S Corporations Owning Multiple Entities: Mastering Tax ...

WHO TO CONTACT DURING THE LIVE PROGRAM

For Additional Registrations:

-Call Strafford Customer Service 1-800-926-7926 x1 (or 404-881-1141 x1)

For Assistance During the Live Program:

-On the web, use the Chat function to send a message

If you get disconnected during the program, you can simply log in using your original instructions and PIN.

IMPORTANT INFORMATION FOR THE LIVE PROGRAM

This program is approved for 2 CPE credit hours. To earn credit you must:

• Participate in the program on your own computer connection (no sharing) – if you need to register

additional people, please call customer service at 1-800-926-7926 ext. 1 (or 404-881-1141 ext. 1).

Strafford accepts American Express, Visa, MasterCard, Discover.

• Listen on-line via your computer speakers.

• Respond to five prompts during the program plus a single verification code.

• To earn full credit, you must remain connected for the entire program.

S Corporations Owning Multiple Entities: Mastering Tax Reporting and Planning Opportunities

THURSDAY, JULY 8, 2021, 1:00-2:50 pm Eastern

FOR LIVE PROGRAM ONLY

Tips for Optimal Quality FOR LIVE PROGRAM ONLY

Sound Quality

When listening via your computer speakers, please note that the quality

of your sound will vary depending on the speed and quality of your internet

connection.

If the sound quality is not satisfactory, please e-mail [email protected]

immediately so we can address the problem.

mailto:[email protected]

Recording our programs is not permitted. However, today's participants can

order a recorded version of this event at a special attendee price. Please call

customer service at 800-926-7926 ext.1 or visit Strafford’s web site

at www.straffordpub.com.

FOR LIVE EVENT ONLY

http://www.straffordpub.com/

July 8, 2021

S Corporations Owning Multiple Entities: Mastering Tax Reporting and Planning Opportunities

Professor Robert W. Jamison, CPA

Professor Emeritus of Accounting

Indiana University

[email protected]

Jason Watson, EA, MBA

Founding Partner

WCG Inc.

[email protected]

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

S Corp Ownership Agenda Problems with S Corps S Corp Owning SMLLCs MMLLC Owned By S Corps Jason Watson Fee for Service Arrangement California Twist S Corp Owning S Corp Robert Jamison Questions and Answers

Multi Owner Problems Reimbursements for home office might be disparate Company cars vary in price Office politics about who contributes what, and how that

might change in the future Required distributions (working capital definitions) Dispute resolution Prohibited ownership transfer Agreements Death, divorce, incapacitation

Problems with S Corps Distributions must be in accordance with shareholder

ownership percentages Does not allow for a production-based income split

▪Financial advisors▪Insurance agents▪Attorneys▪Doctors

Can fix slight deviations with salary, but at some point it is not enough (or at least costly in terms of payroll taxes)

Problems with S Corps Must pay out reasonable salaries to all materially

participating shareholders (but what if you own two businesses?)

Various entity structures can solve some of these problems

Two Businesses Don’t want to S elect both entities Why? Reasonable salary might have to be paid from both

entities to a common shareholder Overpay employer portion of Social Security taxes if

combined salaries exceed $142,800 (2021) What can be done?

Two Businesses S Corp Owns SMLLCs

▪Sole member is S Corp▪LLCs are disregarded▪Separate books▪Income “flows up” into S

Two Businesses Benefits

▪Solves having to run shareholder payroll at each entity▪Provides compartmented business units (subsidiary)▪Expand ownership in a subsidiary▪Efficient wholesale or asset sale of a subsidiary

(branding, asset titles, contracts, assignments, credit history, etc. are encapsulated)

Two Businesses Problems

▪Test for various tax “limits” as the subsidiary level (some deductions might be incorrectly allowed in aggregate)

▪Hobby loss drill down▪Section 199A and SSTB issues within each subsidiary▪Regulatory issues with regulated industries (law,

accounting, real estate, financial advisor, just to name a few)

Multi Owner S Corp Two insurance agents or real estate agents want to team

up, and share costs such as rent, E&O, clerical staff (scaled economies)

Want income split based on production, fluctuating quarterly / annually

Joint venture? Perhaps. Messy Use salaries to true up? Ruins S Corp savings fast What can be done?

