There are two types of interest in a partnership: Capital Interest and Profits Interest.  Both Capital Interest and Profit Interest are determined based on the contribution of property to the partnership and or services performed for the partnership.  The Tax Court has described a Capital Interest is any interest that would entitle the holder to receive a share of partnership assets upon liquidation of the partnership.  Profit Interest is any interest that would not entitle the holder to receive assets on an immediate liquidation but that does give the partner the right to share in future partnership profits or earnings (Mark IV Pictures Inc. v. Commissioner, T.C. Memo 1990-571), Reg. 1.721-1(b)(1) and Reg. 1.704-1(e)(1)(v) respectively.

If a partner receives an interest in the partnership in exchange for services, is beginning basis the partnership interest is the amount of income required to be reported for the transaction.  Under Reg. 1.721-1(b)(1), service provided is not a property that will satisfy the regulation for non taxable transaction.  Therefore, the LLC is deemed to have paid the individual partner for services in cash and the individual partner in return, contributed an equal amount of value (cash) to the partnership in acquisition of an interest in the partnership.  

When services are contributed to a partnership, the tax consequences will depend on the type of partnership interest received by the partner, i.e. whether or not that interest is restricted to the service partner in some way.  If non-restricted interest is received by the service partner, the fair market value of the interest is taxable to the service partner as ordinary income.  The LLC deducts or capitalizes that interest, based on the type of services rendered.  For example, if the service rendered by the partner was related to a capital project e.g. computer programmer created a code that will be used for a software, this type of service must be capitalized by the LLC and cannot be deducted as ordinary expense.

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If you have a small business like a sole proprietorship or an independent contractor, or you operate as Single Member LLC, you generally would consider yourself to be a self-employed.  For tax purposes, you must file IRS Schedule C, Profit or Loss From Business or Schedule C-EZ, Net Profit From Business with your individual income tax return Form 1040.  Here are some important facts for you to know:

If you are self-employed, your net earnings (after business deductions) are subject to Self-employment Tax. This tax consist of Social Security tax and Medicare tax.  Currently, for 2010, you would pay 15.3% of SE tax (subject to Social Security maximum cap).

Half of the SE Tax can be deducted above the line, meaning, this deduction reduces your AGI (Adjusted Gross Income)

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A taxpayer who trades securities, reports his/her trades on schedule D of form 1040. He/she is subject to the $3,000 annual limitation that applies to net realized capital losses. Also, securities are subject to the Wash Sales rules (in a nut-shell; loses will not be recognized for tax purposes if you sell a security at a loss and within 30 days you buy identical security). However, if you devote a great deal of time (see later what this means) trading stock, bonds, options or any other security, you might be able to qualify as a Trader for tax purposes.

This is accomplished by electing IRS Code Sec 475(f), also know as mark-to-market (M2M). By doing so, the Trader elects to mark his/her stock holdings to market at the end of the year. Under this method, all gains and losses are treated as ordinary income or loss. All the securities held as of December 31st are deemed to be sold at the year-end market value. If you were profitable, the realized capital gains from trades are not subject to Self-Employment tax, under IRC Sec 1402 (a)(3)(A). So by making this IRC Sec 475(f) election, a Trader avoids the $3,000 limitation on net capital losses and also he/she is not subject to the Wash Sale rules. If you made mark-to-market election you should report all gains and loses in Part II of Form 4797, instead of Schedule D. Once this election is made, it become irrevocable and cannot be changed without prior approval from the IRS. With mark-to-market, you elect to treat open positions as being sold on the last day of the year at Fair Market Value and immediately re-acquired at FMV in first day of the following year.

After making this election, you also should change the method of accounting by filing Form 3115 Application for Change in Accounting Method as outlined in the Revenue Procedure 2008-52. The 3115 should be attached to the 1040 for the first effective year, and a copy should be sent to the national office. See "Special Rules for Traders in Securities" in Publication 550. Because you are changing the accounting method you need to figur out the Sec. 481 (a) adjustment. This adjustment can be an income or deduction and should be reported on Schedule C and labeled "Section 481(c) Adjustment."

Example: At the end of 2010 you held shares with $26,000 in cost basis (your cost or purchase price) but value of $28,000 (the FMV of those shares at the end of the year). You made the mark-to-market election effective beginning in 2011. On 1/1/2011 the FMV of those shares is $32,000. You will report $4,000 of capital gain (32,000-28,000), in addition, you have also a Sec. 481(a) adjustment of $6,000 (32,000-26,000) in the first year you made the change. The Sec. 481(a) adjustment is the unrealized gain or loss in a trader’s trading account at the end of the prior year. In other words, it is the difference between the cost of the securities owned at the end of the prior year and the market value on January 1st of the following year.

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Many business owners are curious and interested to know about different ways to save money on taxes.  This article will introduce you to a legal way of reducing businesses or corporate taxable income by paying your minor children. The payments to minor children have to be reasonable.  The minor child needs to be compensated for the services actually performed as a bona fide employee of your business or a corporation.  This tax deduction might be appropriate for some business owners.   Minor child is referred to a child between 7 to 18 years of age.  Each state has different guidance and laws about the definition of minor, so please consult your legal advisor.

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The corporation does not recognize gain when it distributes cash to its shareholders.  Also when a shareholder in exchange for cash, redeems a corporation stock, the corporation recognizes no gain. (Sec. 311(a)).  On the other hand, if a corporation distributes property in connection to stock redemption, this may result in corporate-level capital gain and/or ordinary income.

Generally a corporation will recognize capital gains when it distributes capital assets or Sec 1231 assets.  So what happens if a corporation (C Corp or S Corp) distributes property or stock other than cash to a departing shareholder?  The corporation will recognized gain (not loss) if the fair market value (FMV) of the property exceeds its adjusted cost basis (Sec. 311(b)(1)).  The depreciation recapture of certain capital assets will trigger ordinary income and/or special unrecaptured sec. 1250 gain that is subject to 25% capital gain tax.  Basically the non-cash distribution is treated as if the corporation (C Corp or S Corp) had sold that property to the exiting shareholder.  This taxable transaction is reported on Form 1099-DIV and Form 5452.

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If you were thinking of getting additional office help and wanted to hire someone on a part-time of full-time basis you need to understand the difference between employees and independent contractors. There is a major difference between employees and independent contractors when it comes to how much tax you as an employer has to pay and withhold from their paychecks. Additionally, it will affect how much additional cost your business must bear, what documents and information they must provide to you, and what tax documents you must give to them.

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Religious organization can provide to clergy/ministers non-taxable benefits referred to as parsonage allowance. It’s done as part of total compensation paid to the minister. 

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Generally, you cannot deduct amounts that you approximate or estimate. You should keep proper records to prove your expenses or have sufficient evidence that will support your own statement. You must generally prepare a written record for it to be considered Proper. This is because written evidence is more reliable than oral evidence alone. However, if you prepare a record on a computer, it is considered a proper record.

What Are Proper Records?  You should keep the proof you need in a log, account book, diary, statement of expense, or similar record. You should also keep documentary evidence that, together with your record, will support each element of an expense.You generally must have documentary evidence, such as receipts, canceled checks, or bills, to support your expenses.

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