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S corporations
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Topics
- Corporations – General
- S Corporations
- S Corporate Liquidations
S Corporations
Difficulties for tax preparers
- IRS audit issues
- Information lacking
- Complicated tax rules
Page 1
Corporate Formalities
- Articles of incorporation;
- Issue stock;
- Pay corporate debt only from corporate checking;
- Have annual meetings.
Page 1
Note:
Piercing the corporate veil
- Corporate entity is not recognized.
- From either an income tax perspective or from a liability perspective.
Page 2
Insulating the Owners
From liabilities & debts
Only assets of corporation are at risk
Personal signature guarantee
Page 2
Professional negligence
Acts by shareholder who did not act prudently regarding
business operations.
Page 2
What Clients Think …
In one case SP incorporated and dropped all vehicle
insurance.
Page 2
What Clients Think …
He thought the corporate liability shield would
eliminate the need for insurance.
Page 2
What Clients Think …
Under these conditions, the business owner was held
personally liable.
Page 2
Personal Signature
Guarantees
- Many Vendors
- All Banks
Require a personal signature guarantee
Page 2
Incomplete Incorporations
- Reporting the 351 transfer
- Transferring title of assets
- Capitalizing & issuing stock
- Establishing minutes
Page 2
Incomplete Incorporations
- Establishing corporation bank accounts
- Establishing corporate licensing
- Transferring insurance coverage
Page 2
Types of Corporations
S Corporation
Generally, not taxed at Corp Level
Flow-through, taxed at shareholder level
Page 2
Types of Corporations
C Corporation
Separate Taxable Entity
Corporation pays taxes
Distributions taxed again at the shareholder level
Page 2
The LLC C Corporation
- Check the box regulations
- File Form 8832
- No further effort – Entity is taxed as C Corporation
Page 3
The SMLLC S Election
Two-prong procedure WAS required
1. Filing Form 8832 and
2. Filing Form 2553
Page 3
Both forms
no longer necessary
- Filing Form 2553 functions as “deemed” entity classification.
Page 3
Note 2:
When an LLC has EIN chooses to be taxed as a
corporation (C or S), a new EIN is not required.
Page 3
Section 351
Incorporation
Converting an established, sole proprietor or partnership
to a C Corporation.
Tax-Free Exchange
Page 3
§351 Transfer
- Transfer assets and liabilities in exchange for stock
- Receive only stock
Page 3
After the Exchange
In control of corporation
Must own at least 80% total voting power and 80% of all other classes of stock.
Page 3
§351 Transfer
Stock must be only asset received
Anything else is boot.
Gain is recognized to the extent of any boot received.
Page 3
Don’t …
Withdraw significant amounts of cash prior to incorporation.
If it’s working capital.
Working capital should be part of transfer.
Page 3
§351 Transfer
Cannot relieve the owner of debt that exceeds the basis of
the assets which are transferred to the corporation.
Page 4
Example 1:
Basis of AssetsTransferred $15,000Less: Debt Assumed (10,000)
Basis in Stock $ 5,000
Page 4
Example 2:
Basis of AssetsTransferred $ 5,000Less: Debt Assumed (10,000)
Taxable Gain $ 5,000
Stock basis = Zero
Page 4
§351 Incorporation
Balance Sheet
Assets Liabilities & Equity
Checking Account $ 5,000 Debt $105,000
Equipment 200,000 Equity 100,000
$205,000 $205,000
Equipment's FMV is $300,000.The taxpayer received only stock in the transaction. The stock received has a basis of $100,000.
Page 5
Change the facts …
Balance Sheet
Assets Liabilities & Equity
Checking Account $ 5,000 Debt $155,000
Equipment 250,000 Equity 100,000
$255,000 $255,000
The taxpayer also received a note receivable for $50,000.
Page 5
Change the facts - again
Balance Sheet
Assets Liabilities & Equity
Checking Account $ 5,000 Debt $155,000
Equipment 205,000 Equity 55,000
$210,000 $210,000
The taxpayer received a note receivable for $50,000.
Equipment's FMV is $250,000.
Page 5
Change the facts - again
In this last situation, even though the taxpayer received a note receivable for $50,000, only $5,000 is taxable.
Page 5
Page 6
Section 351 Transfer Statement
1. Assets transferred
2. Liabilities assumed
3. Stock received
FMV Basis
4. Notes received
5. Money received
6. Other property received
Sample §351 Statement
Attached to both the:
- Corporate tax return, and
- Individual tax return
Page 6
Wisconsin
Unemployment Insurance
Certain corporations may elect to exclude qualified
corporate offices from “employment” under
Wisconsin’s Unemployment Insurance Law.
Page 7
Wisconsin
Unemployment Insurance
If elected, the officer’s wages are not subject to state Unemployment Insurance taxes.
Remember to check with your specific state.
Page 7
Eligible for the Exclusion
Four conditions:
1. UI taxable payroll is less than $500,000.
2. Election made by March 31
Page 7
Eligible for the Exclusion
3. Election all officers who hold 25% or more interest.
4. The corporation has not previously elected the exclusion.
Page 7
Example 1:
An insurance agent started his S-Corp business in 2021 and
currently is the only employee with a salary of $30,000.
Page 7
Example 1:
His unemployment rate as a new business is 3.05%.
Without officer exclusion:
FUTA $ 42
SUTA 427
Total $469
Page 7
Example 1:
If he elected to exclude from SUTA, his FUTA would be $420.
Question: Is a savings of $49 enough to make the election?
Page 7
Example 2:
Same facts as example 1, except he has been in
business for several years and his SUTA rate is now 2.1%.
Without the exclusion, his
Page 7
Example 2:
His unemployment rate as a new business is 3.05%.
Without officer exclusion:
FUTA $ 42
SUTA 294
Total $336
Page 7
Example 2:
With the exclusion, his tax would be $420.
In this case, it is not beneficial to make the election.
Page 7
Example 3:
A home builder who has been in business for several years
operating as an S Corporation with a SUTA rate of 7.4%.
Page 7
Example 3:
Without the exclusion, his total FUTA and SUTA tax
would be $1,078.
Page 7
Example 3:
With the exclusion, his total FUTA tax would be $420.
A savings of $658 is worth the election.
Page 7
Workman’s
Compensation
Rules vary state to state
In this case, we are discussing Wisconsin only.
Page 8
Page 8
Wisconsin Only
Corporate Officers
If the corp. has no more than 2 corporate officers and no other employees, Worker’s Comp. policy is not required if both officers elect out.
Page 9
Wage for Officers
Workman’s Compensation
Normally based on amount of gross compensation.
For business owner’s it is based on amount of “deemed wages”
Page 9
Wage for Officers
Workman’s Compensation
Regardless of the amount of actual wages paid, the deemed:
Minimum wage = $290/week and
Max. wage = $1,641/week.
