Transcript Slide 1

Chapter 12B.
S Corporations
C10-Chp-12B-1-SCorp-Passthru-Loss-Basis-Dist.ppt
Edited 2010-0221
Howard Godfrey, Ph.D., CPA
Professor of Accounting
Copyright 2010. Howard Godfrey.
The student should be able to:
7. Calculate a shareholder's share of ordinary
income or loss & separately stated items.
8. Determine the limits on a shareholder's
deduction of S corporation losses.
9. Calculate a shareholder's basis in his or
her S corporation's stock and debt.
10. Determine the taxability of distributions
to its shareholders.
11. Explain the procedures for filing an S
corporation tax return.
12. Determine the estimated tax payments
required of an S corporation and its
shareholders.
Lets get a preview of what
we will be computing, and
why it is important to keep
up with E&P (if there is any),
Basis of stock and AAA.
See next slide.
3
Joe owns 100% of S corp. His basis is $18,000.
Balances: AAA = $2,000, E&P = $3,000, debt = $0.
Joe takes a current distribution of $25,000.
How much total income is recognized by Joe?
Dist.
AAA E&P Basis Income
Dist./Balances $25,000 $2,000 $3,000 $18,000
Distribution
Distribution
Distribution
Cap. Gain
Answer if a C corp? E&P=$3,000, AAA-N/A
Joe owns 100% of S corp. His basis is $18,000.
Balances: AAA = $2,000, E&P = $3,000, debt = $0.
Joe takes a current distribution of $25,000.
How much total income is recognized by Joe?
Dist.
AAA E&P Basis Income
Dist./Balances $25,000 $2,000 $3,000 $18,000
Distribution
($2,000) ($2,000)
($2,000)
Distribution
($3,000)
($3,000)
$3,000
$20,000
$0
$0 $16,000
Distribution
($16,000)
($16,000)
Cap. Gain
$4,000
$4,000
Answer if a C corp? E&P=$3,000, AAA-N/A
7. Calculate a
shareholder's
allocable share of
ordinary income or
loss and separately
stated items.
Bow Corp, an S corp, has 3 equal
stockholders. For the year ended
December 31, 2010, Bow had taxable
income of $300,000, and municipal interest
of $20,000.
Bow made cash distributions totaling
$120,000 during 2010.
For 2010, what amount from Bow should be
included in each stockholder's gross
income?
a. $40,000 b. $60,000
c. $100,000 d. $140,000 CPA May, 1987
7
Bow Corp, an S corp, has 3 equal
stockholders. For the year ended
December 31, 2010, Bow had taxable
income of $300,000, and municipal interest
of $20,000.
Bow made cash distributions totaling
$120,000 during 2010.
For 2010, what amount from Bow should be
included in each stockholder's gross
income?
a. $40,000 b. $60,000
c. $100,000 d. $140,000 CPA May, 1987
8
Income Allocation Procedures.
Shareholders report their allocable share of
ordinary income and loss and separately
stated items in the tax year in which the S
corporation's tax year ends.
These allocation rules are known as the
"per day/per share" method.
Special allocations are not allowed.
If stock is transferred during the year,
income must be allocated between the
owners.
9
Mark owns 50% of Scorp.
No Accum. E & P. Also no debt.
On Jan. 1, Mark's Basis in stock:
Scorp reports book income of:
Book income includes:
Mun. Bond Interest Income
Gross Meals & Ent. Expense
Mark's share of ordinary income
reported on his Form 1040.
Mark's stock basis at year-end?
$ 9,000
$ 4,500
$ 2,000
$ 1,000
10
Mark - Book income to TI
Net Income per books
$ 4,500
Tax-free income
Non-deductible Expenses
Ordinary Income
Stock Ownership
Mark's share of ordinary income
50%
Mark - Book income to TI
Net Income per books
Tax-free income
Non-deductible Expenses
$ 4,500
(2,000)
500
Ordinary Income
$ 3,000
Stock Ownership
50%
Mark's share of ordinary income
$ 1,500
Mark - Stock Basis
Sec. 1367
$ 9,000
Investment or Beginning Basis
Add: Ordinary Income
Separate Income & gains
Tax-free income
Contributions of Capital
Less: Ordinary Loss
Separate Exp. & Losses
Non-deductible Expenses
Tax-Free Withdrawals
Ending Stock Basis
Loss limit includes loans to S Corporation.
Mark - Stock Basis
Sec. 1367
$ 9,000
1,500
Investment or Beginning Basis
Add: Ordinary Income
Separate Income & gains
Tax-free income
1,000
Contributions of Capital
Less: Ordinary Loss
Separate Exp. & Losses
Non-deductible Expenses
(250)
Tax-Free Withdrawals
Ending Stock Basis
$ 11,250
Loss limit includes loans to S Corporation.
Look at preceding slide.
Would basis be different if
the corporation borrowed
$100,000 in the last week of
the year, and owed this
amount at year-end?
15
Bern Corp., an S corp, had an ordinary loss
of $36,500 for the year ended December 31.
At January 1, Meyer owned 50% of Bern's
stock.
Meyer held the stock for 40 days in the year
before selling the entire 50% interest to an
unrelated third party.
