 year lease for $108,000. It includes computer, software, training etc. Lease has option to buy back at the end of term for a $1. He paid $1 in oct, $2 in Nov, $100 in dec and then $500 in Jan. His payments will go up. His average payment will be $2,600 per month.
Can corp. take sec 179 in 2005 as this is a "Purchase Disguised as Lease"? Or should I depreciate it? He is paying in installment for 60 months. This machine includes

(b) This client's previous accountant also had additional Paid in capital of $40,000 which was actually loan? Can I just reclass it? How else can you get read of additional paid in capital?

(c) He also has negative share holder loan amount in liability account? This should be reclassed as Receivable form officer, right?

(d) Accrued retirement: Previous accountant accrued retirement on Balance sheet for $41,000 in 2005. Corp deducted 17,000 in 2005 on 1120S. Paid rest in 2006 before the deadline for 2005. Can corp. deduct rest in 2006 or corp. should have deducted in 2005?

Thanks
Barb

[OldJack]

(a) Client bought EMR equipment on lease in Oct 2005 for a 5 year lease for $108,000. It includes computer, software, training etc. Lease has option to buy back at the end of term for a $1. He paid $1 in oct, $2 in Nov, $100 in dec and then $500 in Jan. His payments will go up. His average payment will be $2,600 per month.
Can corp. take sec 179 in 2005 as this is a "Purchase Disguised as Lease"? Or should I depreciate it? He is paying in installment for 60 months. This machine includes

First I would ask the client about his "intent" with regards to purchase of this equipment at the end of the lease. If it is his intent to purchase I would then treate it as a purchase now with appropriate liability account. Basically you would now have a $108,000 asset to depreciate and the payments would be reducing the liability for the purchase. If there is no intent to purchase and would expense the payments as lease expense.

(b) This client's previous accountant also had additional Paid in capital of $40,000 which was actually loan? Can I just reclass it? How else can you get read of additional paid in capital?

Paid in capital is not the same as a loan and can't be simply reclassified as a loan. This is stock basis capital. Paid in capital is usually the excess of capital paid for stock when the stock value has a stated par value. In other words the total of paid in capital account and the stock issued account is the real capital paid in to buy the shares of stock.

Reclassifing it as a loan would require valueing the stock to fair-market-value and considering a portion of the stock as sold by the shareholder to the corporation with taxable gain and then the shareholder loaning the proceeds of the sale back to the corporation. This is not a good thing.

(c) He also has negative share holder loan amount in liability account? This should be reclassed as Receivable form officer, right?

Yes it is a receivable. I would recommend to the shareholder that he consider increasing the shareholders salary and deducting an amount from the paycheck each month to reduce and eliminate the debt owed by the officer. This debt has been some kind of mickey mouse because the officer had taken excess withdrawals or paid for personal expenses from corporate funds. This needs immediate attention. I would also document the debt with appropriate loan papers.

(d) Accrued retirement: Previous accountant accrued retirement on Balance sheet for $41,000 in 2005. Corp deducted 17,000 in 2005 on 1120S. Paid rest in 2006 before the deadline for 2005. Can corp. deduct rest in 2006 or corp. should have deducted in 2005?

Thanks
Barb

Yes the deduction is for 2005 but the deduction for 2005 should be 41,000 and is allowed if paid by March 15, 2006 regardless of the accounting method. The entire deduction belongs in 2005. This is someones idea of deducting payments on a cash basis and that is not how it works.

[rosieea]

I think the only thing I would quibble with is the "intent" notion. I don't think it can be considered a true lease unless the buyout option is at fair market value. I believe that a buyout for a buck is a purchase, and intent has nothing to do with it.

[OldJack]

I believe that a buyout for a buck is a purchase, and intent has nothing to do with it.

Of course that would also depend upon whether you are talking about GAAP or tax accounting. True that a lease for a buck is normally considered a buy, but if the type of equipment is obsolete for the users purpose within the lease period and the user has no intent of owning the property there is no reason to treat it as a purchase. An example of this in the past has been leases of room size computer systems or medical equipment systems that are obsolete to the person using the equipment before or by the end of the lease.

[Barb]

[QUOTE=OldJack]First I would ask the client about his "intent" with regards to purchase of this equipment at the end of the lease. If it is his intent to purchase I would then treate it as a purchase now with appropriate liability account. Basically you would now have a $108,000 asset to depreciate and the payments would be reducing the liability for the purchase. If there is no intent to purchase and would expense the payments as lease expense.