Page 9
Health Insurance
Workman’s compensation
If you elected out of workman’s compensation you may not be covered under your health insurance plan.
Check with your insurance agent.
Page 9
Corporate Officers
An officer cannot be an independent contractor to the corporation.
Page 10
Directors’ Fees
Deductible if it’s reasonable for the services rendered.
Other deduction on 1120
1099-NEC if over $600
Page 10
Social Security
Eligibility
Many business owners “reduce” their wages to stay under wage limits for early retirement.
If full retirement age no income limitations.
Page 10
When you work for
someone else
- Easy to determine if you’re retired
- If you own your business, it’s not so easy to determine.
Page 10
Areas of Concern
S Corporation Distributions
SSA may reclassify as earned income
Rent paid to Shareholders
SSA may reclassify as earned income
Distributions to other family members
Payroll to spouse
Page 10
Hours Worked
Test for business owners:
> 45 hours/month = Not retired
< 15 hours/month = Retired
15-45 hours /month = Maybe
Document your working hours
Page 11
Recommendation
If your client is thinking of early retirement and owns a business have them go to:
www.socialsecurity.gov and print
Form SSA-4184 and review.
Page 11
Leasing Property
to Corporation
Lease payment deductible to Corporation.
Shareholder pays taxes on lease payments.
Rent in excess of FMV could be treated as a dividend.
Page 11
Duplicating Supply Co
Tax court found rent charged was excessive.
- Constructive dividend, plusnegligence penalties.
- Taxpayer made no attempt to determine FMV rent.
Page 11
Note:
Get a letter from local realtor to determine FMV for rental.
Draft a rental agreement
Payments should be made timely
Recorded in corporate minutes
Page 12
Caution:
Rental of personal property
Income is subject to:
Social Security Taxes AND
Sales Taxes
Page 12
Net Investment
Income Surtax (3.8%)
Generally applicable to Rental Income
$250,000 MFJ
$125,000 MFS
$200,000 S, HOH
Page 12
Self-Rental
Property that you rent to a trade or business in which you materially participate.
Page 12
Self-Rental
Deductible to Corporation
Taxable to Shareholder
Also subject to the NIIT if the shareholder does not materially participate.
Page 12
Example:
Tom works for ABC Inc.
He has no ownership in ABC.
Tom purchased RE to rent to ABC Inc.
Page 13
Example:
Tom materially participates in ABC Inc.
The rental property it self-rental – so it’s not subject to the NIIT.
Page 13
Net Investment Income Tax
NIIT does not apply if the taxpayer materially participates in the business.
Includes both:
Rental profits and
Sale of the rental property
Page 13
Renting your Home
For less than 15 days
- Do not report any income
- Do not take any deductions
Page 13
Note:
Some suggest:
- Hold meetings monthly in the shareholder’s home.
- Charge $1,000 per meeting
- Corp takes deduction
- Shareholder does not report
Page 13
Note:
A few basics:
- Must be bona fide meeting
- Rent must be reasonable.
We do not subscribe to this concept.
Page 13
Accrual Basis Corp
Accrues and deducts expenses as of last day of corporation year
No deduction allowed for accrued expense to related cash basis taxpayer
Until related taxpayer reports income
Effectively puts accrual basis corporation on the cash basis with related parties.
Page 13
Related Party Rules
PCS if shareholder owns ANY stock
If shareholder owns > 50% of stock
Most obvious accruals would include
Payroll
Rent
Interest to shareholder
Page 13
Example 1:
Tom owns 100% of ABC Inc.
Pays employees and himself every other week.
Year end pay period falls on the day after the Corporate year end.
Page 14
Example 1:
Tom will accrue the expense for the non-shareholder employees.
Tom will not accrue his payroll.
Page 14
Related Party Rules
Related parties are members of the same family.
Spouse, siblings, ancestors, and lineal descendants.
Page 14
Accrued Payment
Deadline
- Allowed if paid within 2-½ months of year end.
- For calendar year corporations - March 15.
Page 14
Accrued Payment
Deadline
Promissory notes, letters of credit and other evidence of
indebtedness are not considered payment.
Page 14
Office in Home
Corporation could:
Pay rent for the office space,
or
Reimburse the employee.
Page 15
Office in home
non-accountable plan
Taxable to shareholder
Deductible to corporation
Reported on Schedule E
No deductions allowed
Page 15
Office in home
Non-Accountable Plan
- Taxable to shareholder
- Deductible to corporation
Reported on Schedule E
No deductions allowed
Page 15
Example:
Sally is employee of ABC Inc
Operates an office in her home.
ABC Inc pays her $500 per month to rent that area in her home.
Page 15
Example:
Sally reports income on Schedule E.
However, she still may deduct qualified mortgage interest and RE taxes on her Schedule A.
Page 15
Office in home
Accountable Plan
Corporation could reimburse for a portion of the utilities, insurance,
repairs, mortgage interest, …
- Deductible by corporation
- Tax-free to taxpayer
Page 15
Page 16
Total Reimbursement
Home Office Reimbursement
$2,431
S Corporations
Page 17
S Corporation
Problem Areas
Net Income
Calculating basis
Shareholder compensation
Page 17
Note:
Basis calculations and shareholder compensation are obvious concerns for
preparer penalties.
Page 17
Filing Requirements
Required to file regardless of income.
If a corporation was an S corporation any time during the year – you must file Form 1120S
Due date is March 15th.
Page 17
Late Filing
For returns with no tax due
$210 per month for each shareholder during the year.
Page 17
Late Filing
For returns with tax due
Amount calculated above plus
5% of the unpaid tax for each month late up to 25%.
Page 17
Late Filing
The minimum penalty for a return that is > 60 days late is the smaller of tax due or $435.
Page 17
Note:
For a sole shareholder company filing a year late,
the penalty would be $2,520.
Page 17
Eligible S Shareholder
Individuals
Estate
Certain Trusts
(Example: Revocable Trust)
Page 17
Eligible S Shareholder
Not Allowed:
C Corporation
LLC
Partnership
Page 17
Grantor Trust
If the grantor dies the trust is allowed to continue for:
- 60 days, or
- Two years (if the assets of the trust are includable in the estate of the grantor).
Page 17
Testamentary Trust
If the stock is transferred by will.
The trust is allowed to continue for two years after the transfer.
Page 17
Schedule B-1
Must file for an S Corporation that has a disregarded entity,
trust, or an estate as a shareholder.
Page 18
Page 18
SSN of Shareholder
Type of Shareholder
Individual or entity responsible for
reporting tax information
Shareholder of record
Schedule B-1 Form 1120-S
Form 2553
Articles of Incorporation with Secretary of State
Form 2553
Filed within 2½ months
COORDINATE WITH THE ATTORNEY - WHO WILL FILE?
Page 18
Example 1:
ABC Inc began operations Jan. 6
2½ month period ends March 21.
No prior tax year, election cannot be made prior to January 6.