Meyer's basis for the stock was $10,000.
Meyer was a full-time employee of Bern until
the stock was sold.
Meyer's share Bern's loss for the year was
a. $0
b. $2,000 c. $10,000 d. $18,250
CPAM91#56
16
Hint:
Preceding Slide:
Loss is $100 per day for the
corporation.
Sec. 1366(a)(1) Pro-Rata
Sec. 1377(a)(1)
(Per share-Per day)
Bern Corp., an S corp, had an ordinary loss
of $36,500 for the year ended December 31.
At January 1, Meyer owned 50% of Bern's
stock.
Meyer held the stock for 40 days in the year
before selling the entire 50% interest to an
unrelated third party.
Meyer's basis for the stock was $10,000.
Meyer was a full-time employee of Bern until
the stock was sold.
Meyer's share Bern's loss for the year was
a. $0
b. $2,000 c. $10,000 d. $18,250
CPAM91#56
18
LM Corp. Allocations -1
On 1-1 of Yr 1, Lisa & Marie were equal
owners of LM Corp., an S corp.
On April 30, yr 1, Lisa sold half of her stock
to Shelley.
On August 8, yr 1, Marie sold all of her
stock to George.
Corp. had net loss of $50,000 for Yr 1.
How is this loss allocated to Lisa, Marie,
Shelley, and George?
(Year 1 is not a leap year, and the day of
sale is allocated to the seller.)
19
LM Corp. -2
Lisa
Loss for year
Loss per Day
$ 50,000
$
137
Lisa's Share
Days Owned
Percentage Owned
120
50%
Days Owned
Percentage Owned
245
25%
?
?
?
?
Total
20
LM Corp. -3
Lisa
Loss for year
Loss per Day
$ 50,000
$
137
Lisa's Share
Days Owned
Percentage Owned
120
50%
Days Owned
Percentage Owned
245
25%
Total
60
8,220
61
8,391
$ 16,611
21
LM Corp - 4
Shelley
Loss for year
Loss per Day
$ 50,000
$
137
Shelly's Share
Days Owned
Subtotal
Percentage Owned
Shelly's Share
245
33,565
25%
$ 8,391
22
LM Corp. -5
Loss allocations
to Lisa and Marie
should add to 50%
of $50,000
23
LM Corp. Allocations -6
Daily allocation of $50,000 = $137 per day.
Lisa: (50% x 120 x 137) + (25% x 245 x 137)
= $16,611
Shelley (25% x 245 x 137) = $8,391
Marie (50% x 220 x 137) = $15,070
George (50% x 145 x 137) = $9,933
24
Income Allocation Procedures.
A special election is available for allocating the
ordinary income or loss and separately stated
items when the shareholder's interest in the S
corp is terminated during the tax year or when the
interest is substantially reduced, even if not
completely terminated. If the election is made,
the income is allocated according to the
accounting methods used by the S corp (instead
of on a daily basis). The election divides the S
corp's tax year into two parts ending on (1) the
day the shareholder's interest in the corp is
terminated, and (2) the last day of the S corp's tax
year. This election can only be made if all
affected shareholders agree.
25
Loss and Deduction Pass-through to
Shareholders. A corporation's ordinary
loss and separately stated loss and
deduction items pass through to the
shareholder(s) in the tax year in which the S
corporation's tax year-ends.
Allocation of Loss. Allocation of loss
occurs on a daily basis. Losses and
deductions allocated in excess of the
shareholder's income create an NOL for the
shareholder and results in a carryback or
carryover to the shareholder's other tax
years.
26
8. Determine the
limitations on a
shareholder's
deduction of
S corp losses.
Shareholder Loss Limits.
A shareholder’s deduction for his
share of the loss and separately stated
loss and deduction items is limited to
his basis in stock plus basis of any
indebtedness owed directly by S corp.
to shareholder.
Amounts of income or gain for the
year are added to basis before
determining the loss limitation.
Next, basis is reduced for distributions
not included in shareholder’s income.
28
Once the loss limit is determined, the basis
decreases occur in the following sequence:
decreases attributable to nondeductible,
noncapital expenditures, decreases
attributable to ordinary losses, separately
stated loss and deduction items.
Sequencing the basis reduction for
distributions ahead of the absorption of the
losses means that distributions reduce the
deductibility of S corp loss and deduction
passthroughs, but losses do not change
the taxability of S corp distributions.
29
On January 1, Mr. Karl purchased
50% of Olive Inc., an S corporation,
for $75,000.
During the year, Olive Inc. incurred an
ordinary loss of $160,000.
How much of the loss can Mr. Karl
deduct on his personal income tax
return for the year?
a. $160,000 b. $80,000
c. $75,000
d. $37,500
30
On January 1, Mr. Karl purchased
50% of Olive Inc., an S corporation,
for $75,000.
During the year, Olive Inc. incurred an
ordinary loss of $160,000.
How much of the loss can Mr. Karl
deduct on his personal income tax
return for the year?
a. $160,000 b. $80,000
c. $75,000
d. $37,500
31
Bob invested $25,000 for all of the stock of
a new Corp on January 1.
The corp immediately elected S Status.
He also loaned the S Corp $10,000 during
the year which has not been repaid.
