Cellular phones can be a tax trap

Modern Machine Shop, March, 1992 by Irving L. Blackman

Cellular telephones seem to be like mushrooms. They are popping up everywhere. If you are sporting one in your car or elsewhere, think of it as an auto or computer. Why? Well, in terms of the tax law, those little telephones are subject to the same special depreciation and record keeping rules. Here are some of those rules.

Cellular telephones are not eligible for accelerated depreciation unless they are used more than 50 percent of the time in qualified business use. But you can use straight-line depreciation (five-year life) if you miss the 50 percent target.

No deduction is allowed, even if the phone is used for business, unless the business use is substantiated. No personal use, which would mean 100 percent business use, won't work either. The point is, substantiation will make or break your deduction.

When an employee uses a company phone for business, the employee must pay tax on the value of the use unless the business purpose is substantiated. Careful: This one is a double-edged sword. Suppose you don't provide your employer with the necessary proof (substantiation). First, the employer gets no deduction for even the legitimate business use; and, second, you get socked with a tax on the value of the entire phone use.

If you are willing to do it, this will get you home free. Keep a diary of all the business use of your cellular telephone. Mark down the date, time, and business purpose of each call. This tip requires some personal discipline to keep the deduction and avoid the tax penalty.

New IRS Ruling

Opens Transfer-To-Your-Children-Opportunity

Door

About 80 percent of our clients operate as S corporations (as opposed to C corporations - which are taxpaying corporations). If your S corporation, even inadvertently, is held to have two classes of stock, you automatically blow your S corporation status and become a C corporation. As a general rule, the rights of all stockholders in an S corporation must be fairly uniform.

Here are the facts on which a new ruling is based. An S corporation with three equal shareholders agreed to allow one of its shareholders (let's call him Joe) to sell back enough stock to the corporation so that his interest was reduced from 33 1/3 percent to 20 percent. Neither of the other two shareholders were offered this option.

Normally, when a corporation gives a benefit to one shareholder but not the other shareholders, the corporation is considered to have more than one class of stock. However, in this case, the IRS ruled that Joe was not receiving payment for his stock.

The IRS reasoned that even though Joe would end up with money not available to the other two shareholders, his ownership interest would be reduced to 20 percent. Therefore, the IRS ruled that the transaction did not endanger the S corporation status (See Letter Ruling 9124009).

This ruling opens up a great opportunity for transferring your business to your children. Remember, when Joe's interest was reduced to 20 percent, each of the other two stockholder's interest also went up to 40 percent.

So let's apply this situation to a father-kids-in-the-business situation. Father (instead of Joe) can sell part of his shares to the S corporation, thus increasing the ownership interest of his children who are fellow shareholders. My suggestion: Review the numbers and go over the possibilities with your professional advisor.