Chapter 12B. S Corporations C10-Chp-12B-1-SCorp-Passthru-Loss-Basis-Dist.ppt Edited 2010-0221 Howard...

Chapter 12B.S Corporations

C10-Chp-12B-1-SCorp-Passthru-Loss-Basis-Dist.pptEdited 2010-0221

Howard Godfrey, Ph.D., CPAProfessor of Accounting

Copyright 2010. Howard Godfrey.

The student should be able to:7. Calculate a shareholder's share of ordinary

income or loss & separately stated items. 8. Determine the limits on a shareholder's

deduction of S corporation losses. 9. Calculate a shareholder's basis in his or

her S corporation's stock and debt.10. Determine the taxability of distributions

to its shareholders. 11. Explain the procedures for filing an S

corporation tax return. 12. Determine the estimated tax payments required

of an S corporation and its shareholders.

3

Lets get a preview of what we will be computing, and why it is important to keep up with E&P (if there is any),

Basis of stock and AAA.

See next slide.

Joe owns 100% of S corp. His basis is $18,000.

Balances: AAA = $2,000, E&P = $3,000, debt = $0.

Joe takes a current distribution of $25,000.

How much total income is recognized by Joe?

Dist. AAA E&P Basis IncomeDist./Balances $25,000 $2,000 $3,000 $18,000DistributionDistribution

DistributionCap. Gain

Answer if a C corp? E&P=$3,000, AAA-N/A

Joe owns 100% of S corp. His basis is $18,000.

Balances: AAA = $2,000, E&P = $3,000, debt = $0.

Joe takes a current distribution of $25,000.

How much total income is recognized by Joe?

Dist. AAA E&P Basis IncomeDist./Balances $25,000 $2,000 $3,000 $18,000Distribution ($2,000) ($2,000) ($2,000)Distribution ($3,000) ($3,000) $3,000

$20,000 $0 $0 $16,000Distribution ($16,000) ($16,000)Cap. Gain $4,000 $4,000

Answer if a C corp? E&P=$3,000, AAA-N/A

7. Calculate a

shareholder's allocable share of ordinary income or loss and separately stated items.

7

Bow Corp, an S corp, has 3 equal stockholders. For the year ended December 31, 2010, Bow had taxable income of $300,000, and municipal interest of $20,000. Bow made cash distributions totaling $120,000 during 2010. For 2010, what amount from Bow should be included in each stockholder's gross income?

a. $40,000 b. $60,000c. $100,000 d. $140,000 CPA May, 1987

8

Bow Corp, an S corp, has 3 equal stockholders. For the year ended December 31, 2010, Bow had taxable income of $300,000, and municipal interest of $20,000. Bow made cash distributions totaling $120,000 during 2010. For 2010, what amount from Bow should be included in each stockholder's gross income?

a. $40,000 b. $60,000c. $100,000 d. $140,000 CPA May, 1987

9

Income Allocation Procedures. Shareholders report their allocable share of ordinary income and loss and separately stated items in the tax year in which the S corporation's tax year ends.

These allocation rules are known as the "per day/per share" method.

Special allocations are not allowed.

If stock is transferred during the year, income must be allocated between the owners.

10

No Accum. E & P. Also no debt.On Jan. 1, Mark's Basis in stock: 9,000$ Scorp reports book income of: 4,500$

Book income includes:Mun. Bond Interest Income 2,000$ Gross Meals & Ent. Expense 1,000$

Mark's share of ordinary incomereported on his Form 1040.

Mark's stock basis at year-end?

Mark owns 50% of Scorp.

Mark - Book income to TI

Net Income per books 4,500$

Tax-free income

Non-deductible Expenses

Ordinary Income

Stock Ownership 50%

Mark's share of ordinary income

Mark - Book income to TI

Net Income per books 4,500$

Tax-free income (2,000)

Non-deductible Expenses 500

Ordinary Income 3,000$

Stock Ownership 50%

Mark's share of ordinary income 1,500$

Mark - Stock Basis Sec. 1367

Investment or Beginning Basis 9,000$ Add: Ordinary Income

Separate Income & gainsTax-free incomeContributions of Capital

Less: Ordinary LossSeparate Exp. & LossesNon-deductible ExpensesTax-Free Withdrawals

Ending Stock Basis

Loss limit includes loans to S Corporation.

Mark - Stock Basis Sec. 1367

Investment or Beginning Basis 9,000$ Add: Ordinary Income 1,500

Separate Income & gainsTax-free income 1,000 Contributions of Capital

Less: Ordinary LossSeparate Exp. & LossesNon-deductible Expenses (250) Tax-Free Withdrawals

Ending Stock Basis 11,250$


15

Look at preceding slide.

Would basis be different if the corporation borrowed $100,000 in the last week of the year, and owed this amount at year-end?