At year-end the corp owed $100,000 to the
local bank. The S Corp has an operating
loss of $50,000 for the year.
What maximum amount of loss (before
passive and at-risk limitations) can Bob
deduct on his tax return?
a. $35,000 b. $10,000
c. $50,000 d. $25,000
32
Bob invested $25,000 for all of the stock of
a new Corp on January 1.
The corp immediately elected S Status.
He also loaned the S Corp $10,000 during
the year which has not been repaid.
At year-end the corp owed $100,000 to the
local bank. The S Corp has an operating
loss of $50,000 for the year.
What maximum amount of loss (before
passive and at-risk limitations) can Bob
deduct on his tax return?
a. $35,000 b. $10,000
c. $50,000 d. $25,000
33
SamCorp is an S Corp. owned by Sam - 1
No Accum. E & P. Also no debt.
On Jan. 1, Sam's Basis in stock:
$1,000
SamCorp's distribution to Sam:
600
SamCorp's capital gain in year:
200
SamCorp's operating loss for year:
(900)
Amt of distribution taxed to Sam?
Amt of cap. gain Sam reports?
Operating loss Sam reports?
Sam's stock basis at year-end?
Sam's suspended loss?
IRC 1366(d)(1), 1367(a)(1), (2)(A) [1996 Act]
SamCorp is an S Corp. owned by Sam - 2
No Accum. E & P. Also no debt.
On Jan. 1, Sam's Basis in stock:
$ 1,000
SamCorp's distribution to Sam:
600
SamCorp's capital gain in year:
200
SamCorp's operating loss for year:
(900)
Amt of distribution taxed to Sam?
0
Amt of cap. gain Sam reports?
200
Operating loss Sam reports?
(600)
Sam's stock basis at year-end?
0
Sam's suspended loss?
$ 300
IRC 1366(d)(1), 1367((a)1), (2)(A) [1996 Act]
SamCorp is an S Corp. owned by Sam - 3
On Jan. 1, Sam's Basis in stock:
$ 1,000
SamCorp's capital gain in year:
200
Basis before distriburtion
1,200
SamCorp's distribution to Sam:
600
Basis before loss allocation
600
SamCorp's operating loss for year:
(900)
Limit on Sam's loss deduction
(600)
Sam's suspended loss?
(300)
Sam's stock basis at year-end?
$ IRC 1366(d)(1), 1367(1), (2)(A) [1996 Act]
On the preceding slide, Sam’s basis
is increased by income items, then
reduced by the distribution, then the
expense and loss items are taken
into account.
Basis goes from $1,000 to $1,200
due to capital gain. Basis is then
reduced by the $600 distribution.
This gives a net basis of $600 for
considering operating loss of $900.
There is a suspended loss of $300.
On the preceding slide,
how would the results
differ if we first deduct the
loss and then show the
distribution?
Sec. 1368(d)
Consider basis increases
only before distribution.
38
Shareholder Loss Limits.
If stock in an S corp is sold while there are
unused losses due to lack of basis, the
losses lapse and can not be used by the
purchaser.
However, if the shareholder transfers the S
corp stock to a spouse or former spouse
incident to a divorce, the suspended losses
transfer to the spouse or former spouse.
Thus, the spouse or former spouse can
deduct the losses when he or she obtains
sufficient basis.
39
Shareholder Loss & Deduction Limits.
S corp shareholders are subject to three additional
loss limits: the at-risk rules; the passive activity loss
and credit limitation rules; and the hobby loss rules.
Some separately stated loss and deduction items are
subject to shareholder limits (e.g., charitable
contributions, long-term capital losses and
investment interest expense) though they are not
subject to corporate limits. Some separately stated
items are subject to corporate limits but not
shareholder limits (e.g., the 50% nondeductible
portion of travel and entertainment expenses).
Post-termination Loss Carryovers. Loss and
deduction carryovers can be carried over after an S
election is terminated and deducted by the
shareholder in the post-termination transition period.
40
Family S Corporations.
The IRS can reallocate income
attributable to stock that is
transferred to a family member when
the transferor retains the economic
benefits and control over the stock.
The IRS can also allocate the items of
income, deduction, gain, loss and
credit to reflect the value of services
rendered or capital contributed by a
family member.
41
9. Calculate a
shareholder's
basis in S corp's
stock and debt.
Basis Adjustments to S Corp. Stock.
The basis adjustments parallel those
made to determine a partnership
interest's basis.
Adjustments include taxable and taxexempt income, and separately stated
items. Adjustments are made on last
day of tax year.
The formula for determining the basis
for S corporation stock is shown on
the next page.
43
Stock Basis
§1367
Investment or Beginning Basis
Add: Ordinary Income
Separate Income & gains
Tax-free income
Contributions of Capital
Less: Ordinary Loss
Separate Exp. & Losses
Non-deductible Expenses
Tax-Free Withdrawals
Ending Stock Basis
Loss limit includes loans to S Corporation.
Haas Corp., a calendar year S corp, has
two equal shareholders.
For the year ended December 31, Haas had
taxable income of $60,000, which included
$50,000 from operations & $10,000 from
investment interest income.
Hass also had municipal bond interest
income of $8,000. There were no other
transactions that year.
