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1
Balance Sheetsand Basis
Tax Buddha
For EBAEA
©2011
“Gold Hat” played by Alfonso Bedoya
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• Non Compliance Issues– Deducting Personal Expenses– Inadequate Wages– Improperly Calculating Basis
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HR 4213
Make it all taxable
• Ways to address Basis non-compliance
– Require S Corps to Track Shareholder Basis– Send info on how to track basis to new S
Corps– Provide a clear 1-2 page guide on tracking
GAO-10-195
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Basis = Equity?
Inside Basis Outside Basis
Entity’s interest in
any contributed
property
Owner’s adjusted basis in
contributed property
IRC 722 IRC 723
Inside Basis = Outside Basis?
5
Inside Basis Outside Basis
• Stock $1,000 • Stock $1,000
Inside Basis Outside Basis
• Stock $1,000 • Stock $1,000 (taxed)
Money in your pocket isPost-Tax
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Inside Basis Outside Basis
• Stock $1,000• Retained Earn $300
• Stock $1,000 (taxed)• Income $300 (taxed)
Inside Basis Outside Basis
• Stock $1,000• Retained Earn $300
• Stock $1,000 (taxed)• Income $300 (taxed)
• Sale of ownership $1,300 – Tax?
Inside Basis Outside Basis
• Stock $1,000• Retained Earn $300
• Stock $1,000 (taxed)• Income $300 (taxed)
• Sale of ownership $1,300 – Not Taxed!
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Inside Basis Outside Basis
• Stock $1,000• Retained Earn $300
• Stock $1,000 (taxed)• Income $300 (taxed)
• Sale of ownership $1,300 – Not Taxed!
Basis = $1,000 + $300Sale = $1,300
Inside Basis Outside Basis
• Stock $1,000 • Stock $1,000 (taxed)
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Inside Basis Outside Basis
• Stock $1,000• Retained Earn $250
• Stock $1,000 (taxed)• Tax Exempt Income
$250
Inside Basis Outside Basis
• Stock $1,000• Retained Earn $250
• Stock $1,000 (taxed)• Tax Exempt Income
$250
• Sale of Ownership $1,250 – Tax?
Inside Basis Outside Basis
• Stock $1,000• Retained Earn $250
• Stock $1,000 (taxed)• Tax Exempt Income
$250
• Sale of Ownership $1,250 – No Tax
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Inside Basis Outside Basis
• Stock $1,000• Retained Earn $250
• Stock $1,000 (taxed)• Tax Exempt Income
$250
• Sale of Ownership $1,250 – No Tax
Basis = $1,000 + $250Sale = $1,250
Original Owner
• Stock $1,000• Retained Earn $200
• Stock $1,000 (taxed)• Income $200 (taxed)
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Original Owner
• Stock $1,000• Retained Earn $200
• Stock $1,000 (taxed)• Income $200 (taxed)
Original Owner
• Stock $1,000• Retained Earn $200
• Stock $1,000 (taxed)• Income $200 (taxed)
• Sale of Stock $5,000
Original Owner
• Stock $1,000• Retained Earn $200
• Stock $1,000 (taxed)• Income $200 (taxed)
• Sale of Stock $5,000
• Gain $3,800 (taxed)
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Original Owner
• Stock $1,000• Retained Earn $200
• Stock $1,000 (taxed)• Income $200 (taxed)
• Sale of Stock $5,000
• Gain $3,800 (taxed)
Basis = 1,000 + $200
New Owner
• Stock $1,000• Retained Earn $200
• Stock $5,000 (taxed)
Inside Basis = Outside Basis
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Basis = Equity?
