Thursday April 18, 2024

4.10.1 Proprietor Businesses

Proprietor Businesses

Property of Proprietors:  Millions of small business owners operate as sole proprietors.

Goals of Proprietors:  When a proprietor nears retirement, he or she typically has three main goals.

Solutions for Proprietors:  Most solutions focus on two goals.

Property of Proprietors
Millions of small business owners operate as sole proprietors. They own all of their business assets personally. They are personally liable for any claims against the business and they report the income and losses from the business on their personal income tax return Form 1040.

Among the owners who operate as proprietors are many real estate investors, small retail storeowners, consultants, farmers, ranchers and authors. When these proprietors enter into retirement years, it is quite common for them to plan to convert some of the value of their businesses into an income stream. This is an excellent opportunity to consider a charitable gift plan to maximize income and reduce taxation at the same time.

Proprietors have two general categories of assets. These are capital gain assets and ordinary income assets.

The capital gain assets have normally been held long term. The sale of any of these assets will result in capital gain equal to the difference between the fair market value and cost basis of the assets.

The typical capital assets for a proprietor include land, buildings and the goodwill in the business.

Assets that generally would produce ordinary income upon sale would be inventory, some operating assets, receivables and depreciated machinery and equipment. See Sec. 1245.

Goals of Proprietors
When a proprietor nears retirement, he or she typically has three main goals. These are to provide secure retirement income, to minimize taxes and to plan for a future inheritance for children and other family members.

Retirement income may be provided in part by Social Security and an IRA or other qualified retirement plan. However, since the proprietor has focused much of his or her efforts in building the business, it is very common for a major portion of retirement income to come from the sale of business assets.

If a sale of some assets is contemplated, then a business proprietor will desire to minimize tax on the sale. This is especially true with respect to sole proprietorships, since many business owners have very minimal basis in their property.

The third goal is a future inheritance benefit for family. This may be accomplished through distribution of assets in the estate to family members, or through an irrevocable life insurance trust.

Solutions for Proprietors
Most planning solutions focus on two goals. These are to increase liquidity and potential earnings through sale and reinvestment of assets and to reduce the impact of capital gains tax.

The solutions are fairly diverse. They depend to a significant degree on the type of property, the value of the business and whether the business can be sold as an operating entity. After weighing these factors, the business owner and his or her advisors can determine which assets should be sold outright and which assets are appropriate for a charitable plan. The combination of a sale to produce cash and a charitable plan to bypass tax on part of the asset sale, along with use of a charitable deduction to reduce tax on the portion sold, is powerful. It fits very well the financial objectives of many business owners.

Case Studies on Proprietor Businesses

Swenson "Early" Retirement, Part 1:   Bill and Clara Swenson consider themselves very fortunate. Bill was born in Norway. When he was seven years old, his parents immigrated to America. He attended high school and State College in Northern Minnesota. After he received a business degree, Bill moved back home and started a snowmobile and boating dealership. He and Clara worked very hard and now own two other dealerships. All are proprietorships. They also bought a small hotel and four commercial properties in town.

Private Letter Rulings

PLR 9616039 Real Estate Subdivision, Sale of Lots and UBI:   When a charity or a charitable trust receives a property, it is important to examine the potential unrelated business income (UBI) upon sale of the property. If the maximization of return requires sale of the property in lots or parcels, then the question is whether or not this dividing and selling would cause the charity to be entering into the real estate business and generating UBI under Secs. 512 through 514 of the Code.

Related Topics on Proprietor Businesses

4.14.1  Sub S Taxation:    The most common type of corporation is a traditional "C corporation." All companies whose stock is publicly traded are C corporations. C corporations pay tax on their net income at the corporate level and then when that income is distributed to shareholders in the form of dividends, the shareholders also pay tax. The result is that C corporation income is taxed twice - once at the corporate level and once at the shareholder level.

4.8.1  LLC Taxation and Unrelated Business Income:    A limited liability company (LLC) is a newer form of business entity created by state law. The owner of an LLC is called a member. While many LLCs have more than one owner or member, some states allow "single-member LLCs." Single-member LLCs have only one owner and for tax purposes are not recognized as separate from that owner.

Derby:    In Charles A. Derby et al. v. Commissioner; T.C. Memo. 2008-45; Nos. 10930-02, 10931-02,10932-02, 10933-02, 10934-02, 10935-02, 10936-02, 10937-02, 10939-02, 10941-02, 10942-02, 10943-02, 10945-02 (28 Feb 2008), the Tax Court denied a charitable deduction for the transfer of goodwill from a group of medical doctors to a nonprofit medical center.

      Quiz-Basic



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