Each shareholder's basis in the stock of
Haas will increase in the year by
a. $50,000 b. $34,000
c. $30,000 d. $25,000 e. $0
CPA 1994
45
Haas Corporation
Info.
Basis
Taxable Income
$60,000
Ordinary Income
$50,000
$50,000
Investment income
$10,000
10,000
$8,000
8,000
Municipal bond interest
Basis Change: all owners
68,000
Basis Change: 50% owner
$34,000
46
Basis Adjustments to Shareholder Debt.
After a shareholder's basis in the S corporation
stock is reduced to zero, basis in debt owed the
shareholder by the corporation is reduced to
zero. When income or gain items are allocated to
shareholders, they first restore their basis in
shareholder debt, and then increase the basis in
the stock.
If debt is repaid before the basis is fully restored,
the shareholder will recognize a gain. The gain
will be ordinary gain if the debt is unsecured and
capital gain if the debt is secured by a note or
other evidence of indebtedness.
47
Cal Corporation Basis-1
Cal owns a 25 % of Cal Corp., an S corp.
Cal loaned $10,000 to Cal Corp. last
year. On January 1, Cal’s basis in his
stock was $16,000.
a. Cal’s basis in his stock & debt at the
end of the year if the corp. reports a
loss of $60,000 for the year?
b. … if the corp. reports losses of
$90,000?
c. … if the corp. reports a loss of
$120,000?
48
Cal Corp. Stock Basis -2
Part a
Investment or Beginning Basis
$16,000
Add: Ordinary Income
Separate Income & gains
Tax-free income
Contributions of Capital
Less: Ordinary Loss
(15,000)
Separate Exp. & Losses
Non-deductible Expenses
Tax-Free Withdrawals
Ending Stock Basis
$1,000
Loss limit includes loans to S Corporation.
Cal Corp. Stock Basis - 3
Part b
Investment or Beginning Basis
$16,000
Add: Ordinary Income
Separate Income & gains
Tax-free income
Contributions of Capital
Less: Ordinary Loss
(22,500)
Separate Exp. & Losses
Non-deductible Expenses
Tax-Free Withdrawals
Subtotal
($6,500)
Stock Basis-cannot be negative
-0Basis in debt is reduced by $6,500
Cal Corporation Basis - 4
a. Cal’s share of the loss is $15,000 ($60,000
x 25%) and the basis in his stock is $1,000
($16,000 - $15,000 share of the
corporation’s loss). His basis in his debt
remains $10,000.
b. Cal’s share of the loss is $22,500
($90,000 x 25%) and the basis in his stock is
reduced to zero by $16,000 of the loss; his
basis in his debt is reduced to $3,500
($10,000 – $6,500).
51
Cal Corporation Basis - 5
c. Cal’s share of the loss is $30,000
($120,000 x 25%) and the bases of both
his stock and debt are reduced to zero.
He is able to deduct only $26,000 of
the loss as a result.
The remaining $4,000 loss is
suspended and cannot be deducted
until he again has either debt or stock
basis.
52
10. Determine the
taxability of an
S corp's
distributions to its
shareholders.
Sec. 1368. Distributions – Slide 1 of 3
(a) General Rule. A distribution
of property made by an S
corporation with respect to its
stock to which (but for this
subsection) section 301(c) would
apply shall be treated in the
manner provided in subsection
(b) or (c), whichever applies.
54
Sec. 1368. Distributions – Slide 2 of 3
(b) S Corp. Having No Earnings and Profits. In
the case of a distribution described in
subsection (a) by an S corp. which has no
accumulated earnings and profits(1) Amount applied against basis. The
distribution shall not be included in gross
income to the extent that it does not exceed
the adjusted basis of the stock.
(2) Amount in excess of basis. If the amount of
the distribution exceeds the adjusted basis of
the stock, such excess shall be treated as gain
from the sale or exchange of property.
55
Sec. 1368. Distributions – Slide 3 of 3
(c) S Corp. Having Earnings and Profits. ..
(1) Accum. Adjust. Acct. That portion of the
distribution which does not exceed AAA is
treated in manner provided by subsection (b).
(2) Dividend. That portion of the distribution
which remains after the application of
paragraph (1) is treated as a dividend to the
extent it does not exceed AE&P of the S corp.
(3) Treatment of remainder. Any portion of the
distribution remaining after the application of
paragraph (2) of this subsection shall be
treated as in subsection (b).
56
Sec. 1367. Basis, Sec. 1368(e) AAA
Sec. 1367 describes how to compute
stock basis. Note that basis is adjusted
upward for income items, then downward
for distributions and then further
downward for loss and expenses items.
Note that Sec. 1368(3) says that AAA is
adjusted in the same manner as stock
basis, except for tax-free income and
related expenses, -- and AAA can go
negative.
57
Beth invested $25,000 in a new Corp on
January 1.
Beth does not borrow from the Corp or
make loans to the Corp.
The Corp elected S Status on January 1.
The Corp had net income of $50,000 in the
year.
On December 31, 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
58
Beth
Cost of stock
Net income for year
Total Stock Basis
Amt. of Distribution
Gain
Basis
$25,000
59
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
60
Repeat preceding slide.
