Transcript Chapter 1- Instructor PowerPoint Slides. Summer, 2008

Chapter 14
Entity Operations and
Distributions-2010
Howard Godfrey, Ph.D., CPA
UNC Charlotte
Copyright © 2010, Dr. Howard Godfrey
Edited October 30, 2010.
T10-Chp-14-1-Entity-Choice-Operations-and-Dist-2010
1
14. Entity - Operations and Distributions
Proprietorship
Partnership
Income reporting
Net operating Loss
Transaction w/ ptshp
Basis Considerations
Corporation
Capital gains & losses
Div. received deduction
Charitable Contributions
Net operating Loss
Tax Credits
Basis Considerations
S Corporation
Separate items
Recapture
No div. received deduction
Net operating Loss
Basis Considerations
Entity Distributions
Proprietorship
Partnership
Corporation
S Corporation
Tax Planning
Income Splitting
Children-Employees
Family Entities
2
Partnerships
Income reporting
Net operating Loss
Transaction w/ partnership
Basis Considerations
3
Taxation of Operations
The general formula for computing
income tax is:
Gross Income
less: Deductions
Taxable Income
times: Tax rate (for entity)
Income tax
less: Tax prepayments and Tax credits
Tax (refund) due with return
Let’s concentrate on the exceptions
to the general formula
common to each entity.
Sole Proprietorship
• Many items are reported elsewhere on the
owner’s return and not reported as part of the
proprietorship’s income
– Investment income and expense
– Capital gains and losses
– Section 1231 gains and losses
– Passive activity items
– Charitable contributions
– Owner’s personal expenses
– Tax credits
– Net operating losses
Partnership
• Income & expenses are reported by the
partners according to their ownership
interests
• Items which would receive special
treatment on a partner’s return are
reported separately
– All items listed separately for sole
proprietorships
– Amounts expensed under Section 179
– Alternative minimum tax items
– Nondeductible expenses
Partnership Income-1
John Mason and his brother Bennie are
equal partners in Mason Enterprises, which
operates as a partnership.
How would they report the income and loss
items from partnership operations? John
and Bennie each invested $50,000 to start
Mason Enterprises.
Each has a 50% interest in the partnership.
During the first year, the business had the
income and expenses from operations
shown on the next slide:
Mason Enterprises
Consulting revenue
$125,000
Travel expenses
40,000
Transportation
3,000
Advertising
7,000
Office expense
3,000
Telephone
1,000
Dividend Income
5,000
Interest Income
2,000
Charitable contribution
1,000
Political contribution
6,000
What is ordinary Income?
Mason Enterprizes
Consulting rev.
$125,000
Travel expenses
40,000
Transportation
3,000
Advertising
7,000
Office expense
3,000
Telephone
1,000
Dividend Income
5,000
Interest Income
2,000
Charitable cont.
1,000
Political cont.
6,000
Ordinary Income
Ordinary
$125,000
(40,000)
(3,000)
(7,000)
(3,000)
(1,000)
$71,000
Information Form 1065 Sch- K
Mason
Consult rev.
$125,000 $125,000
Travel exp.
40,000
(40,000)
Transport.
3,000
(3,000)
Advertising
7,000
(7,000)
Office exp.
3,000
(3,000)
Telephone
1,000
(1,000)
Dividends
5,000
5,000
Interest
2,000
2,000
Char. cont.
1,000
(1,000)
Political cont.
6,000
(6,000)
Ordinary Income
$71,000
Information Form 1065
Mason
Page 1
Enterprizes
Consult rev.
$125,000 $125,000
Travel exp.
40,000
(40,000)
Transport.
3,000
(3,000)
Advertising
7,000
(7,000)
Office exp.
3,000
(3,000)
Telephone
1,000
(1,000)
Dividends
5,000
Interest
2,000
Char. cont.
1,000
Political cont.
6,000
Ordinary Income
$71,000
Sch- K
Both
Sch- K-1
John
John reports (as
required) the
items below (in
last column) on his
personal Form
1040 on applicable
schedules.
5,000
2,000
1,000
6,000
2,500
1,000
500
3,000
35,500
Partnership
• Losses are deductible subject to
three limitations
–Limited to the amount of a partner’s
basis (capital recovery concept)
–Limited to the partner’s at-risk
amount
–Limited by passive activity rules
Partnership
• Partner’s basis is adjusted to
reflect partnership income and
losses reported
–Increased for income or gains
• Designed to prevent double taxation
–Decreased for losses
• Designed to prevent double benefit
and reflect capital recovery
Problem.
In computing the ordinary business
income of a partnership, a deduction is
allowed for:
a. Net operating loss deduction.
b. Depreciation Expense
c. Short-term capital losses.
d. Gifts to qualified charities.
Gil and Bill partnership had book income of
$37,000 this year which included the following:
Dividend income
$ 1,000
Short-term capital loss
(4,000)
Section 1231 gain
7,000
Ordinary income (sec. 1245 recapture) 1,500
Interest income
1,000
They share profits and losses equally.