• Stock sale/acquisition only by “cash”• Depreciated property contributed in tax
free exchange• Distributions never in excess of basis• No Debit* basis• Positive retained earnings• No Treasury Stock
External Basis
Decreased by• Business losses taken• Section 179• Non-Deductible Expenses• Repayment of Qualified Loans• Non-Taxable Distributions• Shareholder selling their stockPub 551
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External Basis
Increased by• Purchase of Stock by shareholder• Income from Corporation taxed to
shareholder• Contributions• Qualified Loans made to corporation
– need ‘economic outlay’ to add basis
Pub 551
$$/Benefits
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Section 721Basis to Partner
=Basis to Partnership
Section 721
Section 721Basis to Partner
=Basis to Partnership
No Gain/Loss recognized on Contribution
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Section 721Basis to Partner
=Basis to Partnership
No Gain/Loss recognized on Contribution
Holding Period Continues
Section 351 Tax Free Exchange
Contributed Property to Corp
Section 351 Tax Free Exchange
Contributed Property to Corp
If it’s not Controlled, it’s Sold
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Section 351 Tax Free Exchange
Contributed Property to Corp
If it’s not Controlled, it’s Sold
Recognize gain/loss at time of contribution
Section 721:Partnerships, No Gain
Section 351: CorporationsNo Gain if Qualifying
Section 721:Partnerships::
Section 351: Corporations:::
Rule:Exception
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1
Auto Body Shop
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Auto Body Shop
Auto Body Shop
Auto Body Shop
19
Auto Body Shop
Auto Body Shop
Auto Body Shop
20
Auto Body Shop
Auto Body Shop
Auto Body Shop
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Auto Body Shop
Auto Body Shop
Assets Book
Cash $100
Duesenberg $100
Capital-Donald $100
Capital-Andy $100
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Book = Inside Basis
Book = Inside Basis(It is what we say it is)
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Assets Book
Cash $120
Duesenberg $100
Capital-Donald $110
Capital-Andy $110
Assets Book
Cash $140
Duesenberg $100
Capital-Donald $120
Capital-Andy $120
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Is It Taxable?
Is It Taxable?
Is It Taxable?
But I didn’t take the money!
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Is It Taxable?
But I didn’t take the money!
Income istaxed at
least once.
Assets Book
Cash $155
Duesenberg $100
Loan Payable $ 15
Capital-Donald $120
Capital-Andy $120
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Assets Book
Cash $155
Duesenberg $100
Loan Payable $ 15
Capital-Donald $120
Capital-Andy $120
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Take $ 40
Assets Book
Cash $115
Duesenberg $100
Loan Payable $ 15
Capital-Donald $100
Capital-Andy $100
Is It Taxable?
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Is It Taxable?
Once taxed, never taxed again.
Assets Book
Cash $115
Duesenberg $100
Loan Payable $ 15
Capital-Donald $100
Capital-Andy $100
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Take $ 15
Assets Book
Cash $100
Duesenberg $100
Loan Payable $ 15
Capital-Donald $92.5
Capital-Andy $92.5
Is It Taxable?
30
Is It Taxable?
*
• Am I still on the hook for half of $15 loan?
• It is as if I owe the money, not the partnership.
Assets Book
Cash $100
Duesenberg $100
Loan Payable $ 15
Capital-Donald $92.5
Capital-Andy $92.5
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Take $ 100
Assets Book
Cash $ 0
Duesenberg $100
Loan Payable $ 15
Capital-Donald $42.5
Captial-Andy $42.5
Is It Taxable?
32
Is It Taxable?
Auto Body Shop
Is It Taxable?
33
Cash Out $50
Basis In :
Deusenberg $25
Name $0
Outside
Sell For $
Sell For $300
34
Is It Taxable?
Assets Book
Cash $ 0
Duesenberg $100
Loan Payable $ 15
Capital-Donald $42.5
Captial-Andy $42.5
Is It Taxable?
35
Duh!
Is It Taxable?“I got $227.5”
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The formulation of a problem is often more essential than its solution….
---Albert Einstein
Pause
Deducting LossRequires Basis
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Loss deduction limited to shareholder basis(stock + debt*)
Taking Losses (Outside) Reduces (Outside) Basis
Taking Losses (Outside) Reduces (Outside) Basis
Suspended Losses (Outside) Does NOT Reduce
(Outside) Basis
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Bead Store
• Start business with $1,000 cash, Basis = ?