What is Beth’s basis at the
end of the year?
61
12/31/01 AB (C Corp) has Current E&P and
Accum. Earnings and Profits: $ 35,000
1/1/03
AB elects S Status
12/31/10 AB's AAA balance:
$ 20,000
12/31/10 AB's OA balance:
$ 10,000
12/31/10 AB's Accum. Earn. & Profts:
$ 35,000
12/31/10 AB pays dividend to owner:
$ 50,000
12/31/10 What is AB's Accum. E & P
balance after cash dividend?
62
All amounts are in $000
Sec. 1368
Acct. Amt. Form Effect on
Bal. of Dist. 1040 Stk Basis
Stock Basis
Distribution Amt.
$ 50
1 Acc. Adj. Acct. $ 20
2 AE & Profits
35
3 Other Adj.
10
4 Return of Basis
5 Excess
If Corp has no E&P, Start with Step 4.
Layer 3 seems irrelevant, Why?
All amounts are in $000
Sec. 1368
Acct. Amt. Form Effect on
Bal. of Dist. 1040 Stk Basis
Stock Basis
Distribution Amt.
$ 50
1 Acc. Adj. Acct. $ 20 $ (20)
2 AE & Profits
35 $ (30)
3 Other Adj.
10
4 Return of Basis
5 Excess
?
?
If Corp has no E&P, Start with Step 4.
Layer 3 seems irrelevant, Why?
64
All amounts are in $000
Sec. 1368
Acct. Amt. Form Effect on
Bal. of Dist. 1040 Stk Basis
Stock Basis
Distribution Amt.
$ 50
1 Acc. Adj. Acct. $ 20 $ (20)
$
2 AE & Profits
35 $ (30) $ 30
3 Other Adj.
10
4 Return of Basis
5 Excess
(20)
If Corp has no E&P, Start with Step 4.
Layer 3 seems irrelevant, Why?
Explanation of previous slide.
The first $20,000 of the distribution
came out of AAA.
The next $30,000 came out of AE&P.
That means the ending balance in
AE&P is only $5,000.
The $20,000 from AAA was a tax-free
return of basis.
The $30,000 from AE&P is a taxable
dividend and has no impact on stock
basis.
12/31/01 AB (C Corp) has Current E&P and
Accum. Earnings and Profits: $35,000
1/1/03
AB elects S Status
12/31/10 AB's AAA balance:
$20,000
12/31/10 AB's OA balance:
$10,000
12/31/10 AB's Accum. Earn. & Profts:
$35,000
12/31/10 AB pays dividend to owner:
$50,000
12/31/10 What is AB's Accum. E & P
balance after cash dividend?
$5,000
67
Introduction of Wizard Corporation.
It is an S corp. with E&P from old C
Corp. years – before the S election.
Distribution of E&P is taxable to the
shareholder of the S corp. (and does
not reduce stock basis). Otherwise
distributions from an S Corp. are taxfree and reduce basis until all basis is
recovered by the shareholder. Beyond
basis recovery, the additional amounts
are capital gain.
Wizard is a calendar year S corp. - Slide 1
Heil owns 100% of Wizard's stock.
AAA Balance on 1-1-10
$30,000
Accumulated E & P on 1-1-10
75,000
Heil's basis in the stock on 1-1-10
60,000
Wizard's ordinary income for 2008
100,000
In 2010, Wizard distributed $255,000 to Heil.
What amount of dist. is capital gain for Heil?
a. $-0- b. $20,000 c. $105,000
d. $150,000
69
Wizard - ($000) -Slide 2
Amt.
Bal. -1-1-10
Ord. Income
Balance
Distribution
Balance
Distribution
Distribution
Distribution
AAA
$30
100
?
?
(130) ?
?
(75)
(30)
(20)
70
Wizard - ($000) -Slide 3
Amt.
Bal. -1-1-10
Ord. Income
Balance
Distribution
Balance
Distribution
Distribution
Distribution
AAA
$30
100
100
$130
(130) (130)
(75)
(30)
(20)
71
Wizard Corp. - ($000) Slide 4
Amt.
Bal. -1-1-10
Ord. Income
Balance
Distribution
Balance
Distribution
Distribution
Distribution
AAA E&P
$30 $ 75
100
100
$130 $75
(130) (130)
?
(75)
?
(30)
(20)
72
Wizard Corp. - ($000) Slide 5
Amt.
Bal. -1-1-10
Ord. Income
Balance
Distribution
Balance
Distribution
Distribution
Distribution
AAA E&P
$30 $ 75
100
100
$130 $75
(130) (130)
0 75
(75)
(75)
(30)
(20)
73
Wizard Corp. - ($000) Slide 7
AAA E&P Basis
$30 $ 75 $ 60
100
100
100
$130 $75 $160
(130) (130)
(130)
0 75
30
(75)
(75)
(30)
?
(20)
Amt.
Bal. -1-1-10
Ord. Income
Balance
Distribution
Balance
Distribution
Distribution
Distribution
74
Wizard Corp. - ($000) Slide 8
Amt.