16

Bern Corp., an S corp, had an ordinary loss of $36,500 for the year ended December 31. At January 1, Meyer owned 50% of Bern's stock. Meyer held the stock for 40 days in the year before selling the entire 50% interest to an unrelated third party. Meyer's basis for the stock was $10,000. Meyer was a full‑time employee of Bern until the stock was sold. Meyer's share Bern's loss for the year was

a. $0 b. $2,000 c. $10,000 d. $18,250 CPAM91#56

Hint:

Preceding Slide:

Loss is $100 per day for the corporation.

Sec. 1366(a)(1) Pro-Rata

Sec. 1377(a)(1) (Per share-Per day)

18

Bern Corp., an S corp, had an ordinary loss of $36,500 for the year ended December 31. At January 1, Meyer owned 50% of Bern's stock. Meyer held the stock for 40 days in the year before selling the entire 50% interest to an unrelated third party. Meyer's basis for the stock was $10,000. Meyer was a full‑time employee of Bern until the stock was sold. Meyer's share Bern's loss for the year was

a. $0 b. $2,000 c. $10,000 d. $18,250 CPAM91#56

19

LM Corp. Allocations -1 On 1-1 of Yr 1, Lisa & Marie were equal owners of LM Corp., an S corp. On April 30, yr 1, Lisa sold half of her stock to Shelley. On August 8, yr 1, Marie sold all of her stock to George. Corp. had net loss of $50,000 for Yr 1. How is this loss allocated to Lisa, Marie, Shelley, and George? (Year 1 is not a leap year, and the day of sale is allocated to the seller.)

20

LM Corp. -2 Lisa

Loss for year 50,000$ Loss per Day 137$

Lisa's ShareDays Owned 120 Percentage Owned 50% ?

?Days Owned 245 Percentage Owned 25% ?

?

Total

21

LM Corp. -3 Lisa


Lisa's ShareDays Owned 120 Percentage Owned 50% 60

8,220 Days Owned 245 Percentage Owned 25% 61

8,391

Total 16,611$

22

LM Corp - 4 Shelley


Shelly's ShareDays Owned 245 Subtotal 33,565 Percentage Owned 25%

Shelly's Share 8,391$

23

LM Corp. -5Loss allocations to Lisa and Marie should add to 50% of $50,000

24

LM Corp. Allocations -6Daily allocation of $50,000 = $137 per day.

Lisa: (50% x 120 x 137) + (25% x 245 x 137) = $16,611

Shelley (25% x 245 x 137) = $8,391

Marie (50% x 220 x 137) = $15,070

George (50% x 145 x 137) = $9,933

25

Income Allocation Procedures. A special election is available for allocating the ordinary income or loss and separately stated items when the shareholder's interest in the S corp is terminated during the tax year or when the interest is substantially reduced, even if not completely terminated. If the election is made, the income is allocated according to the accounting methods used by the S corp (instead of on a daily basis). The election divides the S corp's tax year into two parts ending on (1) the day the shareholder's interest in the corp is terminated, and (2) the last day of the S corp's tax year. This election can only be made if all affected shareholders agree.

26

Loss and Deduction Pass-through to Shareholders. A corporation's ordinary loss and separately stated loss and deduction items pass through to the shareholder(s) in the tax year in which the S corporation's tax year-ends.Allocation of Loss. Allocation of loss occurs on a daily basis. Losses and deductions allocated in excess of the shareholder's income create an NOL for the shareholder and results in a carryback or carryover to the shareholder's other tax years.

8. Determine the

limitations on a shareholder's deduction of S corp losses.

28

Shareholder Loss Limits. A shareholder’s deduction for his share of the loss and separately stated loss and deduction items is limited to his basis in stock plus basis of any indebtedness owed directly by S corp. to shareholder. Amounts of income or gain for the year are added to basis before determining the loss limitation. Next, basis is reduced for distributions not included in shareholder’s income.

29

Once the loss limit is determined, the basis decreases occur in the following sequence: decreases attributable to nondeductible, noncapital expenditures, decreases attributable to ordinary losses, separately stated loss and deduction items. Sequencing the basis reduction for distributions ahead of the absorption of the losses means that distributions reduce the deductibility of S corp loss and deduction passthroughs, but losses do not change the taxability of S corp distributions.

30

On January 1, Mr. Karl purchased 50% of Olive Inc., an S corporation, for $75,000. During the year, Olive Inc. incurred an ordinary loss of $160,000.

How much of the loss can Mr. Karl deduct on his personal income tax return for the year?

a. $160,000 b. $80,000

c. $75,000 d. $37,500

31

On January 1, Mr. Karl purchased 50% of Olive Inc., an S corporation, for $75,000. During the year, Olive Inc. incurred an ordinary loss of $160,000.

