Pioneer Tax Advisors, LLC

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A common 𝐦𝐢𝐬𝐭𝐚𝐤𝐞 I often see when reviewing 𝐅𝐨𝐫𝐦 𝟏𝟎𝟒𝟎 for 𝐂𝐚𝐥𝐢𝐟𝐨𝐫𝐧𝐢𝐚 𝐫𝐞𝐬𝐢𝐝𝐞𝐧𝐭𝐬 with an 𝐋𝐋𝐂 that is a 𝐝𝐢𝐬𝐫𝐞𝐠𝐚𝐫𝐝𝐞𝐝 𝐞𝐧𝐭𝐢𝐭𝐲 is 𝐟𝐨𝐫𝐠𝐞𝐭𝐭𝐢𝐧𝐠 to include 𝐅𝐨𝐫𝐦 𝐂𝐀 𝟓𝟔𝟖. Let's break it down:

Normally, a 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬𝐡𝐢𝐩 (Form 1065) requires 𝐚𝐭 𝐥𝐞𝐚𝐬𝐭 𝐭𝐰𝐨 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬. But when 𝐨𝐧𝐞 𝐩𝐚𝐫𝐭𝐧𝐞𝐫 𝐥𝐞𝐚𝐯𝐞𝐬, and only one remains, the 𝐋𝐋𝐂 𝐛𝐞𝐜𝐨𝐦𝐞𝐬 𝐚 𝐬𝐢𝐧𝐠𝐥𝐞-𝐦𝐞𝐦𝐛𝐞𝐫 𝐋𝐋𝐂 (𝐒𝐌𝐋𝐋𝐂) and is 𝐜𝐨𝐧𝐬𝐢𝐝𝐞𝐫𝐞𝐝 𝐚 𝐝𝐢𝐬𝐫𝐞𝐠𝐚𝐫𝐝𝐞𝐝 𝐞𝐧𝐭𝐢𝐭𝐲 by the 𝐈𝐑𝐒. An LLC with just two partners, with a 𝐡𝐮𝐬𝐛𝐚𝐧𝐝 𝐚𝐧𝐝 𝐰𝐢𝐟𝐞, can also 𝐞𝐥𝐞𝐜𝐭𝐞𝐝 to be treated as a 𝐝𝐢𝐬𝐫𝐞𝐠𝐚𝐫𝐝𝐞𝐝 𝐞𝐧𝐭𝐢𝐭𝐲 in California.

While the 𝐈𝐑𝐒 𝐝𝐨𝐞𝐬 𝐧𝐨𝐭 require disregarded entities to file Form 1065, 𝐂𝐚𝐥𝐢𝐟𝐨𝐫𝐧𝐢𝐚 𝐡𝐚𝐬 𝐝𝐢𝐟𝐟𝐞𝐫𝐞𝐧𝐭 𝐫𝐮𝐥𝐞𝐬. If you have an LLC in California, and it's disregarded by the IRS, you 𝐬𝐭𝐢𝐥𝐥 𝐧𝐞𝐞𝐝 𝐭𝐨 𝐟𝐢𝐥𝐞 𝐅𝐨𝐫𝐦 𝐂𝐀 𝟓𝟔𝟖. This applies even if an 𝐢𝐧𝐝𝐢𝐯𝐢𝐝𝐮𝐚𝐥 𝐟𝐨𝐫𝐦𝐬 𝐚𝐧 𝐋𝐋𝐂 to report 𝐒𝐜𝐡𝐞𝐝𝐮𝐥𝐞 𝐂 𝐨𝐫 𝐄 income, they must file Form CA 568 for their 𝐒𝐌𝐋𝐋𝐂 in California.

Tax preparers often rely on previous year returns and many times miss Form CA 568 if a 𝐧𝐞𝐰 𝐋𝐋𝐂 was 𝐟𝐨𝐫𝐦𝐞𝐝. For new clients, many times CPAs 𝐪𝐮𝐨𝐭𝐞 𝐟𝐞𝐞𝐬 based on the prior year’s return, but if new LLCs are formed in the current year then it can cause 𝐮𝐧𝐞𝐱𝐩𝐞𝐜𝐭𝐞𝐝 𝐟𝐞𝐞 𝐚𝐝𝐣𝐮𝐬𝐭𝐦𝐞𝐧𝐭𝐬, which can adversely affect client relationships. To avoid this, we have added a question to SOP where we now ask how many LLCs a client has to give accurate quotes and avoid surprises for CA returns.