Page 18
Example 2:
ABC Inc has been filing Form 1120 for several years.
Form 2553 must be filed on or before March 15.
With prior tax year, election can be made any time in prior year.
Page 18
Note:
For a new S Corporate client
Request a copy of 2553 and/or acceptance letter.
Under audit, it will be one of the first items requested.
Page 18
Acceptance or
nonacceptance of Election
Acceptance letter will be sent from IRS within 60 days.
If you do not receive within two months call 1-800-829-4933.
Page 18
Note:
Consider sending Form 2553 certified mail.
IRS could require proof of filing.
Page 19
Caution:
Failure to be recognized as S Corporation problems arise.
Income/Loss is trapped in the
C Corporation.
Any distributions are treated as dividends creating double taxation.
Page 19
Waiver of Invalid S Election
IRS has authority to waive an invalid election and allow the S election to become effective if
certain conditions are met.
Page 19
Waiver of Invalid S Election
1. IRS determines circumstances resulting in the ineffective election were inadvertent.
2. Steps are taken within reasonable period to qualify as S corporation.
3. Corporation and all shareholders agree to IRS adjustments.
Page 19
Methods of
Obtaining Relief
1. Failure to obtain shareholder consents
S corporation can request extension to furnish shareholder consent
2. Relief under Rev Proc 2013-30
3. Request Letter Ruling
Fees do apply for letter rulings
Page 20
Rev. Proc. 2013-30
- Extends time to apply for relief to three years and 75 days.
- Relief is retroactive to intended date if IRS grants relief
- If denied, the taxpayer may still request a letter ruling.
Page 20
To qualify for relief
1. Intended to be classified an S corporation from the beginning.
2. Requests relief within three years and 75 days.
3. Failed to qualify solely for late
Form 2553.
4. Reasonable cause for its failure and acted timely to correct.
Page 20
Basis
Similar to a partnership
Income and/or losses flow through to shareholders
Shareholders pay income tax
Page 24
Unlike a Partnership
If S corporation incurs a loss, basis calculation does not include entity debt.
Loss deduction is more limited than a partnership.
Page 24
Basis Worksheet
Is required for a shareholder who:
- Reports a loss,
- Receives a distribution,
- Disposes of stock, or
- Receives a loan repayment from the S corporation.
Page 25
Page 25Form 1040 Schedule E
Page 2
(e) Check if basis computation
is required
Partnerships and S
Corps also differ
Substantial Economic Effect
Income allocation is:
- Available for a Partnership
- Not available for an S Corporation
Page 25
S Corporation Basis
Important for 3 reasons:
1. Deductible loss limitations
2. Gain/loss on sale of stock
3. Limits tax-free distributions
Page 25
Unallowed Losses
Suspended and carried forward.
Available for use when the shareholder has sufficient basis.
Page 26
Initial Basis
1. Purchase of Stock
2. Shares received in §351
3. C Corporation electing S Status
4. Acquired by Gift
5. Received in exchange for Services
6. Inherited
Page 26
Basis Adjustments
Basis is:
1. Increased by share of income
2. Decreased by distributions and
3. Decreased by share of loss
Page 28
Example 1:
Tom & Jim each contribute $5,000 to form XYZ.
An S Corporation.
Initial basis is $5,000 each.
Page 29
Example 1: During 2020
Business profit of $100,000.
Each received distribution of $35,000.
Both have ending basis of $20,000.
[$5,000 + (50% of $100,000) – $35,000]
Page 29
Example 2:
Assume Instead
Beginning Basis of $5,000.
Business loss of $20,000.
Shareholder distribution of $10,000.
Corporation took a loan of $50,000.
Page 29
Example 2:
Tom’s Beg. Basis $5,000
Distribution of $10,000
Creates $5,000 of taxable income
Capital Gain
Page 29
Example 2:
$50,000 Corporate Loan
No effect on the shareholder’s basis.
Unlike a partnership.
Page 29
Example 2:
$50,000 Corporate Loan
Basis is only enhanced if the loan is directly between the corporation and the shareholder
Page 29
Example 2:
Tom’s share of the $20,000 loss.
Cannot be used until he has sufficient basis.
Loss will be carried forward.
Page 29
Debt Basis
Basis increases with loans direct to S corporation.
When a shareholder’s stock basis is reduced to zero, pass-through losses may still be available to the extent of debt basis.
Page 29
Example 1:
Tom contributes $5,000
Corp has loss of $10,000
Tom can deduct $5,000
The $5,000 loss is suspended until sufficient basis is restored.
Page 29
Example 2:
Assume the same facts as Example 1, except, Tom has a loan to the S Corp of $5,000.
His basis is increased by the debt.
He can now deduct the entire $10,000 loss.
Page 29
Shareholder loan
used to support loss
Repayment of loan can be taxable.
Will be taxed as:
LTCG if written note
Ordinary income if no written note
Page 30
Example:
Same as example 2 except
During 2020 XYZ
Had a loss of $5,000
Repaid the $5,000 loan to Tom
$5,000 loss is suspended for 2020.
Page 30
Example:
Loan repayment reduces
Tom has taxable income of $5,000.
Debt was not evidenced by written note, so he has $5,000 ordinary income for 2020.
Tom’s basis is now zero.
Page 30
Planning Tip 1:
If you anticipate a loss in the corporation.
You have limited basis, and
You anticipate large taxable income from other sources.
Consider lending money to corporation to increase basis & deduct loss.
Page 30
Planning Tip 2:
If you have suspended losses in corp
Anticipate large taxable income from other sources
Consider lending money to Corp
Suspended losses will be deductible
Page 30
S Corporation
Distributions
Distributions from earnings are generally not taxable.
Distribution that exceeds earnings
Return of Stock Basis, then
LTCG
Page 31
Example 1:
Beg. Stock Basis $30,000
Current year income 49,000
Distributions (45,000)
Basis before loss
And deduction items $34,000
Page 31
Example 1:
Basis before loss
and deduction items $34,000
LT Capital Loss Current (2,000)
Ending Basis $32,000
$45,000 distribution is not taxable.
Page 31
Example:
Beg. Stock Basis $30,000
Current year income 49,000
Distributions (90,000)
Basis before loss
And deduction items - 0 -
Page 32
Example:
Basis before loss
and deduction items $ - 0 -
LT Capital Loss Current ---------
Ending Basis $ - 0 -
Page 32
Example:
$90,000 distribution
- Not taxable to the extent of basis of $79,000.
- $11,000 is taxable LTCG.
$2,000 LT Capital Loss carries over.
Page 32
Page 32
ABC Inc. Distribution in excess of basis
Form 8949
Part II
11,000 11,000- 0 -
Disproportionate
Distributions
Distributions based on shares owned by each shareholder.
Disproportionate amounts create a second class of stock, terminating S corporation status.
Page 33
S Corporation
with C Corporation AE&P
Previous “C” Corporate Earnings
Distribution exceeds “S” earnings
What is the excess distribution?