Dear Jack: Thanks for your response.
Lease issue:
Intent is to purchase. So I should be able to use sec 179 eventhough payment will be made on installment up to 60 month? or should I just depreciate it over 7 years?

Paid in capital:
Reclassifing it as a loan would require valueing the stock to fair-market-value and considering a portion of the stock as sold by the shareholder to the corporation with taxable gain and then the shareholder loaning the proceeds of the sale back to the corporation. This is not a good thing.

It was an honest mistake by previous accounatnt to call as add. paid in capital and not loan?

[OldJack]

Lease issue:
Intent is to purchase. So I should be able to use sec 179 even though payment will be made on installment up to 60 month? or should I just depreciate it over 7 years?

You can take §179 and/or regular depreciation of balance (probably 7 years) upto the amount of corp net taxable income. §179 deduction can not create a corporate loss (form 4562 limits). Cash basis method concern is ignored in this type transaction and all payments after you capitalize the equipment are charged to reduce the liability except for possible interest expense if not capitalized.

It was an honest mistake by previous accountant to call as add. paid in capital and not loan?

If it was truly a mistake it should be corrected on an amended tax return of the year of the mistake. If I was an IRS agent I would say tuff luck to your amendment request as that was no mistake as it was capital contributed and you treated it that way and now the rule of estoppel would apply. not a good thing.

On the other hand if it had been a long time ago when the mistake was made (and I accepted your argument as a mistake) I would want interest deemed to be paid by the shareholder and treated as income to the corporation. That would be interest income to the corporation (with tax due) and a possible investment interest deduction limited to investment income on 1040 Sch-A. Thus you need to amend the 1040 for those years. not a good thing.

[Matt Sova]

Lease and Pd in Capital

The lease is a capital lease plain and simple. Intent has nothing to do with it. GAAP or tax acctg has nothing to do with it. Set it up as an asset and a corresponding loan account. You can then Sec 179 the equip if he so wishes.

As far as Pd in Cap goes it does not matter if it was supposed to be an officer loan UNLESS this use to be a C Corp and it was paid in then. The ordering rules for distributions are as follows:

1) AAA - non taxable
2) E&P - Prior C-Corp ret earnings - taxable as a dividend
3) OAA - Other Adj Acct (Things like tax exempt interest) - non taxable
4) Return of Capital - Not taxable up to basis in the stock
5) Excess of basis - Capital Gain

#4 is your answer. You could even apply part of the Officer Loan Receivable against the Pd In Capital if your AAA is taken down to 0.

Matt

[OldJack]

The lease is a capital lease plain and simple. Intent has nothing to do with it.Matt

Matt.. Intent is certainly a main "fact" (see quote) verses just a "important factor" in the determination to capitalize, however, as the poster has stated the intent here is to purchase so it is a non issue.

A lease that contains an option permitting the lessee to buy the property may be construed as a sale so that none of the payments is deductible as rent. Whether the lease is considered to be a sale depends essentially upon the intent of the parties, as shown in the agreement, read in light of the facts and circumstances existing at the time the agreement was made. Important factors indicating sale instead of lease include nominal option price, excessive rent, designating part of the payment as interest, rental plus option price equal to the property's value plus interest, and application of rent payments to the lessee's equity in the property.

[Unregistered]

Matt.. Intent is certainly a main "fact" (see quote) verses just a "important factor" in the determination to capitalize, however, as the poster has stated the intent here is to purchase so it is a non issue.

Matt is correct. Intent has no basis. You would be circumventing (sp?) the depreciation rules if it was a factor of intent. Everyone would simply "intend" to do what ever was more beneficial to them.

[Armando Beaujolais]

Matt is correct. Intent has no basis. You would be circumventing (sp?) the depreciation rules if it was a factor of intent. Everyone would simply "intend" to do what ever was more beneficial to them.

I would clarify this to say "intent has no basis in this situation."

"Intent" is one of the many facts and circumstances that will determine whether a transaction is a lease or a conditional sales contract. The IRS Pub says that treatment depends on the intent of the parties. However, there is a statement in regulations that specifically addresses the type of "lease" that ends up with a purchase for $1 (or a minimal amount) at the end of the lease term.

Intent is an important fact. However, in this case, if you have the option to buy for $1 at the end of the lease term, there ain't no facts or circumstances around that will convince any Tax Court judge that it was anything other than a conditional sales contract.