Always remember to 𝐜𝐡𝐞𝐜𝐤 for 𝐋𝐋𝐂𝐬 on the 𝟏𝟎𝟒𝟎 𝐟𝐨𝐫 𝐂𝐚𝐥𝐢𝐟𝐨𝐫𝐧𝐢𝐚 𝐜𝐥𝐢𝐞𝐧𝐭𝐬, and make sure to 𝐟𝐢𝐥𝐞 𝐅𝐨𝐫𝐦 𝐂𝐀 𝟓𝟔𝟖.

𝐍𝐨𝐭𝐞: An LLC that isn’t registered in California but earns income from the state must still file Form CA 568. The rules are broad, but my goal is to highlight key points to remember when handling California returns.

IRS 5472 Collection Efforts

The IRS is now issuing 5472 penalties to foreign-owned disregarded entities for the 2018 tax year.

Be on the lookout for these notices. If there were no reportable transactions between the owner and the entity, you may be able to have the penalties waived, as these forms are only required if such transactions occurred under IRC 6038A.

If there was a reportable transaction in that tax year, you will need to file the 5472 and ask for a first time penalty abatement.

When preparing a 𝟏𝟎𝟔𝟓 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬𝐡𝐢𝐩 return with 𝐭𝐰𝐨 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬, you might face a situation where 𝐨𝐧𝐞 𝐩𝐚𝐫𝐭𝐧𝐞𝐫 𝐥𝐞𝐚𝐯𝐞𝐬 the business and the 𝐨𝐭𝐡𝐞𝐫 decides to 𝐜𝐨𝐧𝐭𝐢𝐧𝐮𝐞 𝐮𝐧𝐝𝐞𝐫 𝐭𝐡𝐞 𝐬𝐚𝐦𝐞 𝐧𝐚𝐦𝐞. This is where the concept of a "𝐝𝐢𝐬𝐫𝐞𝐠𝐚𝐫𝐝𝐞𝐝 𝐞𝐧𝐭𝐢𝐭𝐲" comes into play. Let’s break it down.

The 𝐫𝐮𝐥𝐞 is simple, a partnership requires 𝐚𝐭 𝐥𝐞𝐚𝐬𝐭 𝐭𝐰𝐨 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬 to be eligible to file a partnership return. If there’s only 𝐨𝐧𝐞 𝐩𝐞𝐫𝐬𝐨𝐧 𝐥𝐞𝐟𝐭, the business is 𝐧𝐨 𝐥𝐨𝐧𝐠𝐞𝐫 considered a 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬𝐡𝐢𝐩 by the IRS. Instead, it becomes a 𝐝𝐢𝐬𝐫𝐞𝐠𝐚𝐫𝐝𝐞𝐝 𝐞𝐧𝐭𝐢𝐭𝐲, meaning you can’t file a partnership return because a partnership, by 𝐝𝐞𝐟𝐢𝐧𝐢𝐭𝐢𝐨𝐧, involves 𝐭𝐰𝐨 𝐨𝐫 𝐦𝐨𝐫𝐞 𝐩𝐞𝐨𝐩𝐥𝐞.