Page 33
Previously a
C Corporation
1. Accum. Adjustments Account (AAA)
2. Dividends to the extent of E&P
3. Reduction of any remaining basis
4. Capital Gain
Page 33
Take Advantage
of lower tax brackets
Dividends are taxed as LTCG rates
(0% , 15%, or 20%)
Client Profile:
Shareholder in 12% bracket
Corporation has excess cash
Consider a dividend distribution
Page 33
Election to
Distribute AE&P First
Made with the consent of all shareholders.
A statement is made on a timely filed or AMENDED 1120S return.
Effective ONLY for year election made.
Page 34
Example:
XYZ Corp $20,000 AE & P
S Corporation
Has $20,000 AAA on books
Took a $10,000 distributions
In 12% marginal tax bracket
Page 34
Example:
He would get prior C Corporation earnings.
While paying no income taxes.
12% marginal = 0% Dividends
Page 34
Deemed Dividend
Distribution
Corporation has insufficient cash to distribute AE & P.
Corp may elect to make a deemed distribution.
Deemed to be made on the last day of the tax year.
Page 35
Example:
Same as above example except no distributions
Deemed electionReduces prior C earnings
No additional tax
Page 35
Page 35
Attach the election to a timely filed return.
Planning Tip:
Election can be made at tax preparation time for deemed distributions.
Page 35
Note:
1. Form 1099-DIV is required
2. Distributions of AE&P can help eliminate or reduce BIG tax or Net Investment Income Tax (NIIT).
Page 35
QBI Deduction
20% deduction for QBI, is potentially limited if the
business is a SSTB.
Page 36
RPE Reporting
A relevant pass-through entity (RPE) can include a:
Partnership,
S corporation,
Trust, or Estate.
Page 36
Schedule K-1 Reporting
RPEs are required to report:
- Whether the business is an SSTB.
- Whether there is more than one trade or business.
Page 37
Schedule K-1 Reporting
- QBI for each business.
- The W-2 wages and UB of qualified property.
- Any REIT dividends.
- Any PTP income.
Page 37
Note:
If the RPE fails to report the information on the
Schedule K-1, the amounts are presumed
to be zero.
Page 37
Generally, …
The deduction cannot exceed the lesser of:
- 20% of the “Combined QBI Amount,” or
- 20% x (total taxable income - capital gain)*
Page 38
Combined QBI amount
1. Is the sum of the deductible amounts for each qualified trade or business,
PLUS
2. REIT dividends and PTP income.
Page 38
Excluded from QBI
1. Any item of capital gain/loss;
2. Any dividend;
3. Any interest income;
4. Any commodity transaction gain/loss.
Page 39
Excluded from QBI
5. Any hedging transactions;
6. Any amount received as an annuity;
7. Any item of deduction or loss properly allocable to an amount described in this list.
Page 39
QBI Doesn’t Include
1. Reasonable compensation paid to the taxpayer for services rendered.
2. Guaranteed payment paid to a partner for services rendered.
3. Any payment to a partner outside of his partner capacity for services.
Page 39
Note:
IRS still expects reasonable compensation for the services
performed and work done.
Page 40
Example:
David is the sole shareholder an S corporation that is a
qualified trade or business.
Page 40
Example:
The business has net income in 2018 of $150,000 after
deducting his $80,000 salary.
Page 40
Example:
David received $80,000 as wages and $150,000 as distributions.
Page 40
Example:
Assume that reasonable compensation for someone with
David’s experience and responsibilities is $120,000.
Page 40
Example:
David’s QBI from the S corp. should be $110,000.
(not $150,000 as reported)
Page 40
Example:
The $40,000 adjustment for payments treated as
reasonable compensation is not QBI.
Page 40
Qualified Trade or
Business
Any trade or business other than a SSTB, or the trade or
business of performing services as an employee.
Page 40
Specified Service
Trade or Business (SSTB)
1. Any trade or business under IRC §1202(e) other than
engineering or architecture.
Page 41
Examples:
Health
Law
Accounting
Actuarial science
Performing arts
Consulting, athletics
Financial / Brokerage services
Page 41
Specified Service
Trade or Business (SSTB)
2. Any trade or business which involves performance of services that consist of investing and investment management, trading, or dealing in securities.
Page 41
Specified Service
Trade or Business (SSTB)
3. And any business where the principal asset of such trade or business is the reputation or skill of one or more of its
employees.
Page 41
Reputation or skill
1. Endorsing products or services.
2. Receiving fees, for the use of an individual’s image, name, or trademark.
Page 41
Reputation or skill
3. Receiving fees, compensation, or other income for appearing at an event or on radio, television, or another media format.
Page 41
Qualified Trade or
Business
However, a SSTB is treated as a qualified trade or business if taxable income is under:
$329,800 MFJ
Page 42
Thresholds and
Exclusions
When taxable income is above the threshold, the
deduction begins to phase-out for a SSTB.
Page 42
Lower Thresholds Upper Thresholds
2018 2021 2018 2021
MFJ $315,000 $329,800 $415,000 $429,800
HOH $157,500 $164,900 $207,500 $214,900
SINGLE $157,500 $164,900 $207,500 $214,900
MFS $157,500 $164,925 $207,500 $214,925
2021 Taxable Income Thresholds
Page 42
Payroll or S Distribution
S income is not SE Income
Distributed or
Not Distributed
Can lead to abuse
Page 43
Reasonable Compensation
IRS has issued no guidance on
“Reasonable Compensation”
However, the IRS can reclassify distributions as wages.
Page 43
Reasonable Compensation
1. Employee Qualifications.
2. Nature, Extent and Scope of Work.
3. Industry Compensation Rates.
4. Size and Complexity of Business.
5. Compensation to non shareholder employees.
Page 43
Note:
Reasonable compensation vs. distribution analysis must look at multiple years.
Not just a single tax year.
Page 43
Potential Problems
- Payroll taxes issues including penalties and interest,
- Insufficient SS contributions
- Could reduce the §199A (QBI)
deduction
Page 43
Watson vs. US
February 2012
Took wages 2002 & 2003 of $24,000
Took distributions
2002 $203,981
2003 $175,470
Court ruled $91,044 was reasonable.
Page 45
Following Factors
1. Accountant with advance degrees
2. 35-40 Hours P/W – Primary earner
3. Earnings over $2 Million (per year)
4. $24,000 unreasonable low versus other accountants at firm
5. Financial position of the company
Page 45
Reasonable Compensation
Simple Solution
What would you pay someone else to do the same job?
Page 48
Industry Compensation
You could hire a consulting firm or go to:
www.salary.com
or
www.bls.gov
or
www.salaryexpert.com
Page 48
Family Members
If family members perform services and do not receive reasonable compensation.
IRS may also recharacterize S Distributions as wages.
