HIS BOOKLET covers the Federal tax problems of

the sole proprietor, the partnership, and the corpo

ration.

It is intended as a guide for the man in business or the man who practices a profession, who needs information about Federal Income Taxes, Excise Taxes, and Employment Taxes in connection with the establishment of a new business, the operation of a going business, and the closing out of a business.

CHECK LIST AND TAX CALENDAR. While the text goes into some detail on many problems, you will find on page 4, a check list which should be of assistance as a ready reference, of particular interest to the new businessman, and on page 126 a tax calendar for 1957.

THE BOOKLET DOES NOT COVER questions pertaining to joint and separate returns, personal exemptions, nonbusiness deductions and other matters not related to the operation of a business. Information on those subjects is contained in the Instructions which accompany Form 1040. Due to space limita

A

tions the tax rate schedules are not reproduced herein. They, too, are included in the Form 1040 Instructions.

The problems of foreign corporations, insurance companies, corporate reorganizations, collapsible corporations, banks, regulated investment companies, etc., are not covered.

TRADE or business is a pursuit or occupation which you carry on for the purpose of livelihood or profit. It includes the practice of a profession. If you engage in an activity for profit, you may be conducting a trade or business even if you are employed elsewhere on a full time basis. Or you may be engaged in more than one trade or business at the same time. However, an isolated transaction does not constitute the carrying on of a trade or business. If you are deemed to be carrying on a trade or

return, the expenses of a hobby are deductible only to the extent of the income from such hobby.

YOUR TAXES ARE IMPORTANT

If you are organizing a business, or have just purchased a going concern, or have already commenced operations, there are many aspects of the Federal tax laws with which you should become familiar so that you pay only your correct tax-no more or no less. You should, for example, understand the elections and choices which you, as a businessman, have as to when and how certain kinds of income shall be taxed to you and when and how certain expenditures shall be deducted. You should also be aware of the kinds of business activities which might subject your business to certain excise taxes. You should understand the difference in the tax treatment accorded to corporations, partnerships, and sole proprietorships.

ESTABLISHING A NEW BUSINESS

A new business is established either by the purchase of a going business or by the initial organization of a new venture. Before you establish your new business you may investigate a number of locations and sites which are available, or a number of going concerns potentially suited for your purposes.

INVESTIGATION EXPENSES. During such an investigation you may spend money for legal, accounting, and appraisal fees, and possibly salaries and travel expenses, as well as other expenses. The funds for such expenses will probably be your personal funds since the investigation is usually made before the business is organized or purchased. Expenditures of this type are not deductible for Federal tax purposes as business expenses because you were not engaged in the trade or business when the expenditures were made. Nor can you deduct such expenses as personal deductions, because they are not of the type specifically deductible by law. They cannot be treated as a loss on a transaction for profit, because you will not have entered into a transaction until you eventually acquire the business.

THESE INVESTIGATIVE EXPENDITURES ARE CAPITAL expenditures. They are not deductible currently and can generally be recovered only upon the sale or ultimate disposition of the business. In the case of a sole proprietorship they are an unamortizable or nondepreciable asset. In the case of a partnership they are part of your interest in the partnership. If the partnership reimburses you for such expenses, they are an unamortizable or nondepreciable asset of the partnership. If the expenses are incurred in the formation of a corporation, they are a part of the cost of your shares of stock in such corporation. If the corporation reimburses you for such expenses, they are a capital expenditure of the corporation, which may or may not be amortized depending upon an election which may be made as explained in Chapter 29. In no case can such expenses be added to the cost of depreciable assets.

IF YOU DO NOT ORGANIZE OR PURCHASE A BUSINESS which you have previously investigated, the expenditures for such investigation may be deductible as a loss on a transaction entered into for profit in the year you abandon the venture, provided your activities were more than a mere preliminary investigation. YOU MUST IDENTIFY EXPENDITURES. In the organization or purchase of a business you will pay for many things, even though some of them are hidden in a combined item under one name. It is important, for tax purposes, to correctly label or classify each item you pay for, since some expenditures can be claimed as deductions during the first year of operations while others cannot.