Bal. -1-1-10
Ord. Income
Balance
Distribution
Balance
Distribution
Distribution
Distribution
AAA E&P Basis
$30 $ 75 $ 60
100
100
100
$130 $75 $160
(130) (130)
(130)
0 75
30
(75)
(75)
(30)
(30)
(20)
75
Wizard Corp. - ($000) Slide 9
Amt.
AAA E&P Basis 1040
Bal 1-1-10
$30 $ 75 $ 60
Ord. Inc.
100 100
100 $ 100
Balance
$130 $75 $160
Dist.
(130) (130)
(130)
Balance
0 75
30
Dist.
(75)
(75)
75
Dist.
(30)
(30)
?
Gain
(20)
?
Total Dist (255)
?
Of $255,000, $60,000 was basis.
76
Wizard Corp. - ($000) Slide 10
Amt.
AAA E&P Basis 1040
Bal 1-1-10
$30 $ 75 $ 60
Ord. Inc.
100
100
100 $ 100
Balance
$130 $75 $160
Dist.
(130) (130)
(130)
Balance
0 75
30
Dist.
(75)
(75)
75
Dist.
(30)
(30)
Gain
(20)
20
Total Dist (255)
195
Of $255,000, $60,000 was basis.
77
Wizard Corp. - ($000) Slide 11
AAA E&P OA Basis 1040
$30 $ 75
$ 60
100 100
100 $ 100
$130 $75
$160
(130) (130)
(130)
75
0
30
(75)
(75)
75
(30)
(30)
(20)
20
(20)
Amt.
Bal 1-1-10
Ord. Inc.
Balance
Dist.
Balance
Dist.
Dist.
Dist.
AAA can be distributed tax-free.
The AAA distribution reduces basis.
E & P is distributed after AAA, and is taxable.
OA is distributed next (accumulated tax-free income.)
78
S Corporation Distributions.
Corp. Having No Earnings and Profits.
For S corps with no accumulated E&P, a
two-tier rule applies. Distributions from an
S corp having no E&P first reduce the basis
in the stock. Distributions in excess of
basis will generate capital gain.
Distributions do not reduce a shareholder's
basis in shareholder debt.
As was the case with partnership
distributions, it may be helpful to explain
the S corp distribution rules by using a T
account, which reflects the basis increases
and decreases.
79
S Corporation Distributions.
Like C corporations, S corporations must
recognize gain on the distribution of
appreciated property. Gain is measured by
the difference between FMV and the
adjusted basis for the property.
The gain recognized by the corporation is
allocated to the shareholders and may be
subject to tax at the corporate level. No
losses are recognized when property that
has declined in value is distributed.
80
S Corporation Distributions.
Corps with Accum. Earnings & Profits.
Prior to 1983, a corp's undistributed
taxable income was taxed to its
shareholders as a deemed distribution
at year-end. This income was
accumulated in a previously taxed
income (PTI) account. E&P earned in
excess of PTI became part of a
corporation's accumulated E&P
account. Starting in 1997, pre-1983
accumulated E&P earned while an S
corporation is no longer a source of S
corporation distributions.
81
S Corporation Distributions.
Corps with Accum. Earnings & Profits.
Under current (post-1982) rules, some
S corps still have PTI and post-1982
E&P balances earned while a C corp
from which part or all of a distribution
may be treated as having been made.
Corps with PTI or E&P must maintain
an Accumulated Adjustments Account
(AAA) and an Other Adjustments
Account in order to determine the
taxability of their distributions.
Distributions first come from AAA.
82
S Corporation Distributions.
Corps with Accum. Earnings & Profits.
1. Money Distributions. For corps having an
accumulated E&P account, cash distributions
come from the four tiers of earnings.
Distributions are made from each tier until the
tier is exhausted.
The AAA is the cumulative total of the ordinary
income or loss and separately stated items for
the S period but not tax-exempt income and the
expenses related to its production. There are
four differences between basis adjustments and
adjustments required for the AAA.
83
S Corporation Distributions.
Other Adjustments Account (OAA)
is maintained only when there are accumulated
E&P at year-end. The account is primarily
increased for tax-exempt income and decreased
for expenses related to tax-exempt income. OAA
is not an earnings account in the distribution
sequence. Earnings in the OAA are considered to
be part of the stock basis when determining the
source of a distribution.
Allocation of the AAA balance to individual
distributions occurs at year-end after taking into
account current year income and loss items. In
general, the AAA amount is allocated ratably to
individual distributions (other than those
distributions coming from E&P or PTI) based on
the amount of money or FMV of nonmoney
property distributed.
84
S Corporation Distributions.
Property Distributions.
Distributions of nonmoney
property cannot reduce PTI. PTI
can only be distributed in money.
Property distributions may also
force the recognition of income or
gain by the distributing
corporation under Sec. 311 as
discussed above.
The FMV of nonmoney property
distributed will reduce AAA.
85
S Corporation Distributions.
Distribution Ordering Elections.
Two elections are available to change the
distribution order. Separate elections are
available to the S corporation to skip over
the AAA and PTI accounts in determining
the source of a cash or property distribution.
If either election is made, the distributions
will normally come from accumulated E&P.
This election can be used to eliminate the
possibility of the excess net passive income
tax applying or the passive income test
being failed and causing a loss of S
corporation status.
86
S Corporation Distributions.
