Charles Blair, DDS
John McGill, MBA, CPA, JD
I purchased a number of rental properties some time ago. They are now causing me significant losses. If I rent my office building to my professional corporation, can I use the profit generated to offset my losses from the other properties?
No. Under Section 469 of the tax law, only income from passive activities can be used to offset losses from passive activities. While leasing real estate is generally characterized as a "passive activity," Treasury Regulation Section 1.469-2(f)(6) recharacterizes rent from property to an activity in which a doctor materially participates (his or her dental practice) as "not from a passive activity." In a recent tax court case - Schwalbach vs. Commissioner, 111 T.C. No. 9 (1998) - the court specifically ruled that this regulation was valid, and that the dentist involved could not use his office building rental profits to offset other real estate losses.
My professional practice has operated a cafeteria plan for a number of years. Many employees have complained because they only can change the amounts withheld from their pay once a year. My CPA said this recently changed. Is he correct?
Yes. In Treasury Decision 8878, Tax Treatment of Cafeteria Plans, the IRS announced that final regulations under Section 125 would now permit mid-year cafeteria-plan elections with respect to medical and group term-life insurance by an employee who has a change in marital status, number of dependents, employment, work situation, etc., during the course of the year. Otherwise, elections are only permitted at the beginning of the year.
My partner and I operate an incorporated (regular C) dental practice and recently began discussions on a buy-sell agreement. Our CPA recommended that, since we will cover each other with buy-sell life insurance, the entire value of each partner's stock ownership interest should be allocated to the purchase of stock in the event of death. However, in the event of retirement or disability, only a minimum value would be placed on the stock itself. The balance would be paid to the selling shareholder as deferred compensation, in order for the practice to be able to deduct it from taxes. I am concerned about this, since we have a different value of the stock itself for death and other buy-out purposes. Will this fly with the IRS?
No. In a recent similar situation involving an incorporated law practice - Estate of Cartwright vs. Commissioner, 84 A.F.T.R.2d 5218 (9th Cir. 1999) - the law firm had a detailed buy-sell agreement which specified that a portion of the value was for the assets of the practice, while a much larger amount was based upon the value of accounts receivable, work in process, and bonuses normally due a shareholder. In this situation, the estate treated the entire amount (more than $5 million) as payment for the stock itself. The estate did this to claim the entire amount as tax-free income, since the stock received a "stepped-up basis" due to its date-of-death value under Section 1014 of the tax law.
The Tax Court, however, agreed with the IRS, holding that the value of the stock was only approximately 20 percent of the total, and the balance (more than $4 million) was deductible to the corporation as compensation, but was fully taxed as ordinary income to the estate. Thus, in your situation, where you are establishing separate stock values based upon the return for payout, the IRS would easily reach the same conclusion - the true stock value in the event of death would be the amount that would have been paid for the stock in the event of disability or retirement, with the balance treated as deferred compensation.
The information provided in this column is based upon the current Internal Revenue Code, regulations, IRS rulings, and court cases as of the date of publication. This column is not to be construed as legal or tax advice with respect to any particular situation. Contact your tax attorney or other adviser before undertaking any tax-related transaction.
Dr. Blair is a nationally known consultant and lecturer, and is a member of the American Academy of Dental Practice Administration. McGill is a tax attorney and MBA. They are the editors of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($155 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, or call (704) 424-9780.