Let us understand by an example: 𝐏𝐚𝐫𝐭𝐧𝐞𝐫 𝐀 and 𝐏𝐚𝐫𝐭𝐧𝐞𝐫 𝐁 run 𝐀𝐁 𝐋𝐋𝐂 together. On June 30th, 𝐏𝐚𝐫𝐭𝐧𝐞𝐫 𝐁 decides to 𝐥𝐞𝐚𝐯𝐞, and Partner A continues to 𝐨𝐩𝐞𝐫𝐚𝐭𝐞 the 𝐀𝐁 𝐋𝐋𝐂 𝐚𝐥𝐨𝐧𝐞. Now that 𝐏𝐚𝐫𝐭𝐧𝐞𝐫 𝐀 is the 𝐨𝐧𝐥𝐲 𝐨𝐰𝐧𝐞𝐫, the 𝐈𝐑𝐒 𝐜𝐨𝐧𝐬𝐢𝐝𝐞𝐫𝐬 𝐀𝐁 𝐋𝐋𝐂 𝐚 𝐝𝐢𝐬𝐫𝐞𝐠𝐚𝐫𝐝𝐞𝐝 entity as of 𝐉𝐮𝐥𝐲 𝟏𝐬𝐭.

For 𝐫𝐞𝐩𝐨𝐫𝐭𝐢𝐧𝐠, the period from 𝐉𝐚𝐧𝐮𝐚𝐫𝐲 𝟏𝐬𝐭 𝐭𝐨 𝐉𝐮𝐧𝐞 𝟑𝟎𝐭𝐡, the income and expenses should be 𝐫𝐞𝐩𝐨𝐫𝐭𝐞𝐝 on 𝐅𝐨𝐫𝐦 𝟏𝟎𝟔𝟓, treating it as if the 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬𝐡𝐢𝐩 has 𝐝𝐢𝐬𝐬𝐨𝐥𝐯𝐞𝐝, closing all assets and liabilities. For the period from 𝐉𝐮𝐥𝐲 𝟏𝐬𝐭 𝐭𝐨 𝐃𝐞𝐜𝐞𝐦𝐛𝐞𝐫 𝟑𝟏𝐬𝐭, 𝐀 would 𝐫𝐞𝐩𝐨𝐫𝐭 the business income and expenses on their 𝐩𝐞𝐫𝐬𝐨𝐧𝐚𝐥 𝐭𝐚𝐱 𝐫𝐞𝐭𝐮𝐫𝐧 (𝐅𝐨𝐫𝐦 𝟏𝟎𝟒𝟎) using 𝐒𝐜𝐡𝐞𝐝𝐮𝐥𝐞 𝐂.

These situations aren’t very common, but when they do arise, proper tax treatment is crucial. Many tax preparers mistakenly include everything in the 1065 return, thinking that since the 𝐛𝐮𝐬𝐢𝐧𝐞𝐬𝐬 𝐜𝐨𝐧𝐭𝐢𝐧𝐮𝐞𝐬 𝐮𝐧𝐝𝐞𝐫 𝐭𝐡𝐞 𝐬𝐚𝐦𝐞 𝐧𝐚𝐦𝐞, it remains a partnership. However, with only one partner left, it’s considered a 𝐝𝐢𝐬𝐫𝐞𝐠𝐚𝐫𝐝𝐞𝐝 𝐞𝐧𝐭𝐢𝐭𝐲, and the reporting rules change.

Thought for the day:

When filing a 𝐅𝐨𝐫𝐦 𝟏𝟎𝟔𝟓 for a 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬𝐡𝐢𝐩, you might have come across a situation where 𝐛𝐨𝐭𝐡 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬 𝐚𝐫𝐞 "𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬𝐡𝐢𝐩 𝐟𝐢𝐫𝐦𝐬". What happens if 𝐨𝐧𝐞 of the 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬𝐡𝐢𝐩 𝐟𝐢𝐫𝐦𝐬 𝐥𝐞𝐚𝐯𝐞𝐬? The entity would be considered a 𝐝𝐢𝐬𝐫𝐞𝐠𝐚𝐫𝐝𝐞𝐝 𝐞𝐧𝐭𝐢𝐭𝐲. Now the question is how to 𝐫𝐞𝐩𝐨𝐫𝐭 profits and losses. Let’s break it down.