What amount of partnership income (excluding
all separately reported items) should each
partner report on his individual income tax return
for the year?
a. $19,625 b. $18,500 c. $ 16,000 d. $7,313
Gil & Bill partnership had book
net income of $37,000 including:
Ordinary
Book income
$37,000
Dividend income
$1,000
ST capital loss
(4,000)
Section 1231 gain
7,000
Ordinary income
(sec. 1245 recapture)
1,500
Interest income
1,000
Ordinary Income
They share profits and losses equally.
What is partnership ordinary income
Gil & Bill partnership had book income
of $37,000 which included:
Ordinary
Book income
$37,000
Dividend income
$1,000 ($1,000)
ST capital loss
(4,000)
4,000
Section 1231 gain
7,000
(7,000)
Ordinary income
(sec. 1245 recapture) 1,500
Interest income
1,000
(1,000)
Ordinary Income
$32,000
They share profits and losses equally.
What is partnership ordinary income
Andrew invested $10,000 for a 25% interest in XYZ
Partnership on 12-31 of Year-1.
In Year-2, XYZ had taxable income of $20,000.
Partnership had nontaxable income of $8,000.
XYZ Partnership made a cash distribution to
Andrew of $12,000.
Assuming no other transaction occurred,
how much income is included on Andrew's tax
return for Year-2?
a. $-0
b. $5,000
c. $10,000 d. $17,000
IRS-1994
Andrew invested $10,000 for a 25% interest in XYZ
Partnership on 12-31 of Year-1.
In Year-2, XYZ had taxable income of $20,000.
It also had nontaxable income of $8,000.
XYZ Partnership made a cash distribution to
Andrew of $12,000.
Assuming no other transactions occurred,
what is Andrew's basis in the partnership at the
end of Year-2?
a. $-0
b. $5,000
c. $10,000 d. $17,000
IRS-1994
XYZ Partnership
Investment or Beginning Basis
Change in share of debt (+ or -)
Add: Ordinary Income
Separate Income & gains
Tax-free income
Contributions of Capital
Less: Ordinary Loss
Separate Exp. & Losses
Non-deductible Expenses
Partner Withdrawals
Ending Basis
Andrew
$ 10,000
XYZ Partnership
Investment or Beginning Basis
Change in share of debt (+ or -)
Add: Ordinary Income
Separate Income & gains
Tax-free income
Contributions of Capital
Less: Ordinary Loss
Separate Exp. & Losses
Non-deductible Expenses
Partner Withdrawals
Ending Basis
Andrew
$ 10,000
5,000
2,000
(12,000)
$ 5,000
Partnership
• Transactions between a partner
and partnership are subject to
related-party rules
–Partner who has > 50% interest
in a partnership is a related
party
–Losses on sales are disallowed
Corporations
Capital gains & losses
Dividends received deduction
Charitable Contributions
Net operating Loss
Tax Credits
Basis
24
Big Picture
Less:
Equals:
Times:
Equals:
Plus:
Less:
Equals:
Gross Income - Sec. 61
Deductible expenses
Taxable income
Corporate tax rate
Corporate income tax
Additions to tax
Tax credits
Net corporate tax
Corporate Tax Rates
15% on first $50,000
25% on $50,001 - $75,000
34% on $75,001 - $100,000
39% (34% + 5% surtax) on $100,001 $335,000
34% on $335,001 - $10,000,000
35% on $10,000,001 - $15,000,000
38% (35% + 3%) on $15,000,001 $18,333,333
26
PSC
• Personal service corporation is a corporation
– that provides service in the fields of
accounting, actuarial science, architecture,
consulting, engineering, health, law, or
performing arts and
– is substantially owned by its employees
• A flat 35% tax rate applies to its entire taxable
income
• The PSC provisions encourage owneremployees to take earnings out as salary
27
Corporation
• Taxable income is determined at the
corporate level under the general
formula
• Exceptions:
–Net capital losses are not deductible
–Corporations must recapture additional
depreciation for Sec. 1250 property =
20% of straight-line depreciation taken
Corporation
–Passive activity losses
• Corporations are not subject to the passive activity
rules
–Personal service corporations must follow them
–Closely-held corporations may use passive losses to offset
active income but not portfolio income
–Charitable contributions are limited to 10% of
taxable income
• Before dividend-received deductions and any
carryovers
• Excess contributions may be carried forward 5 years
Corporation
–Net operating loss cannot be
used in the current year or
distributed to shareholders
•May be carried back 2 years
and forward 20 until used
•May elect to forego the carry
back
Gross income
Less:
Deductions:
Except charity, Div. Rec.,
NOL & C-Loss Carryback
Equals Taxable IncomeLess:
Charitable Cont. < = 10% of T.I. Above
Equals Taxable IncomeLess:
For Charity Limit
Before Div. Rec'd Ded.