Bead Store
• Start business with $1,000 cash
• Buy $500 of inventory, but DON’T pay the vendor.
Basis = ?
39
Bead Store
• Start business with $1,000 cash
• Buy $500 of inventory, but DON’T pay the vendor.
• Pays $500 rent first year in business
Bead Store
• Is First Year Loss of $500 deductible to owner?
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(Basis = $500 after)
Bead Store
• Entity pays $500 rent in Second Year.
Bead Store
• Entity pays $500 rent in Second Year.
• Still haven’t sold beads, nor paid the vendor.
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Bead Store
• Entity pays $500 rent in Second Year.
• Still haven’t sold beads, nor paid the vendor.
• Rent expense deductible to owner in Second Year?
(Basis = $0 after)
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Bead Store
• Entity pays $500 rent in Third year.
Bead Store
• Entity pays $500 rent in Third year.
• Sold the beads at cost for $500 (used to pay the rent), but vendor not paid.
Bead Store
• Entity pays $500 rent in Third year.
• Sold the beads at cost for $500 (used to pay the rent), vendor not paid.
• Rent expense deductible to owner in Third year?
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Bead store
Suspended Loss
Bead Store
• Owner pays the vendor $500 for the beads in Fourth Year by writing a personal check.
Bead Store
• Owner pays the vendor $500 for the beads in Fourth Year by writing a personal check.
• By contributing $500 more, owner now has basis and can take the loss in Fourth Year.
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Bead Store
• Owner pays the vendor $500 for the beads in Fourth Year by writing a personal check.
• By contributing $500 more, owner now has basis and can take the loss in Fourth Year.
• (and should probably go out of business)
Bead Store
• What if the business takes out a LOAN instead of “borrowing” from a vendor?
Loss deduction limited to shareholder basis(stock + debt*)
No credit for corporate debt to outside basis
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Bead Store
Does a “Loan” create Basis?
It Depends…
Who owes the money, nominally?
Another Example
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2
10 Piece Band
• 10 Partners in a Partnership
10 Piece Band
• 10 Partners in a Partnership
• 1 Partner, Kyle, quits, wants his “fair share” and wants to know his basis
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10 Piece Band
• 10 Partners in a Partnership
• 1 Partner, Kyle, quits, wants his “fair share” and wants to know his basis
• Kyle gets all ‘lawyered up.’
10 Piece Band
• Each Partner owns 10%
10 Piece Band
• Each Partner owns 10%
• Each Partner contributed $1,000 cash
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10 Piece Band
• Each Partner owns 10%
• Each Partner contributed $1,000 cash
• Each Partner contributed a Tuba
10 Piece Band
What is Basis for Kyle?
$21,016 assets/10 partners
=
$2,101.60?
10 Piece Band
What’s the story, Asset by Asset?
49
10 Piece Band
• In the Beginning (3-16-01):
– Kyle Contributes $1,000 Cash
Kyle’s Basis• $1,000 – Cash
$1,000.00 Total Basis
10 Piece Band
• In the Beginning (3-16-01):
– Kyle Contributes $1,000 Cash
– Kyle Contributes Golden Tuba $7,000
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Kyle’s Basis• $1,000 – Cash• $7,000 – Golden Tuba
$8,000.00 Total Basis
Only 10% Ownership?
Kyle’s Basis
• Where did the money come from to purchase assets?
• Who benefits from depreciation?