Post-Termination Transition Period.
Distributions of money made during the S corp's
post-termination transition period can be made
tax-free to those shareholders who owned S corp
stock at the time of the termination.
These distributions are considered as coming
first from AAA and then from current and
accumulated E&P.
The amounts coming from AAA are tax-free and
reduce the shareholder's basis in the stock.
Distributions from current and accumulated E&P
are taxable.
AAA remaining after the post-termination
transition period ends can only be distributed as
a basis reduction after current and Accum. E&P
has been exhausted.
87
S Corp. Distributions.
Corps who do not have E&P do
not need to maintain an AAA
for reporting purposes (i.e., the
Form 1120S balance sheet).
The IRS suggests, however,
that an AAA be maintained in
case E&P is acquired from a C
corp. Such is not the usual
practice of most CPAs.
88
Tax Pref. Items & Other AMT Adjustments.
An S corporation is not subject to the
corporate alternative minimum tax.
Items of adjustment or tax preference flow
through to the shareholders. Allocation of
adjustment or tax preference items is made
on a daily basis unless one of the special
allocation elections is in place.
S corps do not have to make the adjustment
for the difference between adjusted current
earnings and pre-adjustment alternative
minimum taxable income that is required of
other corporations.
89
Trans. with Owners & Other Related Parties.
Sec. 267 related party rules deny a payor a
deduction when a mismatching of income
and expense items occurs as a result of
two different accounting methods being
used. S corporations are denied a
deduction when payments involve persons
who directly, indirectly, or constructively
own S corporation stock and different
accounting methods are used. Losses are
also disallowed on sales and exchanges
between S corporations and related parties
as defined in Sec. 267.
90
Fringe Benefits for a Shareholder-Employee.
Shareholder-employees owning more than 2% of
the S corp stock are treated as partners for
purposes of determining the treatment for fringe
benefits. Shareholder-employees owning 2% or
less of the S corp stock are treated as an ordinary
employee.
A more-than-2% shareholder-employee is taxed on
the amount of a fringe benefit, but may deduct the
item if it qualifies as an itemized deduction (e.g.,
health insurance benefits incurred by an S corp
shareholder-employee that are deductible under
Sec. 162(l)). They are included as wages on the
Form W-2 provided to the shareholder-employee.
Fringe benefits paid to more-than-2% shareholder
as compensation are deductible by the corp.
91
Fringe Benefits for a Owner-Employee.
The special fringe benefit rules only apply
to "statutory fringe benefits.” They do not
apply to stock options, qualified retirement
plans, and nonqualified deferred comp.
Fringe benefits which are limited by the
more-than-2%-shareholder rule include:
group term life insurance premiums; $5,000
employee death benefit exclusion; accident
and health benefit plan insurance premiums
and payments; meals and lodging furnished
by the employer; and employer-provided
parking.
92
Question
Fringe benefit rules for shareholders of S
corps have the effect of:
a. Making the S corporation preferable to the
partnership form of organization.
b. Limiting the tax advantages associated
with fringe benefits provided to
shareholders.
c. Increases the limit from $50,000 to
$100,000 for group-term life insurance
provided to an employee who is also a
major shareholder.
d. Increasing the taxes paid by an S
corporation on its net income.
93
Election to Allocate Income Based on
the S Corp's Accounting Methods.
As a general rule, an S corp's income,
gain, loss, deductions and credits are
allocated on a per-share, per-day
basis. The corp can elect to use the
corp's tax accounting methods when
an S election is terminated or an S
corp shareholder terminates his entire
interest. The use of the S corp's
accounting methods can shift income
from one shareholder to another.
94
Election to Allocate Income Based on the S
Corp's Accounting Methods.
By electing to use the S corp's tax
accounting method to allocate profits or
losses between the C short year and S short
year in the year in which the S election
terminates, it is possible to
(1) shift losses into an S short year where
an immediate benefit is obtained by the
shareholders at a marginal tax rate of up
to 35; or
(2) shift profits into a C short year to take
advantage of the 15 and 25% marginal
corporate tax rates.
95
Increasing the Benefits from S Corporation
Losses. A shareholder is limited in the amount of
loss that can be deducted to his basis in his stock.
If income is expected to be taxed at a higher
marginal rate in future years, basis should not be
restored until the later year in order to increase the
amount of tax savings from the unused loss.
The S corp loss carryover is only available to the
shareholder who held the stock when the loss was
incurred. A shareholder should consider
increasing the basis of the stock in order to take
advantage of the loss carryover before the stock is
sold or exchanged. The purchasing shareholder
does not acquire the loss carryover.
96
Passive Income Requirements.
An S corp with Subchapter C E&P is limited as to
the amount of passive income that can be earned
if the excess net passive income tax is to be
avoided. In addition, excessive net passive
income may terminate the S election.
An election is available to distribute Subchapter C
E&P and avoid the corporate level tax. This may
be desirable if the E&P amount is small, or the
shareholder has a NOL.
While the distribution will be taxable, it may be
desirable because unlimited amounts of passive
income can be earned in the future.
97
Passive Income Requirements.
Corps with rental income can avoid the
passive loss rules if significant services
are rendered or if significant costs are
incurred in the rental business. Net
leases will not qualify.