Div. Rec. Deduct.
Equals Taxable Income-
Before carrybacks
Less:
NOL and/or Capital Loss carrybacks
Equals
Taxable Income
31
Capital Losses- Baker
Baker Corp., had taxable income of $36,000
business operations in Year 1.
Baker also had the following:
Short term capital gain
$8,600
Short term capital loss
(9,600)
Long term capital gain
1,500
Long term capital loss
(3,500)
What is taxable income for Year 1?
a. $35,000 b. $33,000
c. $36,000 d. $35,500
CPA - Nov. 1995
32
Capital Losses-Baker
Baker Corp., had taxable income of
$36,000 business operations in Year-1.
Baker also had the following:
Short term capital gain $8,600
Short term capital loss (9,600)
Long term capital gain
1,500
Long term capital loss
(3,500)
What is taxable income for Year-1?
$36,000
33
Corp. Income Tax Prob. - 1
Gross receipts of
$450,000
Cost of goods sold of
145,000
Deductible bus. expenses
276,000
Gain on sale of machine
20,000
Interest on Ohio bonds
500
What is its tax liability?
a. $4,900 b. $7,350
c. $10,000 d. None of these
34
Corporate Income Tax – Problem - 2
A corporation has
Gross receipts
Cost of goods sold
Facts
Return
$450,000 $450,000
$145,000 $145,000
Deductible bus. exp. $276,000
Gain-sale of machine $20,000
Interest- Ohio bonds
$500
Taxable Income
Fed. income tax liability at 15%
35
Corporate Income Tax – Solution-3
A corporation has
Gross receipts
Cost of goods sold
Facts
$450,000
$145,000
Return
$450,000
$145,000
$305,000
Deductible bus. exp. $276,000 ($276,000)
Gain-sale of machine $20,000
$20,000
Interest- Ohio bonds
$500
Taxable Income
$49,000
Fed. income tax liability at 15%
$7,350
36
Dividend Received Deduction
To relieve burden of multiple taxation
DRD based on % ownership in paying corp
100% DRD for 80% or more owned affiliate
80% DRD for ownership of 20% up to 80%
70% DRD for ownership less than 20%
DRD limited to percentage times
lesser of taxable income or dividend income
Unless deducting DRD % x dividend
income creates or increases NOL
37
Grant, Inc. acquired 30% of South Co.’s
voting stock for $200,000 on January 1,
2010. Grant’s 30% interest in South gave
Grant the ability to exercise significant
influence over South’s operating and
financial policies.
During 2010, South earned $80,000 and
paid dividends of $50,000.
What amount of income should Grant
include in its 2010 Federal income tax
return as a result of the investment?
a. $15,000 b. $24,000 c. $35,000
d. $50,000 e. $80,000 CPA Nov. 1995.
38
Grant, Inc. acquired 30% of South Co.’s
voting stock for $200,000 on January 1,
2010. Grant’s 30% interest in South gave
Grant the ability to exercise significant
influence over South’s operating and
financial policies.
During 2010, South earned $80,000 and
paid dividends of $50,000.
What amount of income should Grant
include in its 2010 Federal income tax
return as a result of the investment?
This company will use equity method for
GAAP and cost method for Tax Return.
39
Div. Received- Green - 1
Green Corp. owns 25% of Cande Corp.
This year, Green received $10,000
dividends on the Cande stock.
Assuming no other limit applies,
Green’s dividends-received deduction
is:
a. $7,000. b. $8,000.
c. $2,000. d. $ - 0 -. (IRS-2003)
40
Div. Received- Green – 12
Green Corp. owns 25% of Cande Corp.
This year, Green received $10,000
dividends on the Cande stock.
Assuming no other limit applies,
Green’s dividends-received deduction
is:
a. $7,000. b. $8,000.
c. $2,000. d. $ - 0 -. (IRS-2003)
41
Local Corp - 1. had the following:
Revenue - operations
Operating expenses
$500,000
(490,000)
Operating income (loss)
Dividends from IBM
10,000
50,000
Net income before DRD
Dividend rec. deduction
60,000
Dividends Received Deduction
Limit 1:
Dividends Received
DRD Percentage
Deduction limit - 1
$50,000
70%
$35,000
Limit 2:
Taxable income (Adj)
DRD Percentage
Deduction limit - 2
Div. Rec. Deduction
$60,000
70%
42,000
$35,000
Local Corp - 2. had the following:
Revenue - operations
Operating expenses
$ 500,000
(510,000)
Operating income (loss)
Dividends from IBM
(10,000)
50,000
Net income before DRD
Dividend rec. deduction
40,000
Dividends Received Deduction
Limit 1:
Dividends Received
$50,000
DRD Percentage
Deduction limit - 1
Limit 2:
Taxable income (Adj) $40,000
DRD Percentage
Deduction limit - 2
Div. Rec. Deduction
Dividends Received Deduction
Limit 1:
Dividends Received
$50,000
DRD Percentage
70%
Deduction limit - 1
$35,000
Limit 2:
Taxable income (Adj) $40,000
DRD Percentage
70%
Deduction limit - 2
28,000
Div. Rec. Deduction
$28,000
Local Corp - 3. had the following:
Revenue - operations
Operating expenses
$ 500,000
(520,000)
Operating income (loss)
Dividends from IBM
(20,000)
50,000
Net income before DRD
Dividend rec. deduction
30,000
Dividends Received Deduction
Limit 1:
Dividends Received
$50,000
DRD Percentage
70%
Deduction limit - 1
$35,000
Limit 2:
Taxable income (Adj) $30,000
DRD Percentage
70%
Deduction limit - 2
21,000
Div. Rec. Deduction
$35,000
Page Corp. Div. Received Ded.