CAPITAL EXPENDITURES are expenditures made for the acquisition of assets which have an estimated useful life of more than one year. Such expenditures are also made for improvements, replacements and additions to property which increase the value of the property or prolong its life. These expenditures are depreciable except in the case of land or an asset which does not wear out or become obsolete, such as goodwill. See Chapter 15. Examples are: new buildings, improvements on present buildings, a new roof, bricking up windows or doors, new furniture and fixtures, commissions and other expenditures incident to the acquisition of property and equipment, and tools or instruments having an estimated useful life of more than 1 year. You cannot deduct the full amount of a capital expenditure as an expense in any one taxable year.

BUYING A GOING BUSINESS

The

THE PURCHASE OF A "GOING CONCERN" ordinarily requires the purchase of two or more kinds of property for a fixed or determinable amount. amount in some cases is for the entire business; in other cases an itemized list of the kinds of property purchased and the amount for each item may be contained in the bill of sale. A purchase of this sort does not result in the purchase of a single assetthe business, but such a purchase constitutes the purchase of the individual assets comprising the business. In either case your basis for each item purchased is equal to an amount which represents its fair market value (See Chapter 23), and the balance is usually allocated to an intangible asset of the business called goodwill. For example, assume you purchased an operating taxicab company for $50,000. If the only tangible assets of the business consisted of ten taxicabs with a fair market value of $2,000 each, your basis of each cab is $2,000 and the excess purchase price of $30,000 is your cost of goodwill.

A BARGAIN PURCHASE OF A BUSINESS does not justify a basis for assets purchased in excess of the cost, even though the fair market value of the assets exceeds the cost. The actual cost must be used as a basis and allocated to the assets in proportion to the fair market value of each asset. Consider the case of the taxicab company previously mentioned. If you purchased the company for $5,000, your basis for each of the ten taxicabs would be $500.

GOODWILL AND COVENANTS NOT TO COMPETE. In some cases the excess purchase price over the market value is paid to eliminate future competition from the seller under a covenant not to compete. In other cases the excess purchase price is for both a covenant not to compete and goodwill. In cases of this type you should determine whether the price paid for a covenant not to compete represents a business expense or a purchase of an asset. If you determine that it is for the purchase of an asset, you should also determine whether such asset is amortizable and whether the consideration paid for the covenant is separable from the total amount paid for the business.

GOODWILL. The methods of classifying such an asset differ with the circumstances and the terms of the purchase agreement. But where the purchase agreement is silent with respect to either goodwill or a covenant not to compete, the excess purchase price is allocated to goodwill, which is a capital asset never subject to amortization. If a covenant accompanies the transfer of goodwill and it has the function of assuring you the beneficial enjoyment of the goodwill you acquire, the covenant becomes nonseverable and its value is considered a capital asset not subject to depreciation or amortization.

THE BURDEN OF PROOF IS UPON YOU, the purchaser, to show that the covenant not to compete is not in effect the purchase of goodwill.

TRADEMARKS AND TRADE NAMES. Expenditures of this type are treated the same as goodwill. See further discussion in Chapter 15.

COVENANT NOT TO COMPETE. Where the excess purchase price is proven to be for a covenant not to compete, and the covenant is for a fixed number of years, the excess is deductible as a business expense proportionately over the life of such covenant. If there is no excess purchase price in the agreement but a covenant is executed as a part of the agreement which requires you to make periodic payments under the covenant, you may deduct such payments in the years made if the payments are paid proportionately over the life of the covenant and it is proven that such a covenant (and not goodwill) is being purchased.