Multi Owner S Corp MMLLC Owned By S Corps

▪“Mothership” is MMLC▪Each member is a “baby”

S Corp▪Income split based on

formula, agreement▪Each S Corp receives a

distribution from MMLLC

Multi Owner S Corp Benefits

▪Allows for income split based on production or other metrics (K-1 issued to the S Corp)

▪Still allows for S Corp tax benefits▪401k plan is lodged at MMLLC, each S Corp adopts▪Reimbursements for home office are done at S Corp▪Company car is done at S Corp▪Add spouse and children to S Corp payroll▪Tax deduction / position risk is individualized▪Office politics are reduced

Multi Owner S Corp Problems

▪More expensive (more payroll systems, more tax returns)

▪S Corp carries “investment” on the books▪Do you mark to market with capital account or

valuation? So, could be messy with balance sheet▪S Corp might have an appreciating asset (revocation,

step up issues)▪Personal lending complications since MMLLC is still the

primary entity (lender confusion)

Nexus Problem MMLLC is in California with 3 baby S Corps as members Two S Corps in California, One S Corp in Colorado MMLLC has $1.5M in CA sourced revenue, with $10M

overall It is split 3 ways, with CO S Corp tracing $500,000 to CA CA FTB says $500,000 is investment income not sales Cannot claim use under $500,000 or 25% of revenue Pay CA taxes (perhaps unnecessarily) What can be done?

Nexus Problems MMLLC Owned By People

▪“Mothership” is MMLC▪Each member is a person▪Each person also owns an

S Corp▪S Corp enters into a B2B

fee for service agreement with MMLLC

▪Two K-1’s per person

Nexus Problems Benefits

▪Allows for all the benefits of an MMLLC being owned by baby S Corps (see previous schematic)

▪But! Also allows for restricted state visibility▪MMLLC net income is reduced to a negligible amount

Nexus Problems Benefits (continued)

▪In our California example, the Colorado S Corp is picking up $3.3M total revenue but might have some wiggle room on California sourced revenue and exemption

▪Colorado owner is getting a small California K-1 from the MMLLC and a hopefully a large K-1 from his / her S Corp

▪California cannot recolor the sourced revenue as investment income and automatically disallow it

▪Still must be very careful about revenue tracing

Nexus Problems Problems

▪Additional legal headaches with Fee for Services Agreements and other supporting documents

Variations MMLLC Owned By People

▪We’ve seen this before▪But MMLLC elects S Corp

in California to alter franchise tax calc

Variations C Corp Owned by People

▪A B2B Fee for Service Agreement with S Corp

▪Employees own shares in C Corp (similar to ESOP)

▪Still get S Corp tax efficiency

▪WCG is set up this way(5 partners, 5 S Corps)

Things to Work Through Health Insurance Professional Liability Licensing and Compliance 401k Plans (and other benefits) Added Complexity (but added flexibility)

Qualified Subchapter S Subsidiaries and Other Multi-

Entity ArrangementsRobert W. Jamison, CPA, PhD

Professor Emeritus of Accounting

Indiana University (IUPUI)

[email protected]

Copyright © 2021 by Robert W. Jamison. All rights reserved. 27

Special offer for Participants: This program pays for itself!Good for 2022 editions

Contact me if you are interested in the same terms for the 2021 editions, now in print


Acknowledgement


• This material is based on the author’s work in preparing annual updates for S Corporation Taxation, revised annually by CCH, Incorporated, and for CCH Expert Treatise Library: Federal Taxation of Subchapter S Corporations.

• See https://www.cchcpelink.com/instructor/robert-jamison/

• Permission has been granted by the publisher to use these materials in this course.

https://www.cchcpelink.com/instructor/robert-jamison/

Qualified Subchapter S Subsidiary (QSub)


• S corporation may elect to treat a 100% owned domestic corporation as a QSub. • In general, the subsidiary is treated as a nonentity (in the same manner as a

single-owner limited liability company) for federal income tax purposes.

• Thus, this method can be effective for consolidating operations of various corporations.

Reno, Inc. and Rentco, Inc.

Reno, Inc.• 100% active gross receipts

• Gross receipts $1,000,000 per year.

Rentco, Inc.

• 100% Passive gross receipts

• Gross receipts $300,000 per year.

• Substantial accumulated earnings and profits (AE&P)

• Subject to the passive investment income tax

• Will likely lose its S election unless it pays out its AE&P as dividends.