Page owns 15% of company
Gross Profit
$200,000
Expenses
($300,000)
Operating loss
($100,000)
Dividends Received
$180,000
Tax. Inc. before DRD
DRD
Net operating loss
Page Corp. Div. Received Ded.
Page owns 15% of company
Gross Profit
$200,000
Expenses
($300,000)
Operating loss
($100,000)
Dividends Received $180,000
Tax. Inc. before DRD $80,000
DRD
($126,000)
Net operating loss
($46,000)
Spring Corp’s has income from business
of $500,000 & expenses of $750,000.
Spring also received dividends from the
Acme Corp. of $100,000.
Spring owns 25% Acme.
What is Spring’s NOL for the year?
a. ($150,000) b. ($0).
c. ($220,000) d. ($230,000). (IRS Exam 2003)
51
Spring Corp. Div. Received Ded.
Spring owns 25% of company
Gross Profit
$500,000
Expenses
($750,000)
Operating loss
($250,000)
Dividends Received $100,000
Tax. Inc. before DRD
DRD
Net operating loss
Spring Corp. Div. Received Ded.
Spring owns 25% of company
Gross Profit
$500,000
Expenses
($750,000)
Operating loss
($250,000)
Dividends Received $100,000
Tax. Inc. before DRD ($150,000)
DRD
($80,000)
Net operating loss
($230,000)
Spring Corp’s has income from
business of $500,000 & expenses of
$750,000.
Spring also received dividends from
the Acme Corp. of $100,000.
Spring owns 25% Acme.
What is Spring’s NOL for the year?
($230,000)
54
This year, Pack Corp. had gross income
from operations of $350,000 and
operating expenses of $400,000.
Pack received dividends of $100,000 from
Smith Inc., of which Pack is a 20% owner.
The NOL carryover from last year is
$20,000.
What is Pack's NOL for the current year?
a. $50,000 b. $30,000
c. $20,000 d. $10,000
IRS-1995
55
This year, Pack Corp. had gross income
from operations of $350,000 and
operating expenses of $400,000.
Pack received dividends of $100,000
from Smith Inc., of which Pack is a 20%
owner.
The NOL carryover from last year is
$20,000.
What is Pack's NOL for the current year?
$30,000
56
Pack Corp. Net Operating Loss
Gross Profit
$350,000
Expenses
($400,000)
Operating loss
($50,000)
Dividends Received $100,000
Tax. Inc. before DRD $50,000
DRD (80% )
($80,000)
Net operating loss
($30,000)
57
Maple Corp. had the following for Year 1:
Gross Sales
$340,000
Cost of Goods Sold
$150,000
Depreciation - Books
60,000
Charitable Contribution
10,000
Salaries
130,000
Meals & entertainment
20,000
Total Expenses
370,000
Net income (loss) per books
($30,000)
Maple’s tax deprec. for the year is $75,000.
Taxable income (loss) for the year?
a. $(5,000) b. $(35,000) c. $(25,000) d. $(20,000)
58
Maple Corporation
Gross Sales
Cost of Goods Sold
Depreciation - Books
Depreciation - Tax
Charitable Contribution
Salaries
Meals & entertainment
Total Expenses
Net income (loss)-books
Taxable income?
59
Facts
$340,000
150,000
60,000
10,000
130,000
20,000
370,000
($30,000)
Return
Maple Corporation
Facts
Return
Gross Sales
$340,000 $340,000
Cost of Goods Sold
150,000 150,000
Depreciation - Books
60,000
Depreciation - Tax
75,000
Charitable Contribution
10,000
Salaries
130,000 130,000
Meals & entertainment
20,000
10,000
Total Expenses
370,000 365,000
Net income (loss)-books ($30,000)
Taxable income?
($25,000)
60
Tax vs. GAAP Numbers
Gross revenue from sales
Tax
GAAP
$289,000
$289,000
Cost of sales
(98,000)
(98,000)
Gross margin
Section 179 deduction
(GAAP Deprec. = $5,000)
191,000
(20,000)
191,000
Operating expenses
(122,000)
Gain on sale of machine
21,000
(Gain is $14,000 for GAAP).
