S corporations Alliot Group conference
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Transcript of S corporations Alliot Group conference
S CorporationsUpdate & Issues
Tom Norton, CPAWilliams Overman Pierce LLPRaleigh, NC
S Corp changes
◦ Not many specific to S Corps◦ 2010 K-1 appears to be no changes form 2009
Common Issues & Problems with S Corps
Agenda
User fees for requesting a letter ruling to waive the effect of an invalid S election
User Fee If S Corp’s Gross Income is
$625 less than $250,000 $2,000 > $250,000 and < $1,000,000 $14,000 $1,000,000 or more
Rev. Proc. 2010-1
Section 1374(d)(7) – somewhat reduced stress and impact of Sec. 1374 for 2009 and 2010 and 2011
Built-in Gain Tax Holiday
Pre-SBJA holding period is reduced where the 7th taxable year in the holding period preceded the taxable year beginning in 2009 or 2010
SBJA temporarily shortens the holding period of assets subject to the built-in gains tax to 5 years if the 5th taxable year in the holding period precedes the taxable year beginning in 2011
S Corporation Built-in Gain Holding Period
The result is a 7-year holding period for 2009 and 2010
5-year holding period for 2011 – applies to any conversion made in 2006 or before
Tip to clients –Consider selling in 2011 any BIG asset if elected prior to 2007
Absent further law changes – will revert back to 10 year period in 2012.
S Corporation Built-in Gain Holding Period - Continued
Shareholder’s basis is reduced by the amount of contribution flowing through to the shareholder
Contributions made before Jan 1, 2010 – basis is reduced by the shareholder’s pro rata share of the adjusted basis of the contributed property
Contributions after Dec 31, 2009 – basis is reduced by the shareholder’s pro rata share of the fair market value of the contributed property
Basis Adjustment for Non-cash Charitable Contributions
Reg-153340-09
Eliminates rules for using paper-based federal tax deposit coupons
Tax payments include estimated taxes, income taxes, excise, payroll, and withholding taxes
Proposed regs do not change existing rules for monthly v. semiweekly depositors
Proposed Regulation for EFT
If S Corp uses payroll service – they may not be signed up for EFTPS
If know may be subject to BIG tax – may have to sign up for EFTPS prior to March 15 to avoid incorrect deposit penalty.
BIG Tax Use EFTPS?
$195 per month per shareholder ◦ Max of 12 months◦ 1 shareholder = 12 x 195 = $2,340
Can be abated for reasonable cause
Any luck on getting penalties waived other than reasonable cause?◦ Can we use Rev. Proc. 84-35? – used by small
partnerships (small partnership all partners file on time reporting income from partnership)
Failure to File Penalties
The AICPA has proposed to the IRS a procedure similar to Rev Proc 84-35
The penalty imposed by section 6699 may be abated if
reasonable cause can be shown. We are requesting that the Service consider allowing reasonable cause to be deemed automatic if certain requirements are met. Those requirements include the following:
◦ The S corporation must be composed of ten or fewer shareholders; ◦ the S corporation must have no tax liability due at the entity level; and ◦ all shareholders must have included all items of income, deductions
and credits from the S corporation on their own timely-filed personal income tax returns
AICPA Proposed Revenue Procedure
Preliminary results of National Research Program on S Corps which audited 1,200 for tax year 2003 and 3,700 for 2004 showed:◦ 12% underreporting for 2003 and 16% for 2004◦ Small S Corps (< $200,000 in assets) had
higher percentages of underreporting than large S Corps
Has S- Corp Audit Activity Increased?
Audit Possibilities?
2,000 returns per year for 2010-2012 focusing on employment status◦ Employee v. independent contractor◦ Reasonable compensation◦ S Corp distributions v. salary◦ Matching taxpayer identification numbers
Of the 2,000 returns, 1,500 from Small Business/Self-Employed division
Audit Possibilities? Payroll
S Corporations must only have one class of stock
Distribution differences in timing and/or amount are to could be viewed as a second class of stock
Avoid making disproportionate large distributions to a shareholder on an ongoing basis
A systematic pattern of distributions should be avoided
Should be corrected as soon as possible (loans – “catch-up” distributions)
Disproportionate Distributions
IRS requires that compensation is “reasonable”
There is no rigid set of rules for measuring the reasonableness of compensation – no definition of “reasonable” is contained in the Code
No single factor controls, but rather a combination of factors must be considered
Reasonable Officer Compensation
1. the character and financial condition of the corporation;
2. the role the shareholder plays in the corporation, including the employee's position, hours worked, and duties performed;
3. the corporation's compensation policy for all employees and the shareholder's individual salary history including the corporation's internal consistency in establishing the shareholder's salary;
4. how the compensation compares with similarly situated employees of similar companies;
5. conflicts of interest in setting compensation levels; and
Reasonable Compensation Factors IRS Considers
6. whether a hypothetical independent investor would conclude that there is an adequate return on investment after considering the shareholder's compensation.
7. the employee's qualifications;
8. the size and complexity of the business;
9. a comparison of salaries paid to sales and net income;
10. general economic conditions;
11. comparison of salaries to shareholder distributions and retained earnings;
Reasonable Compensation Factors IRS Considers – Continued
12. compensation paid in prior years;
13. the corporation's dividend history;
14. whether the employee and employer dealt at arms' length;
15. corporate intent; and
16. whether the employee guaranteed the employer's debt.