How much of the loss can Mr. Karl deduct on his personal income tax return for the year?

a. $160,000 b. $80,000

c. $75,000 d. $37,500

32

Bob invested $25,000 for all of the stock of a new Corp on January 1. The corp immediately elected S Status. He also loaned the S Corp $10,000 during the year which has not been repaid. At year-end the corp owed $100,000 to the local bank. The S Corp has an operating loss of $50,000 for the year. What maximum amount of loss (before passive and at-risk limitations) can Bob deduct on his tax return? a. $35,000 b. $10,000c. $50,000 d. $25,000

33

Bob invested $25,000 for all of the stock of a new Corp on January 1. The corp immediately elected S Status. He also loaned the S Corp $10,000 during the year which has not been repaid. At year-end the corp owed $100,000 to the local bank. The S Corp has an operating loss of $50,000 for the year. What maximum amount of loss (before passive and at-risk limitations) can Bob deduct on his tax return? a. $35,000 b. $10,000c. $50,000 d. $25,000

No Accum. E & P. Also no debt.On Jan. 1, Sam's Basis in stock: $1,000SamCorp's distribution to Sam: 600SamCorp's capital gain in year: 200SamCorp's operating loss for year: (900)Amt of distribution taxed to Sam?Amt of cap. gain Sam reports?Operating loss Sam reports?Sam's stock basis at year-end?Sam's suspended loss?

SamCorp is an S Corp. owned by Sam - 1

IRC 1366(d)(1), 1367(a)(1), (2)(A) [1996 Act]

No Accum. E & P. Also no debt.On Jan. 1, Sam's Basis in stock: 1,000$ SamCorp's distribution to Sam: 600SamCorp's capital gain in year: 200SamCorp's operating loss for year: (900)Amt of distribution taxed to Sam? 0Amt of cap. gain Sam reports? 200Operating loss Sam reports? (600)Sam's stock basis at year-end? 0Sam's suspended loss? 300$


IRC 1366(d)(1), 1367((a)1), (2)(A) [1996 Act]

On Jan. 1, Sam's Basis in stock: 1,000$ SamCorp's capital gain in year: 200Basis before distriburtion 1,200SamCorp's distribution to Sam: 600Basis before loss allocation 600SamCorp's operating loss for year: (900)Limit on Sam's loss deduction (600)Sam's suspended loss? (300)Sam's stock basis at year-end? -$


IRC 1366(d)(1), 1367(1), (2)(A) [1996 Act]

On the preceding slide, Sam’s basis is increased by income items, then reduced by the distribution, then the expense and loss items are taken into account. Basis goes from $1,000 to $1,200 due to capital gain. Basis is then reduced by the $600 distribution. This gives a net basis of $600 for considering operating loss of $900. There is a suspended loss of $300.

38

On the preceding slide, how would the results differ if we first deduct the loss and then show the distribution?

Sec. 1368(d)

Consider basis increases only before distribution.

39

Shareholder Loss Limits.

If stock in an S corp is sold while there are unused losses due to lack of basis, the losses lapse and can not be used by the purchaser.

However, if the shareholder transfers the S corp stock to a spouse or former spouse incident to a divorce, the suspended losses transfer to the spouse or former spouse. Thus, the spouse or former spouse can deduct the losses when he or she obtains sufficient basis.

40

Shareholder Loss & Deduction Limits. S corp shareholders are subject to three additional loss limits: the at-risk rules; the passive activity loss and credit limitation rules; and the hobby loss rules. Some separately stated loss and deduction items are subject to shareholder limits (e.g., charitable contributions, long-term capital losses and investment interest expense) though they are not subject to corporate limits. Some separately stated items are subject to corporate limits but not shareholder limits (e.g., the 50% nondeductible portion of travel and entertainment expenses). Post-termination Loss Carryovers. Loss and deduction carryovers can be carried over after an S election is terminated and deducted by the shareholder in the post-termination transition period.

41

Family S Corporations. The IRS can reallocate income attributable to stock that is transferred to a family member when the transferor retains the economic benefits and control over the stock. The IRS can also allocate the items of income, deduction, gain, loss and credit to reflect the value of services rendered or capital contributed by a family member.

9. Calculate a

shareholder's basis in S corp's stock and debt.

43

Basis Adjustments to S Corp. Stock. The basis adjustments parallel those made to determine a partnership interest's basis. Adjustments include taxable and tax-exempt income, and separately stated items. Adjustments are made on last day of tax year. The formula for determining the basis for S corporation stock is shown on the next page.