Taxable Income
GAAP Income before tax
61
Tax vs. GAAP Numbers
Gross revenue from sales
Cost of sales
Gross margin
Section 179 deduction
(GAAP Deprec. = $5,000)
Tax
GAAP
$289,000
$289,000
(98,000)
191,000
(20,000)
(98,000)
191,000
(5,000)
Operating expenses
(122,000)
Gain on sale of machine
(122,000)
21,000
(Gain is $14,000 for GAAP).
14,000
$70,000
Taxable Income
GAAP Income before tax
$78,000
Impact on def. tax account (40% tax rate)?
62
Bard-Inc. Reported the following this year:
Info.
Book net income before tax
Tax
$450,000 $450,000
Included in this $450,000 were:
State corp. income tax refunds
$4,000
Life insurance - officer's death
$15,000
Loss-stock bought for
investment in 2001
($20,000)
Bard's taxable income for the year
a. $435,000 b. $451,000 c.$455,000 d.$470,000 (CPA-87)
63
Bard-Inc. Reported the following this year:
Info.
Book net income before tax
Tax
$450,000 $450,000
Included in this $450,000 were:
State corp. income tax refunds
$4,000
Life insurance - officer's death
$15,000
($15,000)
($20,000)
$20,000
Loss-stock bought for
investment in 2001
Bard's taxable income for the year
$455,000
a. $435,000 b. $451,000 c.$455,000 d.$470,000 (CPA-87)
64
Credits
Debit
Compute Tax. Income
$700,000
Sales
$400,000
Cost of sales
2,000
Mun. bond interest
100,000
Compensation
20,000
Meals (gross)
140,000
Other Expense
660,000 702,000
Subtotal
Net Income before tax
65
Debit
Credits
$700,000
Sales
Cost of sales
$400,000
Mun. bond interest
2,000
Compensation
100,000
Meals, entertain. (Gross)
20,000
Other Expense
140,000
Subtotal
660,000 702,000
Net Income before tax
Add: one half of entertain.
Less: Mun. bond interest
Taxable income
Income Tax
Compute E & P (Similar to Retained Earnings)
66
Debit
Credits
$700,000
Sales
Cost of sales
$400,000
Mun. bond interest
2,000
Compensation
100,000
Meals, entertain. (Gross)
20,000
Other Expense
140,000
Subtotal
660,000
702,000
Net Income before tax
42,000
Add: One half of entertain. 10,000
Less: Mun. bond interest
(2,000)
Taxable income
50,000
Income Tax
7,500
Compute E & P (Similar to Retained Earnings)
67
Charlotte Corp. was organized 1-1-Yr-1
Income per books for Year-1
$400,000
Book Income includes:
Municipal bond Interest
8,000
Meals & entertain. Exp.
20,000
Prem. Paid on officers' life ins.
(corporation is beneficiary)
3,800
Capital losses
1,000
Fines
200
What is taxable income?
a. $400,000 b. $408,000 c. $426,000 d.
68
Char. Corp.-organized 1-1-Yr-1
Income per books - Year 1
Return
$400,000
Book Income includes:
Municipal bond Interest
8,000
Meals & entertain. Exp.
20,000
Prem. - officers' life ins.
(corp. is beneficiary)
3,800
Capital losses
1,000
Fines
200
What is taxable income?
69
$400,000
Char. Corp.-organized 1-1-Yr-1
Income per books - Year 1
Return
$400,000
$400,000
Municipal bond Interest
8,000
(8,000)
Meals & entertain. Exp.
Prem. - officers' life ins.
(corp. is beneficiary)
Capital losses
20,000
10,000
3,800
1,000
3,800
1,000
200
200
Book Income includes:
Fines
What is taxable income?
70
$407,000
S Corporations
Separate items
Recapture
No Div. received deduct
Net operating Loss
Basis for shareholder
71
S Corporation
• Income and expenses are reported by the
shareholders according to their ownership
interest
– Items which would receive special treatment
on a shareholder’s return are reported
separately
– Losses are deductible subject to the three
limitations faced by partnerships
• S corporations are also subject to the corporate
depreciation recapture rules for Section 1250
property
S Corporation
• May not use take the dividendreceived deduction
• NOLs are subject to three
limitations
–Basis limitation
–At-risk limitation
–Passive activity loss limitation
MaxSCorp -income statement- Slide 1
Sales
Less cost of sales
Gross profit on sales
Interest expense
Charitable contributions
Advertising expenses
Other expenses
Operating income
Add: Municipal interest
Dividend income
LT capital gain
Less: ST capital loss
Net income per books
$40,000
(23,000)
17,000
1,200
400
1,500
2,000
300
200
500
(5,100)
11,900
1,000
(150)
$12,750
MaxSCorp-Slide 2
Net income per books
Separate items
Less: Mun. interest
Div. income
LT capital gain
Subtotal
Add: Charitable cont.
