AC 553 W4 – You decide
Will Penny

Memo dated 9/30

John and Lisa,
There many considerations to each of your tax questions. Please find them outlined below.

One: $300,000 influx (fee) from lawsuit
IRS Sec. 7701 states your LLC will be taxed as a partnership unless you elect to be taxed as a corporation. Since it is advantageous to you to be taxed as a partnership (pass through income versus tax on dividends), I will need to verify your LLC has been accepted by the IRS as a partnership.

Code Sec. 448 permits that a LLC can be cash based for tax purposes. The alternative is electing to be accrual based. This is important as to the timing of your income from the law suit. The $300,000 will constitute income in this subject tax year if you are cash based since this is when you received it. However, under accrual method, you could have billed for services over the two years and the “right to receive” that income would be included in the tax year when the bill was created and sent to the client.

As of right now, it looks like the $300,000 will be counted as income for this subject tax year. Next, let’s look at your expenses.

Two: $25,000 as income?
As we just discussed, the timing of expenses will vary depending on cash based versus accrual based accounting method. Since we are going to assume and verify that you are cash based, the $25,000 in expenses paid up front will not reduce your income in this subject year and the $25,000 received will be counted as income on this tax year. If in fact you did not deduct the expense in the past, then the $25,000 will not be taxable since it is a reimbursement.

Three: Buy vs. Rent office space.
Interest on a loan and depreciation are deductible as a business expense but so is your rent. Based on $300,000 income and not electing to be taxed as a corporation, you will be at the 33% tax bracket (Married