Page 49
Items Other than
S Distributions
A loan to shareholder/employee from the corporation could also be an issue.
Re-characterization of the loan payments is possible.
Page 50
Items Other than
S Distributions
In one case an S Corporation entered into an agreement for no distributions and no payroll.
All payments were classified as loans.
Page 50
Items Other than
S Distributions
Based on the following:
- The loans were unsecured demand notes bearing no interest,
- They did not specify repayment terms,
- The shareholder regularly performed substantial services for the Corporation.
Page 50
Note:
Loans from an S Corporation to shareholder/employees should be
properly documented and a reasonable rate of interest paid.
Page 50
Corporate Minutes
We recommend reasonable compensation be reviewed
annually and addressed within the corporate minutes.
Page 51
S Corporation
Health Insurance
Premiums paid on behalf of more-than-2% shareholder-employees are reported as additional compensation.
Page 53
> 2% S shareholder -employees are reported as additional compensation.
Subject to FITW
But not FICA, and Medicare.
S Corporations
Nondiscriminatory
Page 53
Note: 2% Shareholder
Family attribution rules also apply for the spouse,
children, grandchildren, and/or parents.
Page 53
> 2% S shareholder -employees are reported as additional compensation.
Subject to FITW
and FICA, and Medicare.
S Corporation
Discrimination
Page 53
To claim the deduction, the health insurance plan must
be established under the taxpayer's business.
SE Health
Insurance Deduction
Page 54
If the taxpayer is:
A 2%-or-more S corporation shareholder, the policy can be either in the taxpayer's or the S corporation's name.
SE Health
Insurance Deduction
Page 54
To be deductible:
- The shareholder can pay the premiums directly and be reimbursed by the corporation, or
- The S corporation can pay the premiums.
Notice 2008-1 Page 54
Passive
Investment Rules
If a C Corporation switches to an S Corporation, it may
be subject to a tax on excess net passive income.
Page 55
Excess Net
Passive Income
1) C corporation AE & P,
AND
2) Passive investment income more than 25% of gross receipts.
Page 55
Calculated as follows:
“A” “B”
Excess of Net Income = Net Passive X Passive Investment Income
Passive Income Income in Excess of 25% of Gross Receipts
Passive Investment Income
“C”
Page 55
Example 1:
Wild Widget has S Corp status
Has prior “C” E& P
Gross Receipts $8,000
Gross passive income 4,000
Allowable deductions 1,000
Page 56
Example 1:
A = $4,000 - $1,000 = $3,000
B requires two steps
Find 25% of Gross Receipts $8,000 x 25% = $2,000
$4,000 - $2,000 (from above) = $2,000
C = $4,000
Page 56
Example 1:
A B
$3,000 X $2,000 = $1,500
$4,000
C
The excess net passive income tax would be $315 ($1,500 x 21%).
Page 56
Excess Net Passive
Income 3 Consecutive Yrs
S election will terminate if:
Have AE&P
AND
Gross passive investment income exceeds 25% of gross receipts in each of 3 consecutive years.
Page 56
Note:
An election to treat distributions as “C” dividends may avoid the
excess net passive income rules.
Page 56
Taxable Income
Limitation
No tax is imposed if the corporation's taxable income for the year is zero.
Page 57
Example 2:
Assume the same facts as in Example 1, except that Wild
Widget has business expenses of $7,500.
Page 57
Example 2:
Wild Widget's taxable income for the year is $500 ($8,000 - $7,500).
The excess net passive income for the current year is limited to $500.
Page 57
Example 2:
Thus, the excess net passive income tax would be $105.
($500 x 21%)
Page 57
Tax-Exempt
Interest Income
Is included in passive investment income for purposes of the tax on excess net passive income.
Page 57
Example: S Corporation
Gross incomefrom operations $60,000
Operating expenses (20,000)
Tax-exempt interest 50,000
Page 57
Example:
ABC's gross receipts equal $110,000 ($60,000 + $50,000).
Passive investment income and net passive income are $50,000.
ABC's net income (computed as if it were a C corporation) is $40,000.
Page 57
Example:
Step 2:
[(25% × $110,000) = $27,500
$50,000- 27,500$22,500
Page 57
Example:
A B
$50,000 X $22,500 = $22,500
$50,000
C
The excess net passive income tax would be $4,725 ($22,500 x 21%).
Page 57
Built-in-Gains (BIG) Tax
Before electing S Status from C Corp
Consider potential of BIG Tax
Applies if:
1. Was a C Corporation and
2. Made election after 1986
Page 58
Recognition Period
S Corporations recognition period limited to 5 years.
Beginning with the date the S election becomes effective.
Page 58
Concept …
To prevent C Corporations from avoiding taxes.
Taxed at flat 21%
Gain applies to asset gain as if sold on date of S Election.
Page 58
Example:
ABC, Inc. had equipment FMV $4,000 basis of $2,000 at time of the S Election.
If sold within 5 years – the gain is subject to BIG tax.
Page 58
Example:
ABC, Inc. sells equipment for $5,000
$2,000 subject to BIG
($4,000 - $2,000 basis)*
$1,000 not subject to BIG
(Assets appreciation after S Election)
* At the time of the S Election.
Page 58
Accounts Receivable
Cash Basis C Corporations
AR not taxed subject to BIG tax
AP allowed as deduction against AR
Page 58
Example 1:
ABC Inc has AR $50,000
ABC Inc has AP $40,000
BIG tax applicable on $10,000
Page 58
Planning Tip:
Collect as much accounts receivable as you can prior to making election.
Maybe offer discount for early payment
10% is less than 21% BIG tax
Page 59
Deduction for BIG tax
S Corporation pays income tax at 21% for any BIG income.
Income flows to shareholder and taxed at shareholder level.
Page 59
Deduction for BIG tax
However, the shareholder does receive a deduction for the amount of the BIG tax.
Page 59
Example:
ABC Inc sold equipment with gain of $10,000 subject to BIG tax
BIG tax $2,100 ($10,000 x 21%)
Page 59
Example:
Shareholder reports income from the gain in the amount of $7,900.
($10,000 gain – $2,100 BIG Tax)
Page 59
BIG Tax Overall Limit
Limited to gain on assets as if sold attime of S election
FMV *– basis = Potential BIG
*At the time of the S Election.
Page 59
Gain would be taxed in two stages:
1. Potential gain at the time of the
S corporation election, and
2. Gain from date of the S election to the date of the asset sale.
Assets likely to
appreciate in value
Page 59
1) Tax-deferred exchange does not trigger built- in gain in that asset.
(§1031 is only eligible for real property)
2) Deferred if S Corporation has loss
(Deferred only until it has profit)
3) C Corporation NOL
Avoiding the BIG Tax
Page 60
S Corporation
Estimated tax payments
Taxes can be assessed at S Corp level
- Built-in-gains tax,
- Excess net passive income tax, and
- Recapture of business credits claimed as C Corporation.