ST capital loss
Taxable income
$ 12,750
300 Section
1363(b)
200
500
(1,000)
11,750
400
150
550
$ 12,300
Distributions
Proprietorships
Partnerships
Corporations
S Corporations
76
Entity Distributions
The tax treatment of distributions to an
owner depends on the amount and
kind of the distribution and the entity
making the distribution.
• Distributions are either
–Liquidating
–Nonliquidating
What are the effects of
nonliquidating distributions
made by each entity?
Sole Proprietorship
• Distribute cash
–No tax consequences
to owner / entity
• Distribute property
–No gain or loss recognized until
owner sells the property
Partnership
• Distribute cash
–Partner recognizes no gain unless
amount exceeds partner’s basis; excess
is capital gain
–No tax consequences to partnership
• Distribute property
–Partner recognizes no gain or loss;
Basis is the lesser of carryover basis or
partner's basis
–No tax consequences to the entity
The adjusted basis of Jody's partnership
interest was $50,000 immediately
before Jody received a current
distribution of $20,000 cash and
land with an adjusted basis to the
partnership of $40,000 and a
FMV of $35,000.
What amount of taxable gain must Jody
report as a result of this distribution?
a. $0 b. $5,000 c. $10,000
d. $20,000 CPA 11-93
81
The adjusted basis of Jody's partnership
interest was $50,000 immediately
before Jody received a current
distribution of $20,000 cash and land
with an adjusted basis to the
partnership of $40,000 and a
FMV of $35,000.
What is Jody's basis in the land ?
a. $0 b. $30,000 c. $35,000
d. $40,000
CPA 11-93
82
The adjusted basis of Jody's partnership
interest was $50,000 immediately
before Jody received a current
distribution of $20,000 cash and land
with an adjusted basis to the
partnership of $40,000 and a FMV of
$35,000. What is Jody's basis in her
partnership interest after this
distribution?
a. $0 b. $30,000 c. $35,000
d. $40,000
CPA 11-93
83
Non-liquidating Distributions - Sec. 731-33
Solution for Jody's Partnership Dist.
1 Partner's outside basis (Include debt)
2 Less: cash distributed to Partner
3 Gain recognized by Ptnr (Ln 2-Ln 1)
Gain only if cash exceeds outside basis
4 Ptnr's remain. outside basis (Ln 1-Ln 2)
5 Pthp's inside basis - Other prop. dist.
6 Ptnr's basis for other prop (< Ln 4 or 5)
7 Partner's outside basis (Ln 4 - Ln 6)
84
$ 50,000
20,000
Non-liquidating Distributions - Sec. 731-33
Solution for Jody's Partnership Dist.
1 Partner's outside basis (Include debt)
2 Less: cash distributed to Partner
3 Gain recognized by Ptnr (Ln 2-Ln 1)
$ 50,000
20,000
-
Gain only if cash exceeds outside basis
4 Ptnr's remain. outside basis (Ln 1-Ln 2)
30,000
5 Pthp's inside basis - Other prop. dist.
40,000
6 Ptnr's basis for other prop (< Ln 4 or 5)
30,000
7 Partner's outside basis (Ln 4 - Ln 6)
85
-
Ben is a partner in the Success Partnership. The
adjusted basis of Ben's partnership interest was
$25,000 immediately before Ben received a
liquidating distribution of $20,000 cash and
land with an adjusted basis to the partnership
of $40,000 and a fair market value of $50,000.
What is Ben’s basis in the land received in this
distribution?
a. $0
b. $5,000
c. $10,000
d. $15,000
CPA 11-93
Liquidating Distributions - Sec. 731-33
Distribution to Ben
1 Ben's outside basis (Include debt)
25,000
2 Less: Cash distributed to Ben
3 Gain recognized by Ben (Ln 2-Ln 1)
4 Ben's remain. outside basis (Ln 1-Ln 2)
5 Ben's basis for other property Line 4
6 Ben's loss (Excess of Line 4 over 5)
(Loss can be recognized only if no
property is distributed other than cash,
unrealized receivables and inventory.)
7 Ben's remaining partnership basis
$-0-
Liquidating Distributions - Sec. 731-33
Distribution to Ben
1 Ben's outside basis (Include debt)
25,000
2 Less: Cash distributed to Ben
20,000
3 Gain recognized by Ben (Ln 2-Ln 1)
4 Ben's remain. outside basis (Ln 1-Ln 2)
5,000
5 Ben's basis for other property Line 4
5,000
6 Ben's loss (Excess of Line 4 over 5)
(Loss can be recognized only if no
property is distributed other than cash,
unrealized receivables and inventory.)
7 Ben's remaining partnership basis
$-0-
C Corporation
• Distribute cash
– Shareholder reports
• Dividend income to the extent of earnings and
profits or corporation, then
• Return of capital to the extent of basis, then
• Capital gain
– No tax consequences to corporation
• Distribute property
– Shareholder reports same as cash (FMV of Prop.)
