Paying Off Loan Through Corporation Invites IRS Audit

My son, who is in dental school, plans to join me in practice after graduation. Is there any way that my corporation can agree, as part of his employment contract, to pay off his student loan, provide a business car and arrange for a mortgage loan for him through the pension plan?

Charles Blair, DDS and

John McGill, MBA, CPA, JD

Question:

My son, who is in dental school, plans to join me in practice after graduation. Is there any way that my corporation can agree, as part of his employment contract, to pay off his student loan, provide a business car and arrange for a mortgage loan for him through the pension plan?

Basically, can we use pre-tax dollars to pay off his student loan? This is very important since the average dental school loan at the school my son is attending is over $90,000, and my son`s debt will be in excess of $100,000.

Answer:

In the event that your professional corporation chose to pay off the legal obligation of your son for his dental school loan, the IRS would, upon audit, attack the deductibility of the loan payments on the basis that this was not an ordinary and necessary business expense.

In addition, if they were successful in disallowing the deduction to the corporation, they would tax the amount of the loan payments as income either to yourself or to your son. This situation is tantamount to the corporation paying for your son`s dental school education expenses. The IRS has ruled previously that such a payment cannot be made with tax-deductible dollars, since this does not represent an ordinary and necessary business expense because the corporation could elect to hire another dentist without having to undertake this expense burden.

Likewise, the corporation cannot provide a car for your son`s benefit, nor arrange for a mortgage loan through the pension plan, without incurring significant tax problems. The fair- market value of the business car provided would not be a deductible business expense and would, in all likelihood, be subject to personal taxes to your son.

While the terms of your retirement plan may allow loans to be made, this is not a good idea since interest on such loans would not be tax-deductible. Accordingly, cheaper sources of mortgage funds can be found elsewhere and thus we do not recommend that you undertake this transaction.

Question:

How can an incorporated dentist use both the expensing election and $5,000 Americans With Disabilities Act tax credit for equipment purchased through the corporation?

Answer:

The Section 179 expensing election and Section 444 Americans With Disabilities Act tax credit are available to a professional corporation pur- chasing qualified equipment. However, the expensing election and tax credit cannot both be taken with respect to the same equipment purchase cost. For example, if the doctor purchases $15,000 of equipment that would qualify for the ADA tax credit, as well as the Section 179 expensing election, the $5,000 maximum tax credit under the ADA must be subtracted from the cost of the equipment, so that only the remaining $10,000 of cost would be eligible for the Section 179 expensing election.

In addition, a professional corporation must have a tax liability in order for the $5,000 tax credit to be of value to it. The doctor`s professional corporation could accumulate approximately $15,000 in taxable earnings at year`s end, in order to provide the tax necessary to offset the credit amount.

Question:

Last year, I fully redeemed a mutual-fund investment after the big surge in the market. After my original investment, I began contributing a set amount of dollar-cost averaging, and was also reinvesting all dividends and capital-gain distributions. How do I determine my cost basis in the mutual-fund investment for purposes of determining the gain from the sale?

Answer:

Your cost basis in the investment consists of three different components. The first component would be your original investment amount when you opened the account. The second component would be the total of all of the monthly amounts invested under your dollar-cost averaging program. Finally, you would add to this sum, the amount of reinvested dividends and capital gain distributions, since these are treated as if they were paid out to you and then reinvested immediately back into the mutual fund. The total of these three components would equal the total cost basis for purposes of determining the gain on your tax return.

Question:

I sold a stock at a loss on December 29 of last year, and the settlement date for the transaction was January 4, 1996. I did not take a deduction for the loss on my 1995 federal income tax returns since the trade closed out in 1996. Is this correct?

Answer:

No. Doctors are required to report a loss (or gain) on the sale of stocks or bonds in the year in which the transaction takes place, regardless of whether or not the settlement date falls within the same calendar year. Similarly, you also use the trade date of a purchase or sale, not the date of settlement, to determine whether or not the loss is short-term (one year or less) or long-term (more than one year).

It is recommended that you contact your tax attorney or other adviser before undertaking any tax-related transaction.

Dr. Blair is a nationally-known consultant and lecturer. 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 ($130 a year) and consulting information are available from Blair/McGill and Company, 4601 CharlottePark Drive, Suite 230, Charlotte, NC 28217, phone (704) 523-5882.

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