• Shareholders do not want dividend income


Hyco, Inc. and Loco, Inc.

Hyco, Inc. (S Corp.)• Willie owns all stock

• Consistent profits

• Lends to Loco

• Substantial stock basis

• Willie must pay tax

Loco, Inc. (S Corp.)• Willie owns all stock

• Consistent losses

• Borrows from Hyco

• Minimal stock basis

• No basis from Hyco’s loans

• Willie may not deduct losses


Cashco, Inc. and Fixco, Inc.

Cashco, Inc. (S Corp)• Substantial liquid assets

• Little AAA

• Large AE&P

• Distributions would be dividends

Fixco, Inc. (S Corp)• No liquid assets

• Large AAA

• Distributions would be tax free


QSub Election Mitigates


• Reno & Rentco• The gross receipts of the combined entities would be aggregated for

purposes of the passive investment income test.

• Hyco and Loco• Shareholder would have one basis in stock and debt.

• Income and losses of the different corporations would be combined.

• Cashco and Fixco• AAA of the existing corporations is also aggregated.

• Distributions from one of the corporations would be treated as made by the combination, so the source of the distribution could be the liquid assets of either or both.

Qualified Subchapter S Subsidiary (QSub).


• Creative use of the QSub can yield some significant tax planning for S corporations.• For example, using a QSub may enable a corporation to effectively make a

mid-year S election, which is not permitted under the general rules of Subchapter S.

• Similarly, the results of a §338(h)(10) or §336(e) election can be obtained in a stock sale, without the need to meet the qualifications or procedures for these elections.

Disregarded Entity Status of Qualified Subchapter S Subsidiary


• The subsidiary corporation is not treated as a separate corporation for federal income tax purposes.

• All of the assets, liabilities, income, deductions, etc. of the subsidiary corporation are treated as belonging to the parent. [§1361(b)(3)(A).]

Eligibility for QSub Status


• In order to be eligible for a parent – QSub relationship, there must be the following facts present:• The parent corporation (“Purchaser”) must be an S corporation.

• The parent must own 100% of the outstanding stock of the target corporation (“Target”). [§ 1361(b)(3)(B).]

• Target must not have been an S corporation or a QSub of another S corporation within the past five years, unless Purchaser acquires all of the Target stock on a single day and makes an immediate QSub election for Target. [§ 1361(b)(3)(D), Reg. § 1.1361-5(c)(1).]

FACT

The “Master” S Corporation


• Legal Structure of Master S Corporation and Subsidiaries

Holding company

Operating company

1

Operating company

2

Operating company

.....n

Share-

holders

FICTION

The “Master” S Corporation


• Tax Treatment of Master S Corporation and Subsidiaries

Master S Corporation(Holding Company)

QSub 1 QSub 2 QSub ..n

Share-holders

Tiers of QSubs


S Corporation

QSub

QSub

QSub

Share-

holders

QSub

Election: Timing Rules


• The effective date of the QSub election may be not more than two months and 15 days before the filing of the election, nor may it be more than 12 months after the date on which the parent S corporation files the QSub election. • Any date outside of the limit will be effective on the nearest date within the

limit.

• The QSub election need not be made as of the beginning of the taxable year of the subsidiary corporation.

Ceeco – Essco Example


• Ceeco is a C corporation with substantial net operating loss carryforwards.

• Ceeco anticipates substantial profits in the near future.

• There is the possibility of an asset sale in a few years. Ceeco would like to have the benefits of an S election, but does not want to lose its carryforwards.

• Ceeco has one class of stock, is owned by U.S. citizens, and has no aspects that would disqualify it from S status.

• Ceeco uses the calendar year for tax purposes.

• If Ceeco makes an S election, it must start at the beginning of a taxable year. • If it does so within the first two months and 15 days of 2021, the election will be

in effect January 1, 2021.

• If it files the election after March 15, 2021, the election will be effective on January 1, 2022.

Ceeco – Essco Example (Cont.)


• However, as the income starts to materialize, Ceeco may find itself using up its net operating loss carryforwards before or after the next available effective date. • It can only postpone the election in increments of one full year.

• Thus, it may run the danger of under or over utilizing its loss carryforwards.

• Essco is an S corporation that is owned by the same shareholders as Ceeco. • If the shareholders contribute their Ceeco stock to Essco, making sure that

Essco owns all of the Ceeco shares, they can gain some flexibility.