Imagine a 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬𝐡𝐢𝐩 called 𝐀𝐁𝐂𝐃 𝐋𝐋𝐂, where the partners are 𝐀𝐁 𝐋𝐋𝐂 and 𝐂𝐃 𝐋𝐋𝐂 both 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬𝐡𝐢𝐩 𝐟𝐢𝐫𝐦, each holding 50%. On June 30th, 𝐂𝐃 𝐋𝐋𝐂 decides to 𝐩𝐚𝐫𝐭 𝐚𝐰𝐚𝐲, and 𝐀𝐁 𝐋𝐋𝐂 𝐜𝐨𝐧𝐭𝐢𝐧𝐮𝐞𝐬 𝐫𝐮𝐧𝐧𝐢𝐧𝐠 𝐀𝐁𝐂𝐃 𝐋𝐋𝐂 𝐚𝐥𝐨𝐧𝐞. Since AB LLC is now the only owner, the IRS considers 𝐀𝐁𝐂𝐃 𝐋𝐋𝐂 a 𝐝𝐢𝐬𝐫𝐞𝐠𝐚𝐫𝐝𝐞𝐝 𝐞𝐧𝐭𝐢𝐭𝐲 starting from July 1st.

In cases where partners are 𝐢𝐧𝐝𝐢𝐯𝐢𝐝𝐮𝐚𝐥𝐬, and only one is left, the remaining partner 𝐫𝐞𝐩𝐨𝐫𝐭𝐬 all 𝐩𝐫𝐨𝐟𝐢𝐭𝐬 𝐚𝐧𝐝 𝐥𝐨𝐬𝐬𝐞𝐬 on their 𝐢𝐧𝐝𝐢𝐯𝐢𝐝𝐮𝐚𝐥 𝐭𝐚𝐱 𝐫𝐞𝐭𝐮𝐫𝐧 (Form 1040). But what if 𝐛𝐨𝐭𝐡 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬 𝐚𝐫𝐞 𝐩𝐚𝐫𝐭𝐧𝐞𝐫𝐬𝐡𝐢𝐩𝐬, and one leaves?

In this example, from July 1st, 𝐀𝐁𝐂𝐃 𝐋𝐋𝐂 is now considered a 𝐝𝐢𝐬𝐫𝐞𝐠𝐚𝐫𝐝𝐞𝐝 𝐞𝐧𝐭𝐢𝐭𝐲, and 𝐚𝐥𝐥 𝐢𝐭𝐬 𝐩𝐫𝐨𝐟𝐢𝐭𝐬 𝐚𝐧𝐝 𝐥𝐨𝐬𝐬𝐞𝐬 𝐰𝐢𝐥𝐥 𝐛𝐞 𝐜𝐨𝐦𝐛𝐢𝐧𝐞𝐝 𝐰𝐢𝐭𝐡 𝐀𝐁 𝐋𝐋𝐂’𝐬 𝐭𝐚𝐱 𝐫𝐞𝐭𝐮𝐫𝐧 (𝐅𝐨𝐫𝐦 𝟏𝟎𝟔𝟓). This means ABCD LLC will no longer need to file its own 1065 return from next year. Until June 30th form 1065 will be filled for ABCD LL and from July 1st profits and loss will be 𝐜𝐨𝐧𝐬𝐨𝐥𝐢𝐝𝐚𝐭𝐞𝐝 with 𝐀𝐁 𝐋𝐋𝐂’𝐬 𝐫𝐞𝐭𝐮𝐫𝐧.

I have seen this situation many times, and it is important to note that in such cases, no future 1065 returns are filed for the disregarded entity. I have seen preparers making a mistake in this scenario repeatedly.

Q. I have set up my LLC in California state however it did not conduct any business for a particular tax year. Am I required to file the returns and pay taxes?

A. Yes, if you set up an LLC in California, you are required to file the return with the state and pay a minimum franchise tax of $800. Due to the passage of AB 85 law; any LLC, LP, LLP that register or organize to do business in the CA state for taxable years beginning on or after January 1, 2021 and before January 1, 2024 are not required to pay this minimum taxes. However, starting from 2024 tax year, this tax ($800) is required to be paid by the entities even if they have not generated any income during the year.

If you are looking to file your business or indivudual returns or are interested in tax planning; kindly reach out to us and we are always happy to assist you.

Understanding Deferred Tax Assets and Liabilities

Deferred Tax Asset (DTA)
When a company has paid more taxes according to its financial statements than what is due under tax laws. This excess can be used to reduce future tax obligations. It often arises due to differences in accounting practices between tax laws and financial reporting standards (e.g., GAAP or IFRS).

