I write and speak about tax law. Enough so and in various forums that many people tell me that I know a lot about the subject.
Most of all I like things that I don’t know. I am fascinated by my ignorance.
I also do a lot of research and write many, many articles in tax magazines. I don’t even know if anyone is reading it. But to be honest, I don’t care. I write for myself. To learn things.
To quote an old Dylan song, “I have a head full of ideas that drive me crazy.” Writing helps me focus on how to translate the madness into thoughts, for myself and sometimes for others are useful.
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Einstein was a smart guy. He said research is what we do when we don’t know what we are doing. Einstein spent his adult life doing research. I think he thought he didn’t know a lot. And more importantly, wanted to know.
The cool thing about researching things is that they show you all of the things that you don’t know or understand. It nourishes a feeling of wonder at the world and its secrets. It’s the only way I’ve found to stay young
I love the questions I get that I can’t answer right away. Today I’m bringing up a question I received from someone who attended one of my tax law webinars. He had a question he could never ask so he emailed me after that.
I suppose many teachers would ignore the question. The webinar is long over. But it was such a fundamental question that I didn’t know the answer to that I jumped on it.
In 2013, Congress passed a surcharge on investment income. This surcharge was intended to finance the Affordable Care Act (colloquially “Obamacare”).
We know Republicans hate Obamacare. However, they seem to like the income from the 3.8% investment tax. So there has been no effort to get rid of it.
This tax applies to high-income individuals who have capital gains such as dividends, interest, and capital gains. Selling shares results in a capital gain.
S companies are special status companies that allow income to be passed on to owners, avoiding corporate income tax. This pass-through status also triggers a special investment surcharge scheme for stock sales.
When a high income owner sells shares in an S company, the profit is treated as if it came from a sale of the company’s assets. This only applies to the application of the capital gains tax surcharge.
If the assets of the corporation are used commercially, the capital gains can count as operating income that is not subject to the capital gains tax surcharge. However, the seller must prove that he has contributed to the generation of this operating income.
Evidence is provided by showing that the shareholder “played a major role” in the year of sale. We have seven tests, most of which are based on hours spent, to determine Material Contribution (MP).
So here’s the question: what if the stock is sold in January 2021? Remember that MP tests are based on hours spent. The simplest one requires that people work more than 500 hours a year.
The customer of my webinar friend founded and built a company in an S group. He worked full time. Over 2,000 hours per year. He sold the stock for a profit of $ 4.2 million.
The investment premium would be $ 159,600. Well worth researching. There was a business. The seller-owner made a material contribution every year. What about the sales year?
A January sale makes it quite difficult, not impossible, to exceed 500 hour attendance. Could the time of sale really be a $ 159,600 error?
Fortunately no. Just because the business started in 2011. The owner participated significantly from 2011 to 2020 – 10 years. There is a special rule that states that if you have MP in five of the previous 10 years, you are also MP in the current year.
That’s $ 159,600 in relief. My nature is what if the business started in 2017. That only produced MP for four years. The lack of five years of MP history results in a “January effect” of $ 159,600. Really. How about apples?
James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at [email protected].