Page 60
S Corporation
Estimated tax payments
S Corporation required to make estimated tax payments if:
- The corporation subject to one or more of the taxes, and
- The total taxes for the year are more than $500.
Page 60
Example: BIG Tax
XYZ Purchased Equipment for $10,000
S Election on 1/16
Adj. Basis on 1/16 was zero.
Page 60
Example: BIG TAX
May 11, 2020
Sold Equipment for $7,000
BIG Tax = $1,470 ($7,000 x 21%)
Page 60
Page 61
Form 4797
Page 2
7,000
- 0 -
7,00024) Total gain
23) Adjusted basis
20) Gross sales price
Equipment
Page 61
7,000
50,000
7,000
7,000
1,470
1,47023) Tax
21) Enter 21%
Schedule D Form 1120-S
Part III Built-in Gains Tax
16) Excess BIG over Built-in Losses
17) Taxable income
18) Smaller of 16 or 17
Page 62
Form 1120-S
1,470
12) Taxes 1,470
22b) Tax from Sch. D
Page 63
1120S Income $50,000
BIG Tax - $1,470
1120S K-1= $48,530
1) 48,530
Schedule K-1 Form 1120-S
Page 64
$77,000 determined at time S Election is made.
Form 1120-SSchedule B
Termination of S Status
S reverts to C status:
1. Violates Passive Income Rules
2. Fails to qualify as S Corp
3. Shareholders Revoke Election
Page 65
S Corp Election Revocation
Consent of more than 50%
Made on or before 15th day of 3rd
month of taxable year effective.
Page 65
Revocation
Made after the 15th day of 3rd month effective the following year.
Can be made with specific date.
No IRS form for revocation
Two statements requiredOne from Corporation
One from Shareholders
Page 65
Waiting Period
For S status to be reinstated
A 5-year period unless
they receive IRS consent
Page 66
S Corp. Liquidations
Page 67
S Corporation
Liquidations
Reasons to liquidate:
- Cease business activity
- Corporate Sale
Page 67
Cease Business Activity
File inactive return
Any distributions treated as dividends
Liquidate corporation
Distribute cash and/or assets
Treat as dividends
Page 67
Corporate Sale
Can occur as either
Stock sale or
Equipment/asset sale
Completely different results
Page 67
Stock Sale
Taxed on difference between sales price and stock basis.
Page 67
Stock Sale
Two Major Issues:
- Buyer also buys all current and potential liabilities.
- Assets receive no basis adjustment for depreciation purposes.
Page 67
§1202 Exclusion
Stock held for > 5 years
Stock acquired before 2/18/09
50% exclusion Remaining 50% @ 24% rate
Stock acquired after 2/18/09 and before 9/28/10
75% exclusion
Page 67
§1202 Exclusion
Stock held for > 5 years
Stock acquired after 9/27/2010 and before 1/1/2011
100% exclusion
AMT eliminated as preference item
The 2015 PATH Act
(permanent change)
Page 67
Note 1:
For §1202 post-9/27/10
Gain excluded from regular tax
Gain excluded from AMT
Gains excluded from regular tax also excluded from NIIT
Page 68
Note 2:
Gain eligible for exclusion cannot exceed the greater of:
1. $10 million reduced by taxpayer’s total prior year gains of same stock.
2. 10 times taxpayer’s basis in QSBS from corporation disposed during year.
Page 68
§1045 Rollover of Gain
- Stock must have been held more than 6 months.
- Proceeds from the sale must be used to purchase another qualified small business stock within 60 days of the sale.
Page 68
Example:
Oct. 1, 2019: Purch $300,000 of QSBS
Sept. 1, 2020: Sold for $500,000 ($200,000 Gain)
Sept. 1, 2020: Purch QSBS for $450,000
What’s the tax result?
Page 69
Example:
Proceeds from Sale: $500,000
Proceeds Applied (450,000)
Gain Recognized $50,000
Page 69
Purchase Price
New Stock $450,000
Deferred Gain ( 150,000)
Basis in New Stock $300,000
Page 69
Example:
Assets distributed
NOT Part of Liquidation
Not part of complete liquidation.
Tax treatment considerably different.
Page 71
S Corporation
Similar to a C Corporation, an asset distribution is a taxable event.
Unlike a C Corporation, gain flows through to shareholder.
Avoids one layer of tax
Page 71
Example:
Sam distributes company auto to himself
Original Cost $20,000
Depreciation $15,000
FMV $10,000
Page 71
Example:
Corporation reports a gain of $5,000
Gain flows thru to shareholder
See Page 72
Page 2 – 4797 Gain on asset
Schedule K-1 Income - Line 1 $5,000
Schedule K-1 Distribution - Line 16 $10,000
Page 71
Page 72
Deemed
Sale of Auto
Form 4797
Page 72
FMV Distribution
Code D - $10,000
Gain for Sale of Auto
20,000 – 15,000 = 5,000
Schedule K-1
Form 1120-S 1) 5,000
16)
D 10,000
Assets distributed
NOT Part of Liquidation
If there is a loss:
- The loss is not allowed under the related party rules.
- If the shareholder later recognizes a gain, cannot reduce gain.
Page 73
Example:
Sam distributes auto to himself
Original Cost $20,000
Depreciation $10,000
FMV $5,000
Page 73
Example:
No gain or loss to the corporation.
Within a year Sam sells for $10,000.
Sam will report STCG of $5,000.
He cannot reduce the gain by the previously disallowed loss.
Page 73
Assets Distributed
in Liquidation
When a business is sold and the:
- Shareholder wants to retain some assets, or
- Buyer does not want some of the assets
The assets distributed are deemed to be sold to the shareholder at FMV.
Page 73
Example:
Sam sold assets of insurance agency
Sam is keeping company auto:
Original Cost $20,000Depreciation $15,000FMV $10,000
Reported on Form 4797
Page 73
Loss in an
Asset Distributed
Not a complete liquidation:
- Under the related party rules, the loss is not deductible.
Page 74
Loss in an
Asset Distributed
Under a complete liquidation:
The loss may be deductible if:
- The property distributions are prorata to all shareholders, and
- The property was not acquired in a §351 transaction or as a contribution of capital within the last five-years.
Page 74
Due Diligence Tip:
Have the owner get a statement regarding the FMV of the assets.
Page 74
Liability Exceeds
FMV of Distribution
If the liability exceeds the FMV of property distributed, the amount of the liability is the deemed FMV for selling price.
Page 74
Example:
Sam distributes auto from insurance agency to himself as part of complete liquidation.
Auto has basis of $5,000Auto has FMV of $10,000Auto has loan of $15,000
Deemed sales price = $15,000
Corporate recognizes gain $10,000($15,000 debt – $5,000 basis)
Page 74
Previously
Expensed Items
Part of distributions may include items that have been expensed
Tools & Supplies
Recognition of income at FMV
Page 75
Installment Sale Reporting
Equipment:
Any depreciation is taxed as ordinary income and taxed at time of sale.
