Time Warner (TWX) shares were up this week, thanks to a positive earnings announcement on Wednesday. Meanwhile, America Online's (AOL) shares were in the toilet. If you sell AOL and buy Time Warner, is it a wash sale because the companies are expected to merge? We'll tell you today.
We'll also tackle the age-old question of whether a trading business should be set up as a limited liability company or an S corporation.
Have any other tax questions? Send them to
firstname.lastname@example.org, and please include your full name.
Global Tax Forum Notice
The Global Tax Forum, which usually appears every other Wednesday, will be piggybacking onto the regular Saturday Tax Forum from now until April 15. So keep sending your questions about offshore tax issues. We'll address them right here until tax season is over. In fact, let's start with an international issue right now!
Ask your tax questions on the
Tax Forum board
Repaying Dad Overseas
I want to repay my father $30,000 borrowed during my study in the U.S. He prefers to invest it in the U.S. equity market. He doesn't live in U.S. and is not an U.S. resident alien. Question: If I open an online brokerage account for him, cut a check to him for $30,000 and manage the investment for him, will Uncle Sam think I am trying to evade tax liability under my father's name? If so, what should I do? -- Mike Wood
I'm assuming that you are no longer on a student visa and are now a resident alien in the U.S. who is taxed just like a U.S. citizen.
If that's the case, then paying back a debt is not a taxable event, says Clarence Kehoe, partner and director of employee benefits at
Anchin Block & Anchin
, a New York accounting firm. And your repayment wouldn't be subject to gift tax either.
If you set the trading account under your father's name and do not take any money from it, you are not evading taxes; you're just helping your dad with his investments. And fortunately, that's not a taxable event either.
Swapping AOL for Time Warner
I have a wash sale rule question. I am long AOL at an average price of $66. Can I sell my shares at a loss now and buy Time Warner without invoking the wash sale rule? I realize the merger is not a done deal and that it may fall through, but I believe that it is priced into Time Warner as it is less than 1.5 times AOL's price. -- Byra S. Ferkovich
I swiped your question off the
Tax Forum message board. With AOL down 28% since the beginning of the year, I'm assuming there are plenty of readers who can benefit from the answer.
As you say, the deal is not finalized, so you don't have to worry about AOL and Time Warner being
substantially identical, the standard the IRS uses for determining whether investments are subject to the wash sale rule.
Once shareholders approve the merger, it becomes official. At that point, you have to worry about the two securities being considered substantially identical. But until then, "selling the buyer and buying the target is a great merger play," says Robert Willens, a managing director and strategic tax guru at
in New York.
It makes a lot of sense based on AOL's recent stock market performance. So if you sell AOL, you'll generate a tax loss, which you can use to offset future gains. Then by purchasing Time Warner, you'll be right back in the thick of the merger action.
LLC or S Corporation?
Traders ask this question all the time. And now, thanks to
recent columns on
S corporations and
LLCs, you should have a solid understanding of the basics of these business structures. You now need to apply them to your trading situation.
Let's start with the reasons against doing your trading in a business entity like an LLC or S corporation.
Liability protection generally is a big reason to establish one of these entities. A small-business owner needs liability protection so that if a client slips and breaks his back on the way to his office, he won't lose his shirt.
But if you're a trader sitting in your basement in your fuzzy slippers, will you sue yourself if you fall down the stairs? Liability issues are not really a concern for you.
Even though the law allows you to set up a single-person LLC, the
Internal Revenue Service
will not recognize it for tax purposes, says Martin Nissenbaum, national director of personal-income-tax planning at
Ernst & Young
. A single-person LLC is treated like a self-employed person. You'd report everything on your
- Profit or Loss from Business
These things aren't cheap. You'll incur accounting and legal fees to set up and maintain these entities.
Now some reasons to consider a separate business entity:
If you file your tax return as a trader you do not pay into the Social Security system. That means you're on your own for retirement savings. And you don't have earned income, so that means IRAs are out too.
In that case, an S corporation may be an option. "If you set one up, you'll want to pay yourself a salary and thereby pay into the
Social Security system," says Nissenbaum. Your S corporation can then set up a pension plan.
Just weigh the costs of converting your trading income into taxable wages. You'll owe Uncle Sam FICA tax (that's for unemployment and Social Security), not to mention that you'll have bigger accounting and legal fees because an S corporation is required to file a tax return, notes Nissenbaum.
Setting up an entity can add to the validity of your trading business and make it look more official. "And the business also may be able to get preferential rates
for trading with brokerage houses," suggests Charles Vallone, a partner at
Frankel Loughran Starr & Vallone
, a financial advisory firm in New York.
In addition, many traders prefer the anonymity, notes Vallone: The LLC or S corporation would make the trade, not you.
So the decision to make your trading business a separate entity is a personal one. "There is nothing that says you should set up an entity," says Vallone. "But if you get to a level where you're doing a severe number of trades per day, you might want to consider it."
Remember to check your state's laws. Although these entities are recognized on the federal level, some states and municipalities do not acknowledge them. New York City, for instance, doesn't recognize S corporations.
TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.