• Alternatively, the shareholders could form a Master S corporation and contribute all of the Ceeco shares and all of the Essco shares

Ceeco – Essco Example (Cont.)


• At the time of the contribution, Ceeco will continue to be a C corporation. • With the identity of ownership, the stock transfer will not trigger any Code

Section 382 limitations on the losses.

• Thus, as long as Ceeco retains its C corporation status, it may use its net operating loss carryforwards to offset its current income.

• When it has determined that it has gotten full tax benefit from these losses, Essco can make a QSub election for Ceeco.

• Ceeco will be treated as liquidated on the effective date of the QSub election.

• Moreover, the parties have a two month and 15-day hindsight window period to decide on the appropriate time for the QSub election.

Invalid QSub Election


• The IRS did not accept a QSub election, even though it was filed within the two month and 15 day period after acquisition.

• When the parent S corporation filed the election, it had already disposed of the stock.• Presidio Advisors, LLC, Norvest Ltd. v. U.S., 2011-2 USTC ¶50,662 (Fed. Cl.).

Acquisition of a QSub


• Alternative Acquisition Forms

• Survival of Attributes after Change in Ownership

Alternative Acquisition Forms


• Taxable Acquisition of Assets

• Taxable Acquisition of QSub Stock• Acquisition of a C corporation, Other Than a Subsidiary in a Consolidated

Group

• Taxable Acquisition of a Stand-Alone S Corporation (or Consolidated C Corporation Subsidiary)

• Taxable Acquisition of a QSub from Another S Corporation

• Nontaxable (Tax-deferred) Acquisition of QSub Stock

• Partially Taxable Acquisition of QSub Stock (or Assets)

Election: Effect on Subsidiary


• The QSub election is treated as a complete liquidation, if the corporation was a recognized entity for tax purposes. [Reg. §1.1361-4(a)(2)]• In general, the deemed liquidation is tax-free, per §332.

• However, if the subsidiary is insolvent, the liquidation must be taxable.

• Section 332 applies when the parent owns > 80% of vote and value of subsidiary stock. [§1504(a)(2)]• Always met for QSubs, with 100% ownership required.

• In the §332 liquidation, the parent recognizes no gain or loss on the receipt of assets in exchange for its stock. [§332(a)]

• The subsidiary recognizes no gain or loss on distribution of its assets to the parent. [§337(a)]

Effects of Deemed §332 Liquidation


• In general, basis of each asset of the subsidiary becomes basis to the parent. [§334(b).]

• Other tax attributes of the subsidiary are retained, including:• Carryovers from C corporation years.

• Earnings and profits.

• Method of accounting (although change may be required)

• Depreciation methods

• Installment method

• Carryforward of disallowed business interest expense

• Several other items. [§381(c).]

Nontaxable or Partially Taxable Alternatives


• Contribution of stock to parent corporation (§351)

• Tax free reorganization [§354, §368(a)]

Contribution of Stock to Parent Corporation (§351)


• Typically, tax free via §351

• Contributing shareholders must own > 80% of parent corporation stock after transfer.

• Any non-stock consideration is boot:• May trigger gain, but not loss.

• Basis of assets generally carries over

• However, only asset transferred is Target stock.• No adjustment to Target’s asset basis

• Tax attributes, elections, etc. survive.

• If losses, there are possible §382 limitations.

• QSub election treated as a liquidation.

QSub Deemed Liquidation


• Tax free per §332, §337

• Asset basis, tax elections carry over

• Accumulated E&P stay forever, until distributed

• However, AAA is subject to Post Termination Transition Period limits

• Shareholder suspended loss limits disappear.

Reno and Rentco Additional Facts

Reno • Reno has AAA of $3,000,000

• Reno has limited liquid assets

• Reno has no accumulated earnings and profits

Rentco• Rentco has AAA of $150,000

• Rentco has $5,000,000 accumulated earnings and profits


§351 ExampleReno, Inc. and Rentco, Inc.

• Reno, Inc.’s shares have a value of $5,000,000.

• Rentco’s shares are worth $1,000,000.