Key Situations Leading to DTA:
1. Carry forward Losses: When a company experiences a net operating loss (NOL), this can be used to offset future taxable income.
2. Expenses Recognized Earlier in Books than for Tax Purposes: Expenses like warranty provisions or bad debt allowances may be recorded earlier in financial statements, but tax laws may allow deductions only when the actual cash outflow occurs.
3. Tax Credits: Any tax credits earned but not utilized in the current year can lead to a deferred tax asset, reducing future tax liabilities.

Example:
A company records a provision for bad debts of $50,000 in its financial statements, but for tax purposes, this expense will only be recognized when the actual bad debts occur. This creates a deferred tax asset, as the company will save on taxes in the future.

Deferred Tax Liability (DTL)
When a company pays less tax than it has recognized in its financial statements. This creates a liability because the company will owe more taxes in the future as the temporary differences reverse.

Key Situations Leading to DTL:
1. Accelerated Depreciation: If tax laws allow a faster depreciation method (e.g., MACRS) than what is used for financial reporting, the company may have lower taxable income initially, creating a deferred tax liability.
2. Revenue Recognition: If a company recognizes revenue earlier for tax purposes than for financial reporting, it will have to pay taxes on the recognized revenue, creating a DTL.
3. Installment Sales: A company may recognize revenue immediately under GAAP, but tax laws might permit deferral of taxes until payments are received. This creates a temporary difference and a DTL.

Example:
A company uses straight-line depreciation for accounting purposes but uses an accelerated depreciation method for tax purposes. In the earlier years, the depreciation expense for tax is higher, resulting in lower taxable income, but the company will have to pay more tax in later years, creating a deferred tax liability.

Common Interview Questions on DTA and DTL
1. What is the difference between a deferred tax asset and a deferred tax liability?
DTA represents future tax benefits, while DTL indicates future tax obligations due to temporary differences between the book and tax treatments of transactions.

2. Can a company have both a deferred tax asset and liability at the same time?
Yes, a company can have both DTA and DTL if it has temporary differences that result in future tax savings (DTA) and future tax payments (DTL).

Q. What are some of the entity types an individual can set up in US?

A. As a US citizen or a resident, you can set up an S corporation, C- Corporation, sole proprietorship, LLC, LLP, LP in the US.

However, if you are not a US citizen or a resident, you can set up all the entities mentioned above except for S corporations which are only reserved for US Citizens and residents.

If you need any guidance or CPA assistance on what entity type is best suited for you and your business needs, kindly reach out to us on [email protected]

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Q. I started my business as a single member LLC (SMLLC) and elected for an S corp status. This year due to foreign ownership, my entity’s S corp election has been voluntarily terminated. Does that mean it is not taxed as an SMLLC or a partnership since it has 2 owners?

A. So you started as a Single member LLC (SMLLC) and thought you were cool with an S corp election, but now it's been terminated? Well, here's the thing, you don't get to just switch back to being an SMLLC, nope! Now you're basically a C-Corporation, congrats? You'll be filing form 1120 instead of 1120-S, and if you're confused, don't worry, we've got your back!

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Q. When do you need to apply for an ITIN?

Ans. ITIN or the individual tax payer identification number is required for foreign nonresidents aliens who do not have a valid SSN.

One of the common reasons why an individual would need an ITIN is when they intend to set up a business entity in the US and that business starts generating profits.

If you are a foreigner and have set up a foreign owned US disregarded entity in the US, or a partnership entity; you may be required to apply for an ITIN to report business net profits and pay taxes. However, if you as an indivudual set up a C-Corporation in the US; you may not have to apply for an ITIN if no dividends were declared and distributed to the foreign shareholders during the year.

If you need further guidance with ITIN or are looking to set up a business in the US or are looking to file US tax returns, kindly reach out to us and we will be happy to assist you with the services.

Looking for someone in the U.S who is willing to work on a commission basis to generate leads for a U.S. Tax service business. If interested, kindly get in touch with us on [email protected]