John K. McGill, MBA, CPA, JD
I had thought about using my business vehicle as my personal vehicle in the future. But then a question came to mind about selling this vehicle after the business has taken the full depreciation. A colleague of mine recommended that I buy the vehicle, currently valued at $20,000, from my corporation for $2,500, and then sell it for the real value and take the profit as cash. His belief is, since the vehicle was depreciated to zero and has no value, the IRS will allow me to sell it at its actual value and not tax the income. This sounds too good to be true. Will it work?
The strategy recommended of selling a fully depreciated business automobile from the corporation to you at a price well below fair-market value — and then reselling it and claiming the cash proceeds are tax-free — will not work. Even though the business automobile has been fully depreciated by your corporation, the IRS requires that any sale or transfer be at full fair-market value. In the event of an audit, the IRS would require that the difference between the true fair-market value and the price that you paid would have to be claimed by you as income.
If you later sold the car, any gain (sales price above what you paid the corporation for the automobile) would have to be reported as taxable income on your personal tax return. Therefore, the strategies that have been recommended to you will not work.
I own my own home with a value of $800,000, and a current mortgage of $525,000. Since my investments are going nowhere, I have decided to buy a vacation home that has been appreciating rapidly for $1,000,000, and finance $750,000 of that amount. I thought that since each home mortgage was less than $1,000,000, all interest paid would be fully deductible, but my CPA says no. Who is correct?
Your CPA. Section 163 of the tax law governs deductibility of interest expenses. Under this section, interest is deductible on home mortgage indebtedness of up to $1,000,000. However, this is determined on an aggregate basis, not on the basis of each mortgage loan being less than $1,000,000. Accordingly, interest on a total of $1,000,000 of home mortgage debt would be deductible, while interest on the remaining balance ($275,000) would not be deductible. One strategy could salvage a partial deduction — by taking out a home-equity line of credit, interest on an additional $100,000 of debt could be deducted.
Several years ago, I was approached by a financial- planning firm with an offer that sounded too good to be true. Under their plan, I would purchase a disability insurance policy with a premium refund feature. At the end of 10 years, I would receive a return of 80 percent of my premiums paid, less any claims that I had. The sales representative assured me that all of the premium payment could be deducted by my regular "C" corporation and that I would not have to report any of the premiums refunded to me individually as income.
I bought the policy and am nearing my 10th anniversary when the premium refund is due. Can I receive this income tax-free without having to report it?
No. This premium refund feature is essentially a return of a portion of the premiums overpaid from prior years. Since those premiums were deducted by your corporation, the refund must be reported as income.
My children are 8 and 10, and I would like to employ them through my practice on a part-time basis to do clerical and other administrative duties. I have heard that there are substantial tax savings from doing this, but a dental colleague told me that that's not the case, since all income earned by children under the age of 14 is still taxed at my rate. I'm confused! Can you set me straight?
Yes. There are substantial federal and state income tax benefits available when you employ your children through your practice and pay them the highest reasonable salary in exchange for services actually rendered. The provision which your colleague cited applies only to unearned income (rents, dividends, capital gains, etc.) received by a child under the age of 14. A child's earned income is taxed at his or her rate, regardless of age. In 2004, a child can receive up to $4,850 of earned income, without any federal income tax liability.
John K. McGill is a tax attorney, CPA, and MBA, and is the editor of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($199 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, call (704) 424-9780 or visit the Web site at www.bmhgroup.com.