• All of the shares are owned by Allen, Barbara, Caroline and Dylan in the following proportions:

Shareholder Percent of Reno Percent of Rentco

Allen 25 20

Barbara 25 20

Caroline 25 20

Dylan 25 40

Total 100 100


§351 ExampleReno, Inc. and Rentco, Inc. (Continued)


• Before §351 transfer

ShareholdersShareholders

Reno, Inc. Rentco, Inc.

Rentco StockReno Stock

100% 100%



• Assuming the parties want there to be four equal owners of the combined enterprise, they need to compensate Dylan for his reduction in ownership of Rentco.

• They could accomplish this by having each of the other three shareholders purchase five percent of the stock from Dylan, or by having Rentco redeem 15 percent of the stock from Dylan.



• The simplest option is to form a new corporation “Neutrino, Inc.” and elect S status immediately. • Each of the shareholders contributes his or her Reno and Rentco stock to

Neutrino and receives Neutrino stock in the exchange, which takes place on July 8, 2021.

• Rentco could give Dylan some cash, notes or other property to reduce his interest in the new venture.

• This is a classic §351 exchange.

• Only those shareholders who receive the cash or other property would recognize any gain. • No person would recognize any loss.

• None of the three corporations would recognize any gain or loss.



• Formation of Neutrino




100% 100%

Neutrino



• Transfers to NeutrinoShareholdersShareholders



100%

Neutrino

Stock

100%



• Section 351 Exchange




100% 100%

Neutrino

Neutrino Stock



• After Section 351 Exchange


Neutrino

Neutrino Stock




Immediate filing requirements

Assuming that the parties form Neutrino on July 8, 2021, they should take the following actions:

1. File Form 2553 for Neutrino immediately.*

2. Neutrino must file Form 8869 for Reno immediately.*

3. Neutrino must file Form 8869 for Rentco immediately.*

* (within 2 months and 15 days). • Late election relief is available.

• On or before July 8, 2024, relief granted by Service Center (no user fee)

• After July 8, 2024, request letter ruling. Fee currently $38,000

Rev. Proc. 2021-1, Appendix A

Neutrino Form 2553


/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\/\

Reno, Inc.,Form 8869


Rentco, Inc.,Form 8869




Filing requirements for returns

1. Reno and Rentco must each file its final Form 1120-S for the year beginning January 1, 2021, and ending July 8, 2021, by October 15, 2021. (May be extended for 6 months, until April 15, 2022)

2. Neutrino must file its initial Form 1120-S (assuming calendar year) March 15, 2022. (May be extended for 6 months until September 15, 2022)• Reports combined income and balance sheets.

• Check for GAAP requirements

• Shows affiliation with Reno and Rentco on Schedule B

Neutrino Form 1120-S, Schedule B


2021

§351 ExampleReno, Inc. and Rentco, Inc.(Continued)


• After the contribution none of the Neutrino shareholders would be considered as owners of either Reno or Rentco stock.

• If any shareholder had a loss in excess of basis in either of the two corporations, Reg. §1.1366-2(c)(1) allows the shareholder of the acquiring S corporation to use the acquiring S corporation’s income to deduct pre-transaction suspended losses.

• Presumably, a shareholder in one of the acquired corporations could use future income to relax deductions previously suspended under the at-risk rules.

• The §351 exchange would not release any suspended passive activity losses.• However, any passive income from Neutrino would allow the shareholder to

deduct those losses.



• Since neither Reno nor Rentco is a party to the exchange, per se, each would terminate its S election on July 8, 2021.

• This date would be the beginning of the Post-Termination Transition Period (PTTP) for Reno and Rentco.

Post-Termination Transition Period Defined


• The post-termination transition period begins on the day that the S election is no longer effective.

• The period ends on the latest of:• The due date for the final 1120S, including extensions,

• One year after the termination occurs, or,

• 120 days after a closing agreement or final court decision.

• 120 days after an audit of a Subchapter S item.

• Code §1377(b)(1), Reg. §1.1377-2(a).

• In this example it would end for both of the acquired corporations on July 8, 2022 (1 year after the acquisition by Neutrino)• The extended due date for Reno and Rentco’s returns is April 15, 2022

• The extended due date for Neutrino is irrelevant, since its existence did not terminate.



• The PTTP would end on July 8, 2022.• The AAA of Reno would only be available for distributions during the PTTP.

• Moreover, Neutrino and either subsidiary corporation could only distribute cash from Reno’s AAA.

• Other distributions would be limited to the post-combination AAA.