– Corporation reports gain “as if the property was sold”
for its FMV. No loss allowed.
Newell Corporation-1
Debit
Sales
Cost of sales
$400,000
Municipal bond interest
Compensation
100,000
Meals & entertainment (Gross)
20,000
Payroll taxes, & Misc. Expense
140,000
Subtotal
660,000
Net Income (GAAP) before taxes
42,000
Add: One half of entertainment
10,000
Deduct: Mun. bond interest
(2,000)
Taxable income
50,000
Income Tax
7,500
Credits
$700,000
2,000
702,000
Newell Corporation-2
Compute E & P (Similar to Retained Earnings)
Taxable Income
50,000
Add
Tax-exempt income
2,000
Subtract
Federal income taxes
(7,500)
Nondeductible entertainment Subtract
(10,000)
Current Earnings & Profits
34,500
Add: Accum E&P at first of year
100,000
Subtotal
134,500
Less: Dividends paid
Earnings and Profits at End of Year
134,500
Note: E & P is reduced by nondeductible
expenses that reduce dividend paying ability such as non-deductible entertainment expense.
Dahl Corp. (Slide 1)
Accum. E&P at 1-1-09
$120,000
E&P for 2009
160,000
Cash distributions to individual
stockholders during 2009
360,000
What is the amount of dividend
income taxable to Dahl's
stockholders in 2009?
a. $0
b. $160,000
c. $280,000 d. $360,000 CPANov1995
Dahl Corp. (Slide 2)
Accum. E&P at 1-1-09
$120,000
E&P for 2009
160,000
Cash distributions to individual
stockholders during 2009
360,000
What is the amount of dividend
income taxable to Dahl's
stockholders in 2009?
a. $0
b. $160,000
c. $280,000 d. $360,000 CPANov1995
Cole Corp.-1
Cole Corp. distributes $75,000 in cash
along with land having a $50,000 adjusted
basis and a $60,000 FMV to its
shareholder. E&P is not a limiting factor.
What is the amount of dividend income
recognized by shareholder?
a. $75,000. b. $125,000.
c. $ 135,000. d. $ - 0 –.
Cole Corp.-2
Cole Corp. distributes $75,000 in cash
along with land having a $50,000 adjusted
basis and a $60,000 FMV to its
shareholder. E&P is not a limiting factor.
What is the amount of dividend income
recognized by shareholder?
a. $75,000.
b. $125,000.
c. $ 135,000. d. $ - 0 –.
Cole Corp.-3
Cole Corp. distributes $75,000 in cash
along with land having a
$50,000 adjusted basis and a
$60,000 FMV to its shareholder.
What is the shareholder’s basis
in the non-cash property?
a. $0.
b. $50,000.
c. $60,000.
d. $125,000.
Cole Corp.-4
Cole Corp. distributes $75,000 in cash
along with land having a $50,000 adjusted
basis and a $60,000 FMV to its
shareholder.
What is the shareholder’s
basis in the non-cash property?
a. $0.
b. $50,000.
c. $60,000.
d. $125,000.
Property Distributions
• Property distributions – corporation recognizes
gain on distribution of appreciated property
(but not loss)
– Value of distribution is net FMV (net of any
liabilities assumed) and basis to shareholder
is FMV
– Like cash dividends, property dividends
taxable only to extent of E&P
Cole Corp.-5
Cole Corp. distributes $75,000 in cash
along with land having a $50,000 adjusted
basis and a $60,000 FMV to its
shareholder.
What gain must Cole Corp. recognize?
a. $10,000. b. $75,000.
c. $ 25,000. d. $ - 0 –.
(IRS Exam 2003)
Cole Corp.-6
Cole Corp. distributes $75,000 in cash
along with land having a $50,000 adjusted
basis and a $60,000 FMV to its
shareholder.
What gain must Cole Corp. recognize?
a. $10,000. b. $75,000.
c. $ 25,000. d. $ - 0 –.
(IRS Exam 2003)
S Corporation
• Distribute cash
– Shareholder recognizes no gain unless amount
exceeds basis; excess is capital gain
– No tax consequences to corporation
• Distribute property
– Same as for cash
– Corporation reports gain “as if the property was
sold” for its FMV. No loss allowed.
If corporation has been a C corporation and has
earnings and profits, the computations are more
complicated.
Beth invested $25,000 in a new Corp on
January 1, 2010. Beth does not borrow from
the Corp or make loans to the Corp.
The Corp elected S Status on January 1, 2010.
The Corp had net income of $50,000 in 2010.
On December 31, 2010 the Corp distributes
$80,000 to Beth.