All the facts and circumstances must be
considered including, but not limited to,
the number of persons employed to
provide the services and the types and
amounts of costs and expenses incurred
other than depreciation.
98
11. Explain the
procedures
for filing
an S corp
tax return.
Making the Election. The S election is made by
filing Form 2553 (Election by Small Business
Corp to Tax Corp Income Directly to
Shareholders). The election can be signed by
any person who is authorized to sign the
corporation's tax return under Sec. 6037. No
extensions of time to file the S election are
granted. Shareholder consents can be made
either on the Form 2553 or on a separate consent
statement signed by the shareholder and
attached to the corporation's election form.
Extensions of time to file shareholder consents
can be granted by the IRS.
100
Filing the Corporate Tax Return.
An S corp, whether or not there is any
income, must file a return for part or all of
the tax year that they are in existence. The
return is filed not later than the fifteenth
day of the third month following the close
of the tax year.
All S corps that file a return are required to
furnish any shareholder owning stock
during the year a copy of the return.
The basic 3-year statute of limitations
applies to S corporations.
101
12. Determine the
estimated tax
payments required
of an S corp and
its shareholders.
Estimated Tax Payments.
S corps make estimated tax payments for the
following taxes: BIG tax, excess net passive
income tax, and recapture of investment tax
credits claimed in tax years when the S corp was
a C corp. No estimated taxes are owed unless
the total of these taxes is reasonably expected to
exceed $500. There are penalties & interest for
failure to make timely payments of any estimated
tax liabilities. The S corp's shareholders are also
subject to estimated tax payments on their share
of the S corp's income. The amounts are treated
as received concurrently by the shareholders
throughout the year.
103
Consistency Rules.
Shareholders are required to treat all items
of income, gain, loss, deduction or credit
(i.e., a Subchapter S item) in a manner
consistent with their treatment on the Form
1120S (Sec. 6037(c)).
If an item is reported in an inconsistent
manner, the shareholder is required to
notify the IRS of the difference.
Failure to notify the IRS may result in the
imposition penalty under Sec. 6662.
104
BIG Taxes
Section 1374 imposes a corporate
level tax on an S corp's built-in gain
recognized during the 10-year period
beginning with the first taxable year
for which the corp was an S corp. Sec.
1374(a), (d)(3), (7). Built-in gain is
measured by the appreciation in value
of any asset over its adjusted basis as
of the time a corporation converts
from C to S status.
105
BIG Taxes
An S corporation is liable for the builtin gains tax on the disposition of any
asset except to the extent that it
establishes that it did not own the
asset on the day it converted from C to
S status, or the fair market value of the
asset was less than its adjusted basis
on the first day of the first taxable year
for which it was an S corporation.
Sec. 1374(d)(3).
106
Panthers cause BIG Tax-1
Petitioner was incorporated in 1929
and owns and operates the New York
Giants, a professional football
franchise in the National Football
League (NFL).
In 1990, the NFL began exploring the
possibility of expansion and began
considering various franchise
applications.
107
Panthers cause BIG Tax-2
Petitioner elected on March 1, 1993, to be
treated as an S corporation under section
1361(a)(1).
Later in 1993, the NFL awarded new
franchises to Charlotte and Jacksonville.
The expansion agreements required the
new franchises to pay expansion
payments (in six installments) to petitioner
and the member teams of the NFL.
108
Panthers cause BIG Tax-3
Petitioner reported its share of the
NFL expansion payments as capital
gains (not subject to the built-in gains
tax imposed on S corporations by
section 1374) on its S corporation tax
returns (Forms 1120S, U.S. Income
Tax Returns for an S Corporation) for
fiscal years 1996, 1997, and 1998.
109
Panthers cause BIG Tax-4
IRS sent petitioner a notice of
deficiency in which IRS
determined that petitioner was
subject to the built-in gains tax
under section 1374 for the
expansion payments petitioner
received in fiscal years 1996,
1997, and 1998.
110
Panthers cause BIG Tax-5
IRS determined that petitioner is
liable for BIG tax of $574,000 for fiscal
year 1996, $914,334 for fiscal year
1997, and $220,156 for fiscal year
1998, and for accuracy-related
penalties under section 6662(a) of
$114,800 for fiscal year 1996,
$182,867 for fiscal year 1997, and
$44,031 for fiscal year 1998.
111
Van Der Aa Investments, Inc.-1
By notice of deficiency dated Sept 15,
2003 (the IRS determined a deficiency in
the Federal income tax of Van Der Aa
Investments, Inc. (Investments), for its
1999 taxable (calendar) year (1999) in the
amount of $62,604,069, an addition to tax
on account of delinquency under section
6651(a)(1) in the amount of $12,520,814,
and an accuracy-related penalty under
section 6662 in the amount of $3,124,797.
112
Van Der Aa Investments, Inc.-2
For 1999, Investments made a
Federal income tax return as an S
corporation. On that return, among
other things, Investments reported a
built-in gain tax liability of $1,520,140.
The deficiency in tax determined by
respondent results from his
adjustment increasing Investments'
built-in gain tax liability from
$1,520,140 to $64,124,209.
113
The
End
114