Stock Basis §1367Investment or Beginning BasisAdd: Ordinary Income


Less: Ordinary LossSeparate Exp. & LossesNon-deductible ExpensesTax-Free Withdrawals

Ending Stock Basis


45

Haas Corp., a calendar year S corp, has two equal shareholders. For the year ended December 31, Haas had taxable income of $60,000, which included $50,000 from operations & $10,000 from investment interest income. Hass also had municipal bond interest income of $8,000. There were no other transactions that year. Each shareholder's basis in the stock of Haas will increase in the year bya. $50,000 b. $34,000c. $30,000 d. $25,000 e. $0 CPA 1994

46

Haas Corporation Info. Basis

Taxable Income $60,000

Ordinary Income $50,000 $50,000

Investment income $10,000 10,000

Municipal bond interest $8,000 8,000

Basis Change: all owners 68,000

Basis Change: 50% owner $34,000

47

Basis Adjustments to Shareholder Debt.

After a shareholder's basis in the S corporation stock is reduced to zero, basis in debt owed the shareholder by the corporation is reduced to zero. When income or gain items are allocated to shareholders, they first restore their basis in shareholder debt, and then increase the basis in the stock.

If debt is repaid before the basis is fully restored, the shareholder will recognize a gain. The gain will be ordinary gain if the debt is unsecured and capital gain if the debt is secured by a note or other evidence of indebtedness.

48

Cal Corporation Basis-1 Cal owns a 25 % of Cal Corp., an S corp. Cal loaned $10,000 to Cal Corp. last year. On January 1, Cal’s basis in his stock was $16,000.a. Cal’s basis in his stock & debt at the end of the year if the corp. reports a loss of $60,000 for the year?b. … if the corp. reports losses of $90,000?c. … if the corp. reports a loss of $120,000?

Cal Corp. Stock Basis -2 Part a

Investment or Beginning Basis $16,000Add: Ordinary Income


Less: Ordinary Loss (15,000)Separate Exp. & LossesNon-deductible ExpensesTax-Free Withdrawals

Ending Stock Basis $1,000


Cal Corp. Stock Basis - 3 Part b

Investment or Beginning Basis $16,000Add: Ordinary Income


Less: Ordinary Loss (22,500)Separate Exp. & LossesNon-deductible ExpensesTax-Free Withdrawals

Subtotal ($6,500)Stock Basis-cannot be negative -0-Basis in debt is reduced by $6,500

51

Cal Corporation Basis - 4a. Cal’s share of the loss is $15,000 ($60,000 x 25%) and the basis in his stock is $1,000 ($16,000 - $15,000 share of the corporation’s loss). His basis in his debt remains $10,000.b. Cal’s share of the loss is $22,500 ($90,000 x 25%) and the basis in his stock is reduced to zero by $16,000 of the loss; his basis in his debt is reduced to $3,500 ($10,000 – $6,500).

52

Cal Corporation Basis - 5

c. Cal’s share of the loss is $30,000 ($120,000 x 25%) and the bases of both his stock and debt are reduced to zero.

He is able to deduct only $26,000 of the loss as a result. The remaining $4,000 loss is suspended and cannot be deducted until he again has either debt or stock basis.

10. Determine the

taxability of an S corp's distributions to its shareholders.

54

Sec. 1368. Distributions – Slide 1 of 3

(a) General Rule. A distribution of property made by an S corporation with respect to its stock to which (but for this subsection) section 301(c) would apply shall be treated in the manner provided in subsection (b) or (c), whichever applies.

55

Sec. 1368. Distributions – Slide 2 of 3(b) S Corp. Having No Earnings and Profits. In the case of a distribution described in subsection (a) by an S corp. which has no accumulated earnings and profits-

(1) Amount applied against basis. The distribution shall not be included in gross income to the extent that it does not exceed the adjusted basis of the stock.

(2) Amount in excess of basis. If the amount of the distribution exceeds the adjusted basis of the stock, such excess shall be treated as gain from the sale or exchange of property.

56

Sec. 1368. Distributions – Slide 3 of 3(c) S Corp. Having Earnings and Profits. ..(1) Accum. Adjust. Acct. That portion of the distribution which does not exceed AAA is treated in manner provided by subsection (b).(2) Dividend. That portion of the distribution which remains after the application of paragraph (1) is treated as a dividend to the extent it does not exceed AE&P of the S corp.(3) Treatment of remainder. Any portion of the distribution remaining after the application of paragraph (2) of this subsection shall be treated as in subsection (b).

57

Sec. 1367. Basis, Sec. 1368(e) AAASec. 1367 describes how to compute stock basis. Note that basis is adjusted upward for income items, then downward for distributions and then further downward for loss and expenses items.Note that Sec. 1368(3) says that AAA is adjusted in the same manner as stock basis, except for tax-free income and related expenses, -- and AAA can go negative.