• However, Rentco’s AE&P would not disappear either at the time of the combination or at the end of the PTTP.

Method for Survival of AAA


• For the AAA of either or both corporations to survive longer than the PTTP, each of the corporations must be acquired in a transaction to which §381(a)(2) applies. Reg. §1.1377-2(b).

• Code §318(a)(2) applies only to the following reorganizations:• Type A merger or consolidation

• Includes forward triangular and reverse triangular

• Type C acquisition of substantially all assets for stock• Type D acquisition of substantially all assets for stock, when the shareholders

of the acquired corporation are in “control” (>50%) of the acquiring corporation.

• Type F reorganization, which cannot be used to combine corporations or add shareholders.

• Type G reorganization involving transfer of an insolvent corporation’s assets in a bankruptcy proceeding

• A §332 liquidation does not qualify

Method for Survival of AAA (Continued)


• To avoid PTTP limitations, Neutrino cannot acquire the stock of either corporation directly, as in a Type B stock for stock reorganization.

• However, the structures that avoid the PTTP require mergers or asset transfers.

• The parties all want to keep the business operations in separate corporate shells.

Method for Survival of AAA (Continued)


• The options available include the following:• Type A triangular merger into Neutrino newly formed subsidiaries.

• Type A reverse triangular merger, in which Neutrino newly formed subsidiaries merge into Reno and Rentco

• Type C acquisition of substantially all assets of each corporation by a Neutrino subsidiary in exchange for Neutrino stock • However, since Reno and Rentco shareholders are in control of Neutrino after the

reorganization, it would be a Type D reorganization.

• This is the only type of reorganization in which a corporation must recognize gain if its liabilities exceed the adjusted basis of its assets.

Triangular Merger ExampleReno, Inc. and Rentco, Inc.


• The parties have decided to use a Type A triangular merger to acquire each of the corporations.

• Therefore, as soon as Neutrino receives its charter it will charter two new “mirror” subsidiaries.

• There are two options for these subsidiaries:1. Incorporate each and make a QSub election immediately.

2. Form each as a single member LLC (SMLLC), with Neutrino as the sole member.

• In either case, the new entities would be disregarded for tax purposes.

• Reg § 1.368-2(b)(1)(iii), Example 2 treats the merger of a corporation into a disregarded entity as a valid Type A reorganization.

Triangular Merger ExampleReno, Inc. and Rentco, Inc. (Continued)


• The parties have decided to use SMLLCs as the entities into which Reno and Rentco will merge.• Reason for this choice will become apparent later.

• Each one of these entities would receive Neutrino stock.

• Each of these entities would acquire all of the stock of one of the existing corporations, and issue the Neutrino stock to the shareholders in exchange for their Reno and Rentco stock.

Triangular Merger ExampleReno, Inc. and Rentco, Inc. (Continued)


• Formation of Neutrino, same as in §351




100% 100%

Neutrino

Triangular Merger ExampleReno, Inc. and

Rentco, Inc. (Continued)

Formation of SMLLCs owned by Neutrino





100% 100%

Neutrino

Reno, LLC. Rentco, LLC.

100% 100%Neutrino Stock



Exchange of stock





100% 100%

Neutrino


100% 100% Neutrino StockNeutrino Stock



Mergers





Neutrino


100%

Neutrino Stock

100%

Assets,

liabilities,

equity accounts,

tax history

Assets,

liabilities,

equity accounts,

tax history



After Mergers



Neutrino


Neutrino Stock


100%

Triangular Merger ExampleReno, Inc. and Rentco, Inc.(Continued)


• The tax histories of both Reno and Rentco survive permanently

• There is no PTTP

Sale of a QSub


• The sale of any stock of a QSub ends the corporation’s QSub status immediately.

• Accordingly, there must be a “new” corporation, and the new corporation must acquire certain assets (and liabilities).

• 1361(b)(3)(C)(ii) treats a sale of QSub stock is treated as:• A sale by the parent of undivided interests in each of the assets deemed

transferred to the QSub, followed by,

• A contribution of all of the assets to the QSub in a Code Section 351 exchange.

Form of QSub Sale


S Corporation

Parent/

Seller

QSub

(disregarded)

Purchasers:

Any entity, person or

group

QSub

Stock

Cash,

etc.

