question for tax experts

[farmer_giles]

This is copied from another forum, requesting any/all responses:

(I included a few challenges that were made there, for clarification)
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This scenario is about standard tax laws and rules.

A pass-through entity receives initially taxable income. So I want to expense as much as possible to reduce the gross, naturally. Off the top comes standard business expenses to begin with, but let's get creative, shall we?

How about dedicating this entity to a side-business, serving the requests of a family trust? The job of this "robot", this legal organization, is to provide certain benefits to its owners- housing food etc whatever money buys. So every penny spent in this regard is a business expense, this is what it costs to provide the service.

I submit this takes care of the income, by creating corresponding deductions. Even the service of investing and holding is provided- a deposit to a mutual fund or CD is an expense, it is an out-of-pocket cost. The corporation no longer has any of the income it earned at the end of the year; instead of making distributions it made expenses.

Now I understand that benefits received by the owners are gifts, if they aren't paid for. So besides the standard deductions and exemptions which can freely absorb some of the actual income, this business can give some stuff away free, up to the legal exemption limit per person ($12,000 this year coming and it rises every so often).

The business can also lend these benefits, or accept IOU's as payment. These are not income until redemption. If they turn out to be worthless securities, the SOL operates on their taxability.

The model here is to separate the two challenges: first how to expense all the income down to zero; then how to transfer values without incurring a taxable event.

You'd sooner invent a perpetual motion machine.

That's a good analogy, there is still a lot of efficiency to be established out there, machines that do run on a lot less fuel, natural energy systems, etc.

The entity can deduct its ordinary and necessary business expenses only if it's really in business to make a profit.

Yes, the profit is providing goods and services in return for payment- IOU's and some gifting as well. "Borrow one, get one free".

If it simply transfers its income and receives nothing in return, there is no way it will ever make a profit, so that it cannot deduct any of the payments as business expenses.

The return is the IOU's and the right to make gifts. The income is not merely transferred, it is openly spent on various items. These things are needed to run the business, as much as restaurants need to buy food, lodgings need to buy accommodations, rental agencies need something to rent etc.

If a real operating entity earns $100,000 in income and invests it in a CD, it doesn't get a deduction. It made an investment; it didn't incur an expense.

The CD is a business input needed to operate the investment and holding service. Keep in mind the point is not to avoid taxation on the transfer of this benefit to the customer; just to account this an expense to the company, who derives no personal benefit from the CD or other investment. The return to the company is the payment received, whether deferred or waived (within the gift limits).
I pay you to buy investments for me. Apart from your fee you will need something to invest; that's an operating expense. It's like I am leasing the investment, same as I might lease a car. I owe for this transaction and the account receivable is yours as a profitable compensation. Whenever these IOU's actually redeem, that will be gross income.

And there are always stock redemptions besides, or buy-backs. I can spend my shares with the company.

if the entity is a pass-through, its owners (who are presumably the recipients of the distributions) are taxable on all of the entity's income regardless of whether it's distributed or not

that's why we need to expense this income down to zero. Excluding the free standard deduction, exemptions tax credits etc.

none of the distributions are deductible by the entity.

agreed. we don't want any distributions past the free passes and credits.

Under no circumstances are [the distributions] gifts.

Of course not. But the services and goods otherwise provided can be freely gifted up to the limits.

the only gifts entities can deduct for income tax purposes are charitable contributions

The only gifts contemplated here are of services rendered and goods provided to the customers, irrespective of their ownership. In this capacity they are purchasing the trade or business of the company like anyone else might do.

Not deductions for income tax but indeed exemptions from the transfer tax (different part of Title 26) Nothing at all to do with income.

The income of the business from one endeavor is expensed on another, in return for deferred and waived payments.

annual gift tax exclusion that has nothing to do with the income tax

agreed, see above response. The flow is reversed here: instead of working for the company the company works for me. Like a robot-servant.

and that does not provide an income tax deduction.

It provides a way for this robot to render service for free.

lending money to the owners won't reduce the owners' income tax liability (if the entity is a pass-through)

There is no income tax on loans, loans aren't income. As a matter of fact it just occurred to me the loans may simply be an even-exchange; if the company already owes me money and pays in kind or other value that just closes the transaction.

The business income is expensed in the operating of the business of providing goods and services. The compensation for profit on all this is received in a deferred manner, or waived up to the gift exemption limits, or swapped for prior obligations.

if the debt becomes unenforceable the debtor has cancellation-of-indebtedness income.

Only if it is discharged as a write-off and a 1099 "windfall profits" information issues. Anyway all amounts can be perpetually (yes) refinanced, or distributed at some more convenient time, or for-given up to the exemption. Eventually the bankrupt and empty estate may owe...

phony-baloney IOU's that are never intended to be paid won't reduce the entity's income that will flow out to its owners.

in fact the company already owes me since everything they have was lent or invested by the stockholders. I can use my shares to purchase goods and services, which are expensive.

The model here is to separate the two challenges: first how to expense all the income down to zero; then how to transfer values without incurring a taxable event.

The two ought not be mixed, they are different animals.