58

Beth invested $25,000 in a new Corp on January 1. Beth does not borrow from the Corp or make loans to the Corp. The Corp elected S Status on January 1. The Corp had net income of $50,000 in the year. On December 31, the Corp distributes $80,000 to Beth. How much income does Beth recognize as a result of the cash distribution?a. $0 b. $5,000 c. $25,000 d. $80,000

59

Beth Basis

Cost of stock $25,000Net income for yearTotal Stock BasisAmt. of DistributionGain

60

Beth Basis

Cost of stock $25,000Net income for year $50,000Total Stock Basis $75,000Amt. of Distribution $80,000Gain $5,000

61

Repeat preceding slide.

What is Beth’s basis at the end of the year?

62

12/31/01 AB (C Corp) has Current E&P and

Accum. Earnings and Profits: 35,000$

1/1/03 AB elects S Status

12/31/10 AB's AAA balance: 20,000$

12/31/10 AB's OA balance: 10,000$

12/31/10 AB's Accum. Earn. & Profts: 35,000$

12/31/10 AB pays dividend to owner: 50,000$

12/31/10 What is AB's Accum. E & P

balance after cash dividend?

Acct. Amt. Form Effect onBal. of Dist. 1040 Stk Basis

50$ 1 Acc. Adj. Acct. 20$ 2 AE & Profits 35 3 Other Adj. 10 4 Return of Basis5 Excess

If Corp has no E&P, Start with Step 4.

All amounts are in $000Sec. 1368

Layer 3 seems irrelevant, Why?

Stock Basis Distribution Amt.

64


50$ 1 Acc. Adj. Acct. 20$ (20)$ ?2 AE & Profits 35 (30)$ ?3 Other Adj. 10 4 Return of Basis5 Excess






50$ 1 Acc. Adj. Acct. 20$ (20)$ (20)$ 2 AE & Profits 35 (30)$ 30$ 3 Other Adj. 10 4 Return of Basis5 Excess





Explanation of previous slide.

The first $20,000 of the distribution came out of AAA. The next $30,000 came out of AE&P. That means the ending balance in AE&P is only $5,000.

The $20,000 from AAA was a tax-free return of basis. The $30,000 from AE&P is a taxable dividend and has no impact on stock basis.

67

12/31/01 AB (C Corp) has Current E&P and

Accum. Earnings and Profits: $35,000

1/1/03 AB elects S Status

12/31/10 AB's AAA balance: $20,000

12/31/10 AB's OA balance: $10,000

12/31/10 AB's Accum. Earn. & Profts: $35,000

12/31/10 AB pays dividend to owner: $50,000

12/31/10 What is AB's Accum. E & P

balance after cash dividend? $5,000

Introduction of Wizard Corporation.

It is an S corp. with E&P from old C Corp. years – before the S election. Distribution of E&P is taxable to the shareholder of the S corp. (and does not reduce stock basis). Otherwise distributions from an S Corp. are tax-free and reduce basis until all basis is recovered by the shareholder. Beyond basis recovery, the additional amounts are capital gain.

69

Wizard is a calendar year S corp. - Slide 1

Heil owns 100% of Wizard's stock.

AAA Balance on 1-1-10 $30,000

Accumulated E & P on 1-1-10 75,000

Heil's basis in the stock on 1-1-10 60,000

Wizard's ordinary income for 2008 100,000

In 2010, Wizard distributed $255,000 to Heil.

What amount of dist. is capital gain for Heil?

a. $-0 b. $20,000 c. $105,000 d. $150,000

70

Amt. AAABal. -1-1-10 $30Ord. Income 100 ?Balance ?Distribution (130) ?Balance ?Distribution (75) Distribution (30) Distribution (20)

Wizard - ($000) -Slide 2

71

Amt. AAABal. -1-1-10 $30Ord. Income 100 100 Balance $130Distribution (130) (130) Balance - Distribution (75) Distribution (30) Distribution (20)

Wizard - ($000) -Slide 3

72

Amt. AAA E&PBal. -1-1-10 $30 75$ Ord. Income 100 100 Balance $130 $75Distribution (130) (130) Balance - ?Distribution (75) ?Distribution (30) Distribution (20)

Wizard Corp. - ($000) Slide 4

73

Amt. AAA E&PBal. -1-1-10 $30 75$ Ord. Income 100 100 Balance $130 $75Distribution (130) (130) Balance 0 75 Distribution (75) (75) Distribution (30) Distribution (20)


74

Amt. AAA E&P BasisBal. -1-1-10 $30 75$ 60$ Ord. Income 100 100 100 Balance $130 $75 $160Distribution (130) (130) (130) Balance 0 75 30 Distribution (75) (75) Distribution (30) ?Distribution (20)


75

Amt. AAA E&P BasisBal. -1-1-10 $30 75$ 60$ Ord. Income 100 100 100 Balance $130 $75 $160Distribution (130) (130) (130) Balance 0 75 30 Distribution (75) (75) Distribution (30) (30) Distribution (20)


76

Amt. AAA E&P Basis 1040Bal 1-1-10 $30 75$ 60$ Ord. Inc. 100 100 100 100$ Balance $130 $75 $160Dist. (130) (130) (130) Balance 0 75 30 Dist. (75) (75) 75 Dist. (30) (30) ?Gain (20) ?Total Dist (255) ?Of $255,000, $60,000 was basis.