Reasonable Compensation Factors IRS Considers – Continued
Formal employment contract specifying that no or low salary is to be paid (Joseph Radtke - Dunn and Clarke P.A.)
Payment for services called a distribution or a draw (Revenue Ruling 82-83).
Compensation disguised as loans to shareholders – (Must be a “bona fide loan”)
Reasonable Compensation – Factors That Don’t Guarantee Reasonableness
Distributions can be recharacterized even if wages are paid◦ In Watson,
S Corp’s sole shareholder, a CPA Annual salary of $24,000 and dividend distribution of
$320,000 over two years IRS sought to recharacterize $60,044 of the dividend
income as compensation District Court, citied Rev. Rul. 74-44 and Joseph
Radtke, and held the IRS has the power to convert dividends to salary
Distributions Recharacterized
Used to think any compensation greater than zero was OK.
IRS seems to be more willing to attack very low salaries
What do you do after year-end if no salaries paid?◦ Reclass some distributions to salary – pay late
fees re payroll deposits?
What are Clients Doing -Reasonable Comp?
2% shareholder can claim deduction if◦ S Corp pays the premiums for the accident and health insurance
policy covering 2% shareholder (and his/her spouse and dependents); OR
◦ The 2% shareholder pays the premiums and provides proof of payment to the S Corp, and then the S Corp reimburses the 2% shareholder for the premium payments in the current tax year
Health insurance premiums paid or reimbursed as wages must be reported on the 2% shareholder’s and family members Forms W-2
If caught, Can we just amend the W-2(s)
Health Insurance Premium Deduction
Partnership exchanges assets and liabilities for corporation stock
Partnership liquidates distributing S Corp stock to partners
With a timely election, Corporation becomes an S Corp without ever being a C Corp
Potential Problem – Liabilities exceed basis of assets – gain upon contribution to S Corp.
Issues Partnership to S Corp Conversion
Not required if File 2553
IRS often will incorrectly process the 2553 or incorrectly ask for 8832 for which you have to correspond to correct
LLC Converting to S CorpFile 8832?
In general, no carryovers except against built-in-gains (BIG) (Code Section 1371 (b))
◦ C Corporation Credits and NOLs generally carryover to the S corporation upon conversion – however can only be used to offset Built in Gain Tax
Carrying Over Losses and Credits from C Corp Tax Years
No carryover from “C” year
However, any open tax year, 2003-2011, can be amended to revoke previous section 179 expense
Carrying Over Section 179 from C Corp Tax Years
If S Corp doesn’t have AE&P, AAA is not used as a measure of nontaxable distributions
If no AE&P – Basis in S corporation Stock determines if distributions are taxable
Instructions to Form 1120S state that AAA should be calculated each year, even if there is no AE&P
AAA With No AE&P
Loans from bank to S Corp that were cosigned and guaranteed by the taxpayers
A loan from the taxpayers’ C Corp to the S Corp
Short-term notes that were actually notes between taxpayers’ partnership and the S Corp
AJES reclassifying loans 2 years after origination –not accepted
Failed Attempts to Deduct Shareholder Losses Against Debt Basis
Cash advances made directly to the S Corp Best to have funds transferred and loaned
directly from shareholder
Court case addressing all of the above◦Russell,Donald v Commissioner TC Memo
2008-246
Successful Attempt to Deduct Shareholder Losses Against Debt Basis
Basis is adjusted by pass-through items and distributions to shareholders
Basis is 1. Increased by stockholder’s share of income and gain items;
then2. Decreased by distributions that are a nontaxable return or
basis; and, finally,3. Decreased by the stockholder’s share of loss and deduction
items
What may be thought as a dist in excess of basis – capital gain – may be ordinary income due to ordering rules (see example)
S Corp Basis Ordering Rules
New Co with a beginning basis of $0 has the following activity in year one◦ Ordinary Income $20,000◦ Section 179 Expense (20,000)◦ Distributions to S/H 10,000
How should the activity be recorded on the K-1?
How much and what character of carry-forward loss?
S Corp Basis Ordering Rules - Example
Basis Order Cumulative Carryforward
Beginning Basis 0 0
Ordinary Income
20,000 20,000
Distribution 10,000 10,000
Section 179 10,000 0 10,000
Ordinary Income
20,000
Section 179 (10,000)
Cfwd Sec 179 Loss
10,000
S Corp Basis Ordering Rules – Example Answer
When an S Corp conducts more than one activity, a schedule should be attached to the tax return, Form 1120S and the Schedules K-1, so the shareholders can identify the income or loss of each separate activity
Separate reporting required or proper classification by shareholders re: type of activity and passive activity classification
Reporting Multiple Activities
IRS ruled that administrative dissolution of an S Corp under state law (because its registration to do business in the state had expired) did not terminate the S election.
This is the first ruling holding that the S election did not terminate even though the corporation was not retroactively reinstated under state law
Relief from Corporation Dissolution under State Law
An S Corp shareholder can rent a portion of the shareholder’s home to the S Corp
Rental income must be reported on the shareholder’s Form 1040
Only allowable rental deductions are deductions deductible in the absence of any business use, generally mortgage interest and real estate taxes
May want to rent if shareholder does not itemize deductions or over $ 1 million limit
Way to get $ out of corp if have basis limitations
Renting Home Office Space
AICPA is petitioning that the following changes be made to tax return due dates
Proposed Due Date Change
Form Orig Due Ext Due
1065 March 15 Sept 15
1120-S March 31 September 30
1041 April 15 September 30
C Corp April 15 October 15
1040 April 15 October 15