SETTING UP A NEW BUSINESS

Organizing a new business usually involves the purchase of assets individually or in groups. The basis of each asset purchased is its cost. If you purchase some assets in groups, see the discussion in Chapter 23 under Assets Acquired in Groups for the method of allocating the purchase price to each asset. Sometimes assets which are used for personal purposes, such as a personal residence, are converted in whole or in part to a business purpose when a new business is started. For a discussion of this problem and other basis questions see Chapter 23.

REORGANIZING A BUSINESS

COMBINING SEVERAL BUSINESSES. Oftentimes a new form of business is organized by one or more persons without the necessity of purchasing assets. This occurs when two or more people wish to consolidate their individual businesses into a partnership or another form of organization. See Chapter 28. It also occurs when a partnership incorporates or when you incorporate your sole proprietorship. Again, the property of a sole proprietorship or partnership may be transferred to a previously existing corporation. See Chapter 29.

A NONTAXABLE GAIN MAY RESULT in cases of this sort. See Chapters 21, 28, and 29. In such cases be sure to consider the tax consequences not only of the tax-free transfer of the property but also of the income of the business in the year of transfer and in subsequent years.

FOR EXAMPLE, you may own a warehouse which has appreciated in value since you acquired it. If you transfer the building to a corporation in a tax-free exchange, the basis of the building remains the same in the hands of the corporation as it was in your hands. See Chapter 23.

RELATED PARTIES. In the sale or exchange of depreciable property, if the transaction is between husband and wife, or an individual and his controlled corporation, any gain will be taxed as ordinary income. Losses are not allowed between related parties. See Chapter 21.

KINDS OF BUSINESS ORGANIZATIONS Ordinarily there are 3 kinds of business organiza

The discussion in this booklet applies equally well, with exceptions noted, to partnerships and corporations, as well as to individuals or sole proprietorships. Chapters 28 and 29 are devoted entirely to partnerships and corporations.

It is important during the organization of any business to bear in mind the effect of the various income tax laws on the business. The effect of the laws upon any business depends upon the classification or definition of that business for tax purposes.

There are two classes of income tax rates-those applicable to corporations and those applicable to individuals. The corporation rates vary for different classes of corporations and also apply to joint stock companies and certain associations. See Chapter 29. The individual income tax rates apply to sole proprietors and members of a partnership.

Partnerships are usually treated as partnerships for Federal tax purposes. But they can be taxed as corporations-by election or by the presence of certain corporate characteristics in their make-up or operation. On the other hand, a corporation in some cases may be treated as a sole proprietorship or partnership.

Ordinarily, however, corporation income is taxed at corporation rates to the corporation, and its earnings which are distributed to the shareholders are taxed to them at individual rates. While a partnership is required to file a partnership income tax return, it is no more than an information return, and each partner is taxed on his share of the partnership earnings whether they are distributed or not.

EXCISE AND EMPLOYMENT TAXES

There are several types of Federal taxes, in addition to income tax, for which you may be liable, depending upon the type of business in which you are engaged. If you are a manufacturer of certain articles, you may be liable for the manufacturer's excise tax. If you sell certain merchandise at retail, you may be liable for the retailer's excise tax. See Chapter 26, for a discussion of excise taxes.

Should you hire one or more employees to assist you in the operation of your business, you are liable. for the Federal employment tax. See Chapter 24.

You will find that most Federal taxes, exclusive of the income tax, will be equally applicable whether you conduct your business as a sole proprietorship, partnership or corporation. However, a corporation is not liable for the self-employment tax, but you as an individual or a member of a partnership may be liable. See Chapter 25.

AVAILABLE ELECTIONS

There are several ways in which you can account for and report taxable income and compute your Federal taxes. Under most circumstances you have the right to choose the method which you deem most suitable for your business. Ordinarily elections are to be made during the first year of operation, but an election may be changed in subsequent years to meet the needs of the business if application is made to the Commissioner of Internal Revenue. However, some elections may be made without prior approval as explained throughout this booklet.