77

Amt. AAA E&P Basis 1040Bal 1-1-10 $30 75$ 60$ Ord. Inc. 100 100 100 100$ Balance $130 $75 $160Dist. (130) (130) (130) Balance 0 75 30 Dist. (75) (75) 75 Dist. (30) (30) Gain (20) 20 Total Dist (255) 195 Of $255,000, $60,000 was basis.


78

Amt. AAA E&P OA Basis 1040Bal 1-1-10 $30 75$ 60$ Ord. Inc. 100 100 100 100$ Balance $130 $75 $160Dist. (130) (130) (130) Balance 0 75 30 Dist. (75) (75) 75 Dist. (30) (30) Dist. (20) (20) 20


AAA can be distributed tax-free. The AAA distribution reduces basis.E & P is distributed after AAA, and is taxable.OA is distributed next (accumulated tax-free income.)

79

S Corporation Distributions.Corp. Having No Earnings and Profits. For S corps with no accumulated E&P, a two-tier rule applies. Distributions from an S corp having no E&P first reduce the basis in the stock. Distributions in excess of basis will generate capital gain. Distributions do not reduce a shareholder's basis in shareholder debt.As was the case with partnership distributions, it may be helpful to explain the S corp distribution rules by using a T account, which reflects the basis increases and decreases.

80

S Corporation Distributions.

Like C corporations, S corporations must recognize gain on the distribution of appreciated property. Gain is measured by the difference between FMV and the adjusted basis for the property.

The gain recognized by the corporation is allocated to the shareholders and may be subject to tax at the corporate level. No losses are recognized when property that has declined in value is distributed.

81

S Corporation Distributions.Corps with Accum. Earnings & Profits. Prior to 1983, a corp's undistributed taxable income was taxed to its shareholders as a deemed distribution at year-end. This income was accumulated in a previously taxed income (PTI) account. E&P earned in excess of PTI became part of a corporation's accumulated E&P account. Starting in 1997, pre-1983 accumulated E&P earned while an S corporation is no longer a source of S corporation distributions.

82

S Corporation Distributions.Corps with Accum. Earnings & Profits. Under current (post-1982) rules, some S corps still have PTI and post-1982 E&P balances earned while a C corp from which part or all of a distribution may be treated as having been made. Corps with PTI or E&P must maintain an Accumulated Adjustments Account (AAA) and an Other Adjustments Account in order to determine the taxability of their distributions. Distributions first come from AAA.

83

S Corporation Distributions.Corps with Accum. Earnings & Profits. 1. Money Distributions. For corps having an accumulated E&P account, cash distributions come from the four tiers of earnings. Distributions are made from each tier until the tier is exhausted.The AAA is the cumulative total of the ordinary income or loss and separately stated items for the S period but not tax-exempt income and the expenses related to its production. There are four differences between basis adjustments and adjustments required for the AAA.

84

S Corporation Distributions.Other Adjustments Account (OAA) is maintained only when there are accumulated E&P at year-end. The account is primarily increased for tax-exempt income and decreased for expenses related to tax-exempt income. OAA is not an earnings account in the distribution sequence. Earnings in the OAA are considered to be part of the stock basis when determining the source of a distribution. Allocation of the AAA balance to individual distributions occurs at year-end after taking into account current year income and loss items. In general, the AAA amount is allocated ratably to individual distributions (other than those distributions coming from E&P or PTI) based on the amount of money or FMV of nonmoney property distributed.

85

S Corporation Distributions.Property Distributions. Distributions of nonmoney property cannot reduce PTI. PTI can only be distributed in money. Property distributions may also force the recognition of income or gain by the distributing corporation under Sec. 311 as discussed above. The FMV of nonmoney property distributed will reduce AAA.

86

S Corporation Distributions.Distribution Ordering Elections. Two elections are available to change the distribution order. Separate elections are available to the S corporation to skip over the AAA and PTI accounts in determining the source of a cash or property distribution. If either election is made, the distributions will normally come from accumulated E&P. This election can be used to eliminate the possibility of the excess net passive income tax applying or the passive income test being failed and causing a loss of S corporation status.

87

S Corporation Distributions.Post-Termination Transition Period. Distributions of money made during the S corp's post-termination transition period can be made tax-free to those shareholders who owned S corp stock at the time of the termination. These distributions are considered as coming first from AAA and then from current and accumulated E&P. The amounts coming from AAA are tax-free and reduce the shareholder's basis in the stock. Distributions from current and accumulated E&P are taxable. AAA remaining after the post-termination transition period ends can only be distributed as a basis reduction after current and Accum. E&P has been exhausted.