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10 Piece Band
• Kyle has received benefit of 10% of the depreciation on HIS CONTRIBUTED TUBA, or $700
10 Piece Band
• Kyle has received benefit of 10% of the depreciation on HIS CONTRIBUTED TUBA, or $700
Now that it is a Partnership Asset, Kyle only gets his portion of the Depreciation
Kyle’s Basis• $1,000 – Cash• $7,000 – Golden Tuba• Less $700 – Depreciation on Golden Tuba
$7,300.00 Total Basis
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10 Piece Band
• Kyle has received benefit of 10% of the depreciation on HIS CONTRIBUTED TUBA, or $700
AND
• Kyle has received benefit of 10% of the depreciation on the OTHER NINE TUBAS, or $3,500
Kyle’s Basis• $1,000 – Cash• $7,000 – Golden Tuba• Less $700 – Depreciation on Golden Tuba• Less $3,500 – Depreciation on 9 Tubas
$3,800 Total Basis
10 Piece Band
• Group buys a Mixer 6-10-05 for $2,010
53
10 Piece Band
• Group buys a Mixer 6-10-05 for $2,010
• Kyle “owns” 10% of the mixer
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10 Piece Band
• Group buys a Mixer 6-10-05 for $2,010
• Kyle “owns” 10% of the mixer
• Kyle has received benefit of 10% of the depreciation
Kyle’s Basis• $1,000 – Cash• $7,000 – Golden Tuba• Less $700 – Depreciation on Golden Tuba• Less $3,500 – Depreciation on 9 Tubas• $44.90 – Mixer
$3,844.90 Total Basis
10 Piece Band
• Group creates a Copyright for “Tubas on the Beach” 4-15-08 for $1,500
55
10 Piece Band
• Group creates a Copyright for “Tubas on the Beach” 4-15-08 for $1,500
• Kyle “owns” 10% of the Copyright
10 Piece Band
• Group creates a Copyright for “Tubas on the Beach” 4-15-08 for $1,500
• Kyle “owns” 10% of the Copyright
• Kyle has received benefit of 10% of the amortization
Kyle’s Basis• $1,000 – Cash• $7,000 – Golden Tuba• Less $700 – Depreciation on Golden Tuba• Less $3,500 – Depreciation on 9 Tubas• $44.90 – Mixer• $128.20 – Copyright
$3,973.10 Total Basis
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10 Piece Band
• Group buys inventory for $5,500
• Kyle “owns” 10% of the inventory
Kyle’s Basis• $1,000 – Cash• $7,000 – Golden Tuba• Less $700 – Depreciation on Golden Tuba• Less $3,500 – Depreciation on 9 Tubas• $44.90 – Mixer• $128.20 – Copyright• $550 – Inventory
$4,523.10 Total Basis
10 Piece Band
• Group buys Microphones 7-15-09 for $5,000
57
10 Piece Band
• Group buys Microphones 7-15-09 for $5,000
• Kyle “owns” 10% of the Microphones
10 Piece Band
• Group buys Microphones 7-15-09 for $5,000
• Kyle “owns” 10% of the Microphones
• Kyle has received benefit of 10% of the depreciation
Kyle’s Basis• $1,000 – Cash• $7,000 – Golden Tuba• Less $700 – Depreciation on Golden Tuba• Less $3,500 – Depreciation on 9 Tubas• $44.90 – Mixer• $128.20 – Copyright• $550 – Inventory• $428.50 – Microphones
$4,951.60 Total Basis
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Kyle’s Basis
• Not 10% of Balance Sheet $2,15.16 –Inside Basis
• Kyle’s Basis = $4,951.60
Kyle’s Basis
• If contributions were all equal, and disbursements were all equal, the 10% WOULD have worked.
Kyle’s Basis
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Kyle’s Basis
• Kyle takes the Golden Tuba
Kyle’s Basis
• Kyle takes the Golden Tuba
• FMV = $4,000
Kyle’s Basis
• Kyle takes the Golden Tuba
• FMV = $4,000
• Basis $4,951.60 – Tuba $4,000
= $951.60 Loss
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Kyle’s Basis
• Kyle takes the Golden Tuba
Kyle’s Basis
• Kyle takes the Golden Tuba
• FMV = $7,000
Kyle’s Basis
• Kyle takes the Golden Tuba
• FMV = $7,000
• Basis $4,951.60 – Tuba $7,000
= $2,048.40 Gain
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Further Questions: [email protected]
fin
© 2010
Household PayrollLafayette CA 1/24/11
www.TaxBuddha.com/quiz