Any §1231 gain eligible for installment sale.
Page 75
Installment Sale Reporting
Building:
Entire sale qualifies for installment sale.
Depreciation unrecapture max 25% first then max 20% LTCG rate.
Page 75
Installment Sale Reporting
Land:
Entire sale qualifies for installment sale
Taxed as LTCG
Page 75
Installment Sale Reporting
Previously purchased Goodwill:
Treat the same as equipment amortization subject to recapture.
Excess of amortization = §1231 gain and eligible for installment sale reporting.
Page 75
Installment Sale Reporting
Previously purchased Covenant:
Treat the same as equipment amortization subject to recapture.
Excess of amortization = §1231 gain and eligible for installment sale reporting.
Page 75
Goodwill
Corporation Created
Sale of a capital asset
Eligible for installment sale
Page 76
Note:
Covenant not to compete:
Should be between shareholder and the buyer
If inadvertently tied to corporate sale taxed immediately upon distribution to the shareholder.
Page 76
Planning Tip:
If you want to reward a key person.
Consider having key employee receive a covenant of their own as part of sale.
Avoids payroll taxes to seller if he was going to reward the employee.
Page 76
Special rule for
S Corporations
Installment obligations:
If distributed within 12 months of liquidation.
S Corp recognize gain only if BIG tax is involved.
Page 76
Example:
Smith’s Insurance Agency - Liquidation
Sold goodwill under installment sale for $150,000
Goodwill has no basis
Installment sale distributed to Sam within 12 months of liquidation
Page 77
Example:
Deferred gain is NOT recognized at corporate level
Sam will receive 1099-DIV that reflects $150,000 non-cash liquidating distribution
Sam will report sale on Form 1040, Form 6252 on his personal return as principal received
Page 77
Note 1:
Any previous installment sales prior to a plan of liquidation
Distributed to shareholder
Taxable upon distribution to shareholder!
Page 77
Note 2:
If the installment sale is distributed to shareholder NOT with liquidation
Taxes would be do immediately upon distribution to shareholder!
Page 77
Liquidation for
an S Corporation
Receives step up in basis in corporation for gain recognized by corporation
Distribution GENERALLY not taxed again
- Watch for built-in-gains tax
Page 77
Due Date of
Final return
S Corporation
15th day of 3rd month following end of the tax year.
Example:
Sam completes liquidation 6/30/21.
Final return due on or before 9/15/21.
Page 77
Sales Agreement
Make sure the sales agreement includes:
1. What was sold
2. Who was the seller (Corporation or the Shareholder – Covenant)
3. What portion of the sale does the down payment apply to
4. What components of sale are seller finance (if any).
Page 78
Valuation - Liquidation
If liquidation is in conjunction with business sale, assets (goodwill –covenant) have assignable value.
Also allocate the basis for each asset.
Focal point to determine gain/loss becomes FMV at time of liquidation.
Page 78
In many cases
May be wise to have appraisals.
Even if the business is sold to outside buyer and owner does not sell all the assets.
Page 78
Example:
Tom sells assets of corporation.
Tom retains company vehicle for his own personal use.
Tom should get estimate of FMV from a used car dealer.
Corporation must treat as a sale at FMV
Page 78
Taxation
Seller – S Corporation
Item Corporate Individual
Description Taxpayer Taxpayer
Equipment Sold by corp. Flows to sh
Previously
Purchased GW Sold by corp. Flows to sh
Goodwill Could be Could be = LTCG
Covenant Could be Could be = OI
Page 79
Note:
A covenant not to compete should be sold as separate
item between buyer and seller.
Page 79
Tax Considerations
for the Buyer
Asset Deducted
Equipment 7 years MCRS
Goodwill SL over 15 years
Covenant SL over 15 years
Page 79
Net Investment
Income Tax
3.8% tax
Applicable to interest
Generally applicable to Rental Income
$250,000 MFJ
$125,000 MFS
$200,000 S, HOH
Page 80
NIIT with
Material Participation
An item of income from an active trade or business of the taxpayer -i.e., one in which the taxpayer materially participates, isn't included in Net Investment Income.
Page 81
Liquidating Corporation
Retaining Building
Rental Income:
NIIT will be applied after the liquidation of the corporation.
Page 81
Liquidating Corporation
Retaining Building
Gain from sale:
If the shareholder has real estate that he sells, while materially participating in the business, the gain on the sale of the rental property is also exempt from NIIT.
Page 81
Liquidating corporation
retaining building, cont.
If you materially participated 5 of the last 10 years you maintain the NIIT exemption for both the:
Rental income, and
Sale of the building
Page 81
Administratively
Dissolved by State
Does not mean you are liquidated.
Voluntary dissolution is PART of, not the entire process.
Still required to follow federal rules for liquidation.
Page 81
Note:
Most states allow on-line verification for annual filing.
You may want to verify if your client is current each year, or at least when you start the liquidation process.
Page 81
As an S Corporation
If you are administratively dissolved, but have not completed corporate liquidation, any distributions are treated the same as if you withdrew as an operating S corporation.
Page 81
Plan of Dissolution
As part of the process:
The shareholders must formally elect a resolution or plan of dissolution or liquidation.
Page 82
Form 966 Reporting
Required to file with the IRS within 30 days after adopting a resolution or plan of dissolution or liquidation.
Page 82
Form 1099-DIV
A liquidating distribution is:
- Reported to the shareholders on Form 1099-DIV
(If in excess of $600)
Page 82
Example
S Corporation Sale
Sam Smith – sole stockholder, Incorporated January 1, 2008.
Smith’s Insurance Agency adopted a plan to liquidate in early 2020.
Page 83
Example
S Corporation Sale
Sam agreed to sell equipment and client files for $700,000
At closing buyer pays $300,000
Seller takes note in the amount of $400,000
Sales agreement specifically states $100,000 cash at closing = equip. sale
Page 83
January 1
Balance Sheet
Assets
Cash $200,000Equipment 300,000Accum Depr. (300,000)
Total Assets $200,000
Page 83
January 1
Balance Sheet
Equity
Stock $50,000RE 150,000
Total Equity $200,000
Page 83
Prior to Liquidation
Corporation owns
Assets FMV Cost Basis
Equipment $200,000 $300,000 $ -0-Cash 300,000 N/A 300,000Client Files 500,000 N/A - 0 -
Totals $200,000 $300,000 $300,000
Page 83
Balance Sheet
After the Sale
Assets
Cash $600,000Installment Note 400,000
Total Assets $1,000,000
Page 84
Balance Sheet
After the Sale
Liabilities 6252 Deferred Gain $400,000
EquityStock $50,000Beginning RE 150,000Current Earnings 400,000
Total Equity 600,000
Total Liabilities & Equity $1,000,000
Page 84
Caution – not in text
If equipment is sold on the installment method the entire gain taxable in year of the sale.