88

S Corp. Distributions.Corps who do not have E&P do not need to maintain an AAA for reporting purposes (i.e., the Form 1120S balance sheet). The IRS suggests, however, that an AAA be maintained in case E&P is acquired from a C corp. Such is not the usual practice of most CPAs.

89

Tax Pref. Items & Other AMT Adjustments. An S corporation is not subject to the corporate alternative minimum tax. Items of adjustment or tax preference flow through to the shareholders. Allocation of adjustment or tax preference items is made on a daily basis unless one of the special allocation elections is in place. S corps do not have to make the adjustment for the difference between adjusted current earnings and pre-adjustment alternative minimum taxable income that is required of other corporations.

90

Trans. with Owners & Other Related Parties.

Sec. 267 related party rules deny a payor a deduction when a mismatching of income and expense items occurs as a result of two different accounting methods being used. S corporations are denied a deduction when payments involve persons who directly, indirectly, or constructively own S corporation stock and different accounting methods are used. Losses are also disallowed on sales and exchanges between S corporations and related parties as defined in Sec. 267.

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Fringe Benefits for a Shareholder-Employee. Shareholder-employees owning more than 2% of the S corp stock are treated as partners for purposes of determining the treatment for fringe benefits. Shareholder-employees owning 2% or less of the S corp stock are treated as an ordinary employee. A more-than-2% shareholder-employee is taxed on the amount of a fringe benefit, but may deduct the item if it qualifies as an itemized deduction (e.g., health insurance benefits incurred by an S corp shareholder-employee that are deductible under Sec. 162(l)). They are included as wages on the Form W-2 provided to the shareholder-employee. Fringe benefits paid to more-than-2% shareholder as compensation are deductible by the corp.

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Fringe Benefits for a Owner-Employee. The special fringe benefit rules only apply to "statutory fringe benefits.” They do not apply to stock options, qualified retirement plans, and nonqualified deferred comp. Fringe benefits which are limited by the more-than-2%-shareholder rule include: group term life insurance premiums; $5,000 employee death benefit exclusion; accident and health benefit plan insurance premiums and payments; meals and lodging furnished by the employer; and employer-provided parking.

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QuestionFringe benefit rules for shareholders of S

corps have the effect of:a. Making the S corporation preferable to the

partnership form of organization.b. Limiting the tax advantages associated

with fringe benefits provided to shareholders.

c. Increases the limit from $50,000 to $100,000 for group-term life insurance provided to an employee who is also a major shareholder.

d. Increasing the taxes paid by an S corporation on its net income.

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Election to Allocate Income Based on the S Corp's Accounting Methods. As a general rule, an S corp's income, gain, loss, deductions and credits are allocated on a per-share, per-day basis. The corp can elect to use the corp's tax accounting methods when an S election is terminated or an S corp shareholder terminates his entire interest. The use of the S corp's accounting methods can shift income from one shareholder to another.

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Election to Allocate Income Based on the S Corp's Accounting Methods. By electing to use the S corp's tax accounting method to allocate profits or losses between the C short year and S short year in the year in which the S election terminates, it is possible to (1) shift losses into an S short year where an immediate benefit is obtained by the shareholders at a marginal tax rate of up to 35; or (2) shift profits into a C short year to take advantage of the 15 and 25% marginal corporate tax rates.

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Increasing the Benefits from S Corporation Losses. A shareholder is limited in the amount of loss that can be deducted to his basis in his stock. If income is expected to be taxed at a higher marginal rate in future years, basis should not be restored until the later year in order to increase the amount of tax savings from the unused loss.

The S corp loss carryover is only available to the shareholder who held the stock when the loss was incurred. A shareholder should consider increasing the basis of the stock in order to take advantage of the loss carryover before the stock is sold or exchanged. The purchasing shareholder does not acquire the loss carryover.

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Passive Income Requirements.

An S corp with Subchapter C E&P is limited as to the amount of passive income that can be earned if the excess net passive income tax is to be avoided. In addition, excessive net passive income may terminate the S election.

An election is available to distribute Subchapter C E&P and avoid the corporate level tax. This may be desirable if the E&P amount is small, or the shareholder has a NOL.

While the distribution will be taxable, it may be desirable because unlimited amounts of passive income can be earned in the future.

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Passive Income Requirements. Corps with rental income can avoid the passive loss rules if significant services are rendered or if significant costs are incurred in the rental business. Net leases will not qualify. All the facts and circumstances must be considered including, but not limited to, the number of persons employed to provide the services and the types and amounts of costs and expenses incurred other than depreciation.

11. Explain the

procedures for filing an S corp tax return.