Here's what the rules are for. Let's say I want to buy a building for $100,000, and another guy wants to sell it. I want a quicker write-off than 39 years. I want to write if off over 5 years. I make deal with the seller that we enter into a 5-year lease. I'll pay $20,000 a year in "lease" payments, and write it off. Then at the end of the "lease" term, I'll have an option to buy for $1. I end up writing off the cost in half the time, and the seller ends up with a big capital loss when it's all said and done.

Sounds great. But it won't fly if it's ever questioned. The key is whether the asset really will be worth only $1 when the lease is over. If that $1 doesn't reflect reality, I'm going to have call this one a "Rudolf."

[OldJack]

I would clarify this to say "intent has no basis in this situation."

The key is whether the asset really will be worth only $1 when the lease is over. If that $1 doesn't reflect reality, I'm going to have call this one a "Rudolf."

You should not make broad statements without considering exceptions, facts, and circumstances.

I will agree that the tax preparer is a "tax expert" but unless he has "telepathic" abilities he has to humble himself to "ask" his client what the client's intent was before automatically assuming to capitalize the lease. It is a fact that the tax expert is not a party to the lease and therefore does not know the intent of either party.

The tax preparer should not automatically assume the lease may be an attempt to expense and avoid taxes as an IRS agent might think. In fact it may be in the clients best interest to capitalize the equipment and write-off the entire expense in the first year.

The tax preparer should not automatically assume that $1 is below fair-market-value when if investigated he might find that it is in "excess" of fair-market-value due to the nature of the equipment concerned. As an example the lab equipment, by normal use, will be contaminated at the end of the lease causing huge costs to remove and dispose of as hazardous waste therefore having a negative fair-market-value. This would have been a consideration by both parties in determining the terms of the lease. The client may very well have no intent to assume such liability and the preparer should have considered his intent before deciding in error to capitalize. "Rudolf" nose may indeed be red with a large lawsuit to match.

[JON]

I thought this issue was resolved in the 80s..

In the 1980s the IRS established and defined what they considered to be a financing lease and a sale and leaseback. I think there were several factors, but nominal buyout was the main one. You take the sale price at the beginning, the interest implicit in the lease and guess what 99 times out of a 100 you have all the information you should need.. In the 80s you could even ask the lessor how they are treating it. I think you can always come up with your own rules and definitions, but a financing lease is not that difficult to discover or find the details... If you have the incidents of ownership and a nominal buyout at the end (less than 10% of original) you are there 99 out of 100 times, or you have no one owning it. NAPCO or NATCO(?) case plus others. Lessor wants to make his money for financing, manufacturing for selling and buyer for using in his business. There maybe exceptions, but they are the EXCEPTION.

[OldJack]

A tax preparer can't simply ignore his clients intent as IRS does not ignore his intent:

Sale or lease.
Some agreements that seem to
be leases may really be conditional sales contracts.
The intention of the parties to the agreement
can help you distinguish between a sale
and a lease.
There is no test or group of tests to prove
what the parties intended when they made the
agreement. You should consider each agreement
based on its own facts and circumstances.
For more information on leases, see chapter 4 in
Publication 535, Business Expenses.

Conditional sales contract.
Whether an agreement is a conditional sales contract
depends on the intent of the parties. Determine intent
based on the provisions of the agreement
and the facts and circumstances that exist when
you make the agreement. No single test, or special
combination of tests, always applies.
However, in general, an agreement may be considered
a conditional sales contract rather than
a lease if any of the following is true.

*The agreement applies part of each payment
toward an equity interest you will receive.
*You get title to the property after you make
a stated amount of required payments.
*You pay much more than the current
rental value of the property.
*You have an option to buy the property at a
nominal price compared to the value of
the property when you may exercise the
option. Determine this value when you
make the agreement.
*You have an option to buy the property at a
nominal price compared to the total amount
you have to pay under the agreement.
*The agreement designates part of the pay-
ments as interest, or that part is easy to
recognize as interest.

Leased property.
You can depreciate leased property only if you
retain the incidents of ownership (explained
below) in the property. This means you bear the burden of
exhaustion of the capital investment in the property. There-
fore, if you lease property from someone to use in your
trade or business or for the production of income, you
generally cannot depreciate its cost because you do not
retain the incidents of ownership. You can, however,
depreciate any capital improvements you make to the property.

Incidents of ownership. Incidents of ownership in
property include the following.
*The legal title to the property.
*The legal obligation to pay for the property.
*The responsibility to pay maintenance and operating
expenses.
*The duty to pay any taxes on the property.
*The risk of loss if the property is destroyed, condemned,
or diminished in value through obsolescence or exhaustion.