Speaking of fun, there are always fun and interesting tales and hypothetical situations that we find ourselves in or have at least asked about. The following situation was relayed to me by one of the CPA’s (certified public accountant) I work with. It goes to show that you need to ask a professional before making a financial decision that will change your life.Due to Colorado’s CPA/client privilege, the client name was not given, so I will call him John Q. Business Owner.John Q. Business Owner was doing business as a subchapter S corporation, reporting on the calendar year. S corporations are like partnerships in many ways. The S corporation’s income is directly taxable to its owners, and its losses pass through to owners for deduction on their tax returns. This corporation had a very poor year in sales with heavy losses and was under water with the loans the owner took out to stay afloat. John Q. Business Owner did what he thought was prudent and filed for bankruptcy on Dec. 15 – two weeks too soon!Why? When John Q. Business Owner filed a bankruptcy petition, all of the assets, with a few exemptions and exclusions, passed immediately to the bankruptcy trustee to be used to pay creditors who are, for the most part, unsecured creditors. In this case, the John Q. Business Owner’s S corporation stock was an asset passed to the trustee. With it went an asset of great value – that year’s tax-deductible loss.In the hands of John Q. Business Owner, the loss would have been enough to eliminate current tax and generate a big net operating loss. Such a loss can be carried back to other years, eliminating or reducing tax in those years.Because of when John Q. Business Owner filed bankruptcy, the owner didn’t own the loss. An S corporation’s loss for a year is determined at the end of the calendar year in this case. The S corporation stock was owned by the bankruptcy trustee at the end of the year. By filing for bankruptcy before the end of the year, the owner gave the bankruptcy trustee the loss.The trustee acquired the right to carry the year’s loss to other years, including back to a prior year when John Q. Business Owner had profits. With this right, the bankruptcy trustee could obtain a refund for the taxes the owner had paid in a previous year, even if the owner had made no claim – and didn’t know such a claim existed. Alternatively, the trustee can carry the loss to future years to offset income arising during bankruptcy from the owner’s assets now held by the trustee!The rules of bankruptcy overrule the laws concerning S corporations and pro-rated losses. The owner had argued that since he had held the stock 11/12 of the year, he should be entitled to 11/12 of the year’s loss. Not a bad argument, since the law pro-rates an S corporation stockholder’s share of the corporation’s loss on a daily basis throughout the year. When the trustee took ownership of the stock on Dec. 15, it received all the rights attached to that stock, including the right to claim all the loss determined at year-end.Moral of the story? As Benjamin Franklin once quipped, “The only thing certain in life is death and taxes.” Just don’t go out of your way to pay more than you really need to! CPAs, attorneys and a wide range of other professionals are available. Please make sure to use them before you jump off that cliff!About Alex Donnell and Colorado Comprehensive Wealth ManagementAlex Donnell is a nationally published author on topics in a variety of topics including estate planning and financial planning. Alex Donnell, founder and president of Colorado Comprehensive Wealth Management in Colorado Springs, and independent investment advisor representative for Heartland Financial Consultants, has been a part of the financial services industry for more than 17 years.Securities offered through Securities America, Inc., Member FINRA/SIPC, L. Alexander Donnell, registered representative. Advisory services offered through Heartland Financial, L. Alexander Donnell, investment advisor representative. Colorado Comprehensive Wealth Management, Heartland Financial Companies, and Securities America are not affiliated. Securities America and its representatives do not provide tax or legal advice. Any tax or legal information provided here is merely a summary of our understanding and interpretation of current tax and/or legal regulation and is not exhaustive. Please consult an appropriate advisor regarding your personal situation prior to acting on the information in this letter. 07/2009 SAI 71638