Regardless of principal received
Depreciation recapture not eligible for installment reporting
Page 84
Individual Income
Information
Interest Income $ 5,000
Dividends Earned 5,000
Salary 100,000
Installment Sale
Received after 6252 trans 20,000
Interest received on 6252 10,000
Page 84
Page 85
This would be the same
whether S or C Corporation
Page 86
This would be the same
whether S or C
Corporation
Consent to the adoption of the dissolution
Page 86
The only difference in C or S Corporation
would be checking either 1120 or 1120S Box
Form 966
Note:
Wisconsin Forms
www.wdfi.org/corporations/forms
Arizona Forms
www.cc.state.az.us/corp
Not in Text
This would be the
same whether S or
C Corporation
Note: In Wisconsin - the liquidation paperwork is
different for an LLC taxed as an S corporation.
Always remember to check with your state.
Page 87
Articles of Dissolution
Limited Liability Company
Page 88
Installment sale notreported on 1120-S.
Reported on Form 6252direct to Schedule K-1.
Form 1120-S
Page 89
Beginning AAA = 150,000
Bus Operations Inc = 100,000
Equip Sale Profit = 200,000
Installment Sale Rec’d= 100,000
Amount Distributed = $550,000
Form 1120-SSchedule M-1
Page 89Schedule DForm 1120-S
11) LTCG from installment sale Form 6252
15) Net LTCG or (loss) 15) 100,000
11) 100,000
Page 90Schedule DForm 1120-S
1/1/20 RE Prev. Taxed $ 150,000
Stock Basis 50,000
2020 Earnings
Bus Operations 100,000
Equip Gain 200,000
Inst Sale rec 1120S 100,000
Def Inst Sale 400,000
Total Distribution $1,000,000
From 1120-S Form 6252
Received as S Corp $100,000
Ordinary Income = $100,000
1245 Depr. Rec. = $200,000
Line 1 = $300,000
Page 90
Ordinary Income
§1245 Depreciation Rec.
Equipment Sale
Form 4797
Page 91
Sales Price $500,000 Goodwill
Installment Payments Received
as an S Corporation $100,000
Form 6252
26) 100,000
7) 500,000
Page 91
1/1/20 RE Prev. Taxed $ 150,000
Stock Basis 50,000
2020 Earnings
Bus Operations 100,000
Equip Gain 200,000
Inst Sale rec 1120S 100,000
Def Inst Sale 400,000
Total Distribution $1,000,000
Checking Acct = $600,000
6252 Deferred Gain = $400,000
Form 1099-DIV
9) 600,000 10) 400,000
Page 94
DRAKE if entered properly OI from
1120-S automatic exempt from NIIT
Form 8960
4b) - 300,000
5b) - 120,000
Only interest + dividends
Subject to NIIT $20,0008) 20,000
From DRAKE override screen
17) 76017) NIIT
Page 94
5b) - 120,000
DRAKE Override screen
If you use DRAKE software
5b) Net gain from disposition of property not subject to NIIT
Exempt form NIIT with material participation in the business.
Page 96
Sale price on 1120-S 6252 $500,000
Rec’d $100,000 prior to liquidation
Amount still due to shareholder $400,000
Payments received after liquidated to Sam
Form 6252
21) 20,000
5) 400,000
Form 8594
Consistent reporting between buyer and seller
Congress developed §1060
Buyer and seller attach a copy to their income tax return
Page 96
Attorney who
Drafts the Contract
Should address this issue
Reduces the chance that the parties will have conflicting allocations later
Reduces the chance of audit
Page 96
Allocating
Purchase Price
Assets that constitute trade or business:
I. Cash
II. Traded Personal Property
III. Accts Receivable, mortgages, and credit card receivables
IV. Inventory
Page 97
Allocating
Purchase Price
Assets that constitute trade or business:
V. All assets not in I,II,III,VI or VIIEquipment & Building
VI. All 197 except GoodwillCovenant
VII. Goodwill
Page 97
Section 197 Considerations
Subject to amortization over 15 years
Includes:
Goodwill
Workforce in place
Books and records
Patent, copyright, formula process, etc.
Customer based intangible
Franchise, trademark, or trade name
Page 97
Page 96
Equipment = $200,000
Client Files = $500,000
Form 8594
6/15/20
Section 1244 Stock
Generally, a loss on the sale of stock is LTCL.
§1244 Stock losses can be treated as an ordinary loss.
Page 99
Example:
ABC liquidated
Shareholder receives cash $50,000
Shareholder assumed liability $150,000
Shareholder’s Stock Basis $5,000
Page 96
Example:
Cash received $ 50,000
Debt Assumed (150,000)
Net to Shareholder (100,000)
Stock Basis - 5,000
Stock Loss ($105,000)
1244 Stock Loss $5,000
LTCL $100,000
Page 99
§1244 Stock
Requirements
1. The stock must be issued for money or property.
(not securities or services)
2. Domestic small business
Capital contributions less than $1,000,000.
Page 99
§1244 Stock
Requirements
3. 5 most recent tax years before the loss > 50% gross receipts other than royalties, rents, dividends, interest, annuities, sale of stock,
4. Shareholder was originally issued stock from the corporation.
(Gift, inheritance, not eligible)
Page 99
§1244 Stock
Requirements
5. Issued before 7/19/84 must be common stock, after 7/18/84 can be common or preferred.
6. Shareholder cannot be a trust, or an estate, or corporation. However available to partner if the partner was member of partnership when acquired stock AND partnership sold the stock.
Page 99
§1244 Loss Limitation
Ordinary loss is limited to $100,000.
Any excess = LTCL
Page 100
Example:
Current year §1244 Loss of $110,000
Deduct $100,000 Ordinary loss
Remaining $10,000 = LTCL
No other LTCG deduct $3,000 this year
$7,000 LTCL carryover to next year
Page 100
Contributions to Capital
If basis of §1244 stock is increased through capital contributions or otherwise
It does not increase amount allocated to §1244 stock at time of sale.
Page 100
Example:
Tom received 100 Shares 1244 stock for $20,000 in Dec. 2002
Contribution of $5,000 in June 2006 increasing basis of stock to $25,000.
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Example:
Sold stock for $15,000 in April 2020 with Loss of $10,000.
$8,000 Ordinary loss
($10,000 x $20,000/$25,000)
Remaining $2,000 = LCTL
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S Corporation
§1244 Stock Loss
Applies to both C & S Corporations
Calculated differently
Previously reported losses may reduce original basis.
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Example:
Sam has original capital contribution of $100,000.
The S corporation had losses of $20,000 over the years.
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Example:
In liquidation Sam receives no asset and no liabilities.
Sam will be entitled to a §1244 loss of $80,000.
($100,000 - $20,000)
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Note:
Report §1244 loss on Form 4797
Any capital loss report on Sch D
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