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Are You Preparing That Tax Return the Same Way You Did 5 Years Ago?

Posted on by Rachel Andujar
Tax return

Most likely, the answer is no. Remember the days with paper client files, colorful sticky notes, and calculator tapes? If you think about it, the “old way” of preparing tax returns was not that long ago. Change is happening and it’s happening fast.

In just 5 years, the tax preparation process has changed a lot. It went from paper documents and paper filing to electronic document storage and electronic filing (except for some old-school states and random filings). It then shifted to importing tax data into tax return software with one click (with some data manipulation, of course). Then it shifted to the initial tax preparation and data import process being outsourced overseas. All of this in 5 years. What will the next 5 years look like? How much time will you be spending on the actual compliance process in 5 years?

At the AICPA ENGAGE conference, Kimberly Ellison-Taylor and Barry Melancon gave an update on the profession. According to Accounting Today, American Institute of CPAs president and CEO Barry Melancon said, “We will not recognize our profession in the next 10 years – but it will still be critical.” He continued, “And honestly, I said 10 years so it wouldn’t scare you so much. It will probably be unrecognizable in five.”

You may want to say, “There will always be compliance work. The government still needs their tax returns.” This is true. Melancon said, “Most of you think your competition is the firm down the street but it may well be a company that doesn’t exist yet.”

This has already begun for virtual individual tax preparation services such as TaxFyle which wants to be “the Uber for taxes”. Of course, this is only for individual tax returns but it’s just the beginning in terms of industry disruption.

What it all boils down to is a reallocation of time. Instead of spending our time on data entry and data manipulation, we will be spending more and more of our time on providing strategy and consulting services to our clients. The firms that view this as an opportunity will reap the results. The firms that type in everything by hand and artistically color code their paper client folders may not.

What do you think? How has your tax preparation process changed in the past 5 years at your firm? What will the tax preparation process look like in 5 years at your firm?

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S Corp Shareholders Are Going to Have Basis Issues at Year End – Four Things for Them to Keep in Mind

When somebody repays a loan, that’s not income to the lender, is it? It can be when a shareholder loans money to an S corporation. New York businessmen Ira and Sheldon Nathel learned that the hard way in court this week. Ira and Sheldon each owned shares in food distributors that were set up as S corporations. When you own an S corporation you may deduct corporate losses on your 1040, but only if you have basis in your S corporation stock or in loans you have made to the corporation (guarantees of corporate debt don’t work).

Yes, there’s a catch. When you take S corporation losses, they reduce your basis — first in your stock, then in your loans. Subsequent income, including tax-exempt income, restores your basis in your debt andr. If you repay a loan with reduced basis, you have taxable income to the extent the repayment exceeds your basis.


At the end of 2000, IRA and Sheldon each loaned $649,775 to one of their S corporations. That enabled them to take losses of $537,228 or so, leaving them with $112,547 in remaining loan basis. That would have been fine if they had waited patiently until S corporation income had restored their basis. Their patience ran out in February 2001, when they repaid the loan in full.

They may have had second thoughts. In August 2001 Ira and Sheldon each made a capital contribution to the S corporation — $537,228, coincidentally. They then took a novel position on their 2001 tax returns. The Second Circuit Court of Appeals takes up the story:

In calculating their 2001 taxes, the Nathels treated their capital contributions… as constituting “tax-exempt income” to the corporations for the purposes of § 1366(a)(1)(A). Therefore, because the Nathels’ bases in their stock previously had been reduced to zero and because their bases in the loans they made to the corporations were also reduced, the Nathels used their capital contributions to restore their bases in the loans pursuant to § 1367(b)(2)(B). Without such an increase in their bases, the petitioners would have been taxed on the ordinary income that would have resulted from the corporations’ repayment of the petitioners’ loans in amounts above the petitioners’ previously reduced bases.

The IRS didn’t buy the idea that a capital contribution was some sort of income. They said a capital contribution increases capital, not debt, and is allocable to stock basis. That meant $537,228 in ordinary taxable income. Unfortunately for Ira and Sheldon, the Tax Court, and now the Second Circuit, continue to recognize the capital/income distinction that has been around for approximately forever.

The economy being what it is (still crappy), lots of S corporation shareholder are going to have basis problems at year end. They should keep a few points in mind:

• Basis is necessary to deduct losses, but it isn’t sufficient – Your basis has to be “at-risk” and you have to clear the maze of the “passive loss” rules.

• Use caution when repaying loans – When you make a year-end loan to your S corporation to enable you to deduct losses, repaying the loan will trigger taxable income until the loan basis is restored by subsequent S corporation income.

• “Open account” loans can be tricky – Regulations split “open account” debt into separate “loans” when the loan amounts exceed $25,000. That means fluctuating open account balances during the tax year can lead to taxable income, even if the balance ends up higher at year end than it was at the start of the year.

• Related party issues – It’s dangerous to borrow from one S corporation you control and loan the funds to another one. The IRS likes to attack such loans as lacking substance.

So Ira and Sheldon get to write some big checks to the IRS. They have the consolation of having $537,228 more basis in their stock, to offset other income somewhere, somehow, someday.

Joe Kristan is a shareholder of Roth & Company, P.C. in Des Moines, Iowa, author of the Tax Update Blog and Going Concern contributor. You can see all of his posts for GC here.