Tax Treatment of QSub Sale


•Fictional Step 1: Asset sale/purchase

S Corporation

Parent/

Seller

QSub

(disregarded)

Purchasers:


groupCash,

etc.

Assets,

Liabilities

Tax Treatment of QSub Sale


•Fictional Step 2: Formation of “new” Corporation

Purchasers:


group

S Corporation

Parent/

Seller

New

Corporation

(Former QSub)

Assets,

Liabilities

Stock

“Foot-Faults” with QSubs


• Subsidiary may have violated QSub rules

• Parent may have violated Subchapter S rules.

• Prospective purchaser of corporation may discover possible violations during due diligence examination.

• Often, current owner must request letter ruling granting inadvertent termination relief. • [Fee currently $38,000: Rev. Proc. 2021-1, Appendix A]

• If prior violation is discovered, and not rectified, risk is on the buyer.

• Unknowingly, buyer has purchased a C corporation’ stock. • No adjustment to basis of target’s assets

• Potential liability for C corporation income tax

Remedy for Buyer’s Risks


• Require that selling corporation convert target to LLC status

• Seller has no realization event:• Conversion of one form of disregarded entity to another form of disregarded

entity.

• Purchase of SMLLC has same treatment as purchase of QSub.

• However, risk of prior reclassification stays with seller

Related Party Consequences


• Stock acquisition not eligible for §338(h)(10) or §336(e).

• Acquiring corporation must purchase > 80% of stock within one year from unrelated persons.

• Related parties defined in §318(a):• Family

• Owner-entity

• Entity-owner

Related Party Consequences (Continued)


• No loss allowed on any asset if basis > FMV. §267(a)(1).

• Gain on depreciable assets is ordinary income. §1239.

• Applies to buildings, goodwill and other intangibles. • See Fish v. Comm’r, TC Memo 2013-270.

• Related parties defined in §267

§267 Relationships

TABLE 10-2: RELATIONSHIPS AS DEFINED IN CODE SEC. 267(b )1

*Section 267(c)(4) defines members of family as:The family of an individual shall include only his brothers and sisters (whether by the whole or half-blood), spouse, ancestors, and lineal descendants**Controlled group requires more than 50 percent common ownership.Note this provision overlaps Sections 267(b)(11) and (12)*** Already treated as related parties by Section 267(b)(3).

Source: Robert W. Jamison, S Corporation Taxation, 2021 Edition, Chicago, CCH Incorporated, TABLE 10-1, ¶1007.01


Forbidden Structure


• Partnership as shareholder

S Corporation

Share-

holders

Partnership

Others

Forbidden Structure


• C Corporation as shareholder

C Corporation

Share-holders

S Corporation

Forbidden Structure


• S Corporation as shareholder

S Corporation

Share-holders

S Corporation

S Corporation as Partner in Partnership


• Permitted

• Often used by professional organizations

S Corporation

Share-holders

Partnership

Others

C Corporation Subsidiary


• Permitted

• S Corporation may be only shareholder or there may be others

S Corporation

Share-

holders

C Corporation

Uses of a C Corporation Subsidiary


• C corporation retains some viability.

• The S corporation is limited as to the excludable fringe benefits it can offer to a person who actually or constructively owns more than 2% of the corporation’s outstanding stock.

• A C corporation is considerably less restrictive.• The corporation can offer such fringes as accident and health insurance, or

meals and lodging for the convenience of the employer.• Although a shareholder of an S corporation cannot exclude these benefits,

any employee, even a 100% shareholder, of a C corporation is permitted this exclusion.

• To avail oneself of a fringe benefit exclusion, a person must be an employee of the C corporation.

• If the person is also an employee of the S corporation, the employers could be exposed to double payroll taxation.

Common Paymaster Election


• When an individual works for more than one employer, and the total wages exceed the social security tax wage base, there is a duplication of employer FICA taxes. (The employee may receive a refund of his excess tax as a refundable credit on Form 1040.) • Usually, both employers also are required to pay state and federal

unemployment taxes.

• The burden of these taxes on related corporate employers can be substantially reduced if the employers qualify to select (and do select) a common paymaster for concurrent employees.

• When a common paymaster is used, the corporations are treated as one employer for FICA tax and for federal unemployment tax.

S Corporations Owning Multiple Entities: Mastering Tax ...

Documents

Transcript of S Corporations Owning Multiple Entities: Mastering Tax ...