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Making the Election. The S election is made by filing Form 2553 (Election by Small Business Corp to Tax Corp Income Directly to Shareholders). The election can be signed by any person who is authorized to sign the corporation's tax return under Sec. 6037. No extensions of time to file the S election are granted. Shareholder consents can be made either on the Form 2553 or on a separate consent statement signed by the shareholder and attached to the corporation's election form. Extensions of time to file shareholder consents can be granted by the IRS.

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Filing the Corporate Tax Return. An S corp, whether or not there is any income, must file a return for part or all of the tax year that they are in existence. The return is filed not later than the fifteenth day of the third month following the close of the tax year. All S corps that file a return are required to furnish any shareholder owning stock during the year a copy of the return. The basic 3-year statute of limitations applies to S corporations.

12. Determine the

estimated tax payments requiredof an S corp and its shareholders.

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Estimated Tax Payments.

S corps make estimated tax payments for the following taxes: BIG tax, excess net passive income tax, and recapture of investment tax credits claimed in tax years when the S corp was a C corp. No estimated taxes are owed unless the total of these taxes is reasonably expected to exceed $500. There are penalties & interest for failure to make timely payments of any estimated tax liabilities. The S corp's shareholders are also subject to estimated tax payments on their share of the S corp's income. The amounts are treated as received concurrently by the shareholders throughout the year.

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Consistency Rules.

Shareholders are required to treat all items of income, gain, loss, deduction or credit (i.e., a Subchapter S item) in a manner consistent with their treatment on the Form 1120S (Sec. 6037(c)). If an item is reported in an inconsistent manner, the shareholder is required to notify the IRS of the difference. Failure to notify the IRS may result in the imposition penalty under Sec. 6662.

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BIG TaxesSection 1374 imposes a corporate level tax on an S corp's built-in gain recognized during the 10-year period beginning with the first taxable year for which the corp was an S corp. Sec. 1374(a), (d)(3), (7). Built-in gain is measured by the appreciation in value of any asset over its adjusted basis as of the time a corporation converts from C to S status.

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BIG TaxesAn S corporation is liable for the built-in gains tax on the disposition of any asset except to the extent that it establishes that it did not own the asset on the day it converted from C to S status, or the fair market value of the asset was less than its adjusted basis on the first day of the first taxable year for which it was an S corporation. Sec. 1374(d)(3).

107

Panthers cause BIG Tax-1Petitioner was incorporated in 1929 and owns and operates the New York Giants, a professional football franchise in the National Football League (NFL).

In 1990, the NFL began exploring the possibility of expansion and began considering various franchise applications.

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Panthers cause BIG Tax-2Petitioner elected on March 1, 1993, to be treated as an S corporation under section 1361(a)(1).

Later in 1993, the NFL awarded new franchises to Charlotte and Jacksonville. The expansion agreements required the new franchises to pay expansion payments (in six installments) to petitioner and the member teams of the NFL.

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Panthers cause BIG Tax-3Petitioner reported its share of the NFL expansion payments as capital gains (not subject to the built-in gains tax imposed on S corporations by section 1374) on its S corporation tax returns (Forms 1120S, U.S. Income Tax Returns for an S Corporation) for fiscal years 1996, 1997, and 1998.

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Panthers cause BIG Tax-4

IRS sent petitioner a notice of deficiency in which IRS determined that petitioner was subject to the built-in gains tax under section 1374 for the expansion payments petitioner received in fiscal years 1996, 1997, and 1998.

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Panthers cause BIG Tax-5IRS determined that petitioner is liable for BIG tax of $574,000 for fiscal year 1996, $914,334 for fiscal year 1997, and $220,156 for fiscal year 1998, and for accuracy-related penalties under section 6662(a) of $114,800 for fiscal year 1996, $182,867 for fiscal year 1997, and $44,031 for fiscal year 1998.

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Van Der Aa Investments, Inc.-1By notice of deficiency dated Sept 15, 2003 (the IRS determined a deficiency in the Federal income tax of Van Der Aa Investments, Inc. (Investments), for its 1999 taxable (calendar) year (1999) in the amount of $62,604,069, an addition to tax on account of delinquency under section 6651(a)(1) in the amount of $12,520,814, and an accuracy-related penalty under section 6662 in the amount of $3,124,797.

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Van Der Aa Investments, Inc.-2For 1999, Investments made a Federal income tax return as an S corporation. On that return, among other things, Investments reported a built-in gain tax liability of $1,520,140.

The deficiency in tax determined by respondent results from his adjustment increasing Investments' built-in gain tax liability from $1,520,140 to $64,124,209.

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The

End

Chapter 12B. S Corporations C10-Chp-12B-1-SCorp-Passthru-Loss-Basis-Dist.ppt Edited 2010-0221 Howard...

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Transcript of Chapter 12B. S Corporations C10-Chp-12B-1-SCorp-Passthru-Loss-Basis-Dist.ppt Edited 2010-0221 Howard...