How much income does Beth recognize as a
result of the cash distribution?
a. $0
b. $5,000
c. $25,000 d. $80,000
102
Beth
Cost of stock
Net income for year
Total Stock Basis
Amt. of Distribution
Gain
103
Basis
$25,000
Beth
Basis
Cost of stock
$25,000
Net income for year $50,000
Total Stock Basis
$75,000
Amt. of Distribution $80,000
Gain
$5,000
104
Repeat preceding slide.
What is Beth’s basis at
the end of the year?
$0
105
What are the effects of
liquidating distributions made
by each entity?
Sole Proprietorship
• Distribute cash
–No tax consequences
to owner / entity
• Distribute property
–When property is sold;
gain or loss = FMV less basis
Partnership
• Distribute cash
– Partner recognizes
• No gain unless amount exceeds partner’s basis;
excess is capital gain
• If only cash is distributed, loss may be
recognized
– No tax consequences to partnership
• Distribute property
– Partner recognizes no gain or loss; Basis is the
lesser of carryover basis or partner's basis
– No tax consequences to the entity
Brody is a partner in the Success Partnership.
The adjusted basis of Brody's partnership
interest was $25,000 immediately before
Brody received a liquidating distribution of
$20,000 cash and land with an
adjusted basis to partnership of $40,000
and a fair market value of $50,000.
What is Brody’s basis in the land received this
distribution?
a. $0 b. $5,000 c. $10,000 d. $15,000 CPA 11-93
Liquidating Distributions - Sec. 731-33
Distribution to Brody
1 Partner's outside basis (Include debt)
25,000
2 Less: cash distributed to Partner
3 Gain recognized by Ptnr (Ln 2-Ln 1)
4 Ptnr's remain. outside basis (Ln 1-Ln 2)
5 Ptnr's basis for other property Line 4
6 Partner's loss on distribution (Line 5)
(Positive amount on line 5 is the loss,
if no property distributed other than cash,
unrealized receivables and inventory.)
7 Remaining Outside Basis
$-0-
Liquidating Distributions - Sec. 731-33
Distribution to Brody
1 Partner's outside basis (Include debt)
25,000
2 Less: cash distributed to Partner
20,000
3 Gain recognized by Ptnr (Ln 2-Ln 1)
4 Ptnr's remain. outside basis (Ln 1-Ln 2)
5,000
5 Ptnr's basis for other property Line 4
5,000
6 Partner's loss on distribution (Line 5)
(Positive amount on line 5 is the loss,
if no property distributed other than cash,
unrealized receivables and inventory.)
7 Remaining Outside Basis
$-0-
C Corporation
Distribute cash
Shareholder reports capital gain or
loss = amount less basis
No tax consequences to corporation
Distribute property
Shareholder reports same as cash
Corporation reports gain or loss “as
if the property was sold” for its FMV
L Corp. adopted a plan of liquidation on Jan. 31.
L sold its property, paid its income taxes and
distributed cash of $900,000 to its only
stockholder in complete liquidation. E & P
before the distribution were $600,000.
Stockholder’s adjusted basis in L Corp. stock was
$700,000.
Tax effects of the liquidation to stockholder?
[Sec. 331(a)]
Dividend income? ____________
Capital gain of? ____________
L Corp. adopted a plan of liquidation on Jan. 31.
L sold its property, paid its income taxes and
distributed cash of $900,000 to its only
stockholder in complete liquidation. E & P
before the distribution were $600,000.
Stockholder’s adjusted basis in L Corp. stock was
$700,000.
Tax effects of the liquidation to stockholder?
[Sec. 331(a)]
Dividend income? 0
Capital gain of? $200,000
E&P not relevant for liquidation.
Sue owns all of the stock in Big Corp.
Sue has a basis of $5,000 in the stock.
Big adopts a plan of liquidation, pays all tax
liabilities for the year, and distributes two assets
to Sue:
(1) Cash of $10,000 and
(2) Land: Basis of $30,000 &
FMV of $70,000.
Income or gain recognized by Sue?
[Sec. 331(a), 1001]
Dividend income? ____________
Capital gain of? ____________
Sue owns all of the stock in Big Corp.
Sue has a basis of $5,000 in the stock.
Big adopts a plan of liquidation, pays all tax
liabilities for the year, and distributes two assets
to Sue:
(1) Cash of $10,000 and
(2) Land: Basis of $30,000.
FMV of $70,000.
Income or gain recognized by Sue?
[Sec. 331(a), 1001]
Dividend income? 0
Capital gain of? $75,000
S Corporation
Distribute cash
Shareholder recognizes capital gain
or loss equal to distribution amount
less basis
No tax consequences to corporation
Distribute property
Shareholder reports same as for cash
Corporation reports gain or loss “as if
the property was sold” for its FMV
Tax Planning
Income Splitting
Child-Employee
Family Entities
118
Tax Planning
With proper tax planning, owners
of entities can minimize their
overall tax liability by taking full
advantage of the progressive tax
rate structure.
–Income splitting
–Children as employees
–Family entities
The End