+ All Categories
Home > Documents > Subchapter S (Day 2)

Subchapter S (Day 2)

Date post: 17-Jan-2016
Category:
Upload: nguyet
View: 32 times
Download: 0 times
Share this document with a friend
Description:
Subchapter S (Day 2). Robert R. Oliva, Ph.D., LL.M., J.D., CPA. University of Arkansas at Little Rock. Introduction. Tax effect of S election Subchapter S taxes BIG/PII Recapture Shareholder taxes: Pass Throughs: Separately stated Not separately stated. Tax Effect of S Election on S. - PowerPoint PPT Presentation
78
Subchapter S (Day 2) Robert R. Oliva, Ph.D., LL.M., J.D., CPA University of Arkansas at Little Rock
Transcript

1

Subchapter S (Day 2)

Robert R. Oliva, Ph.D., LL.M., J.D., CPA

University of Arkansas at Little Rock

2

Introduction

Tax effect of S election Subchapter S taxes

» BIG/PII» Recapture

Shareholder taxes: Pass Throughs: » Separately stated» Not separately stated

3

Tax Effect of S Election on S

Information return No federal income taxes paid, except

» BIG» PII» Recapture: LIFO reserve; ITC

4

Tax Effect of S Election on Shareholders

Introduction Separately stated items Nonseparately stated items

5

Introduction

S v. partnerships S v. corporations

6

S Corp v. partnerships

Similar in income computation: » Separately and non-separately stated items.

However,» S measures property distributions at FMV

– Partnerships distributions measured at AB

» S debt does not affect shareholders’ AB. – Partnership’s debt affects partners’ AB

» Disproportional distributions permitted in partnerships

– But could cause the S termination b/c creates second class of stock

7

S Corp v. C Corp

Unless otherwise stated follow Sub C rules » Like C Corps, S Corps

– allowed IRC 248 org. exp. Amortization– Recognize gain on distributions of appreciated property

However, while gain is passed through but shareholder does not report it as dividend.

» But unlike C Corps, – S Corps are not allowed to an IRC 243 or IRC 291

deductions – S Corps separately report items that may have different

treatments at shareholder level.

8

Separately Stated Items

charitable contributions (no 10% limit) foreign/possessions taxes

» Shareholder to elect deduction or credit tax exempt income

» Passes through as increases to AB income/loss/deduction/credit requiring separate

treatment» Capital gains & losses» IRC 1231 gains & losses» Interest and dividends received by an S, e.g., portfolio

income

9

Separately Stated Deductions

IRC 179 Nonbusiness bad debt (IRC 166(d):

STCL)

10

Non-separately Stated Items

Gross income less deductions Deductions: IRC 248, 291, depreciation

(not 179). Disallowed deductions: sep. stated;

personal;

11

Computation of shareholders’ share

Pro rata: daily/per share Daily: Yearly income(loss) / days in

taxable year Per share: Daily income(loss) / # shares

outstanding

12

Example 1: Pro rata

A and B equal owners of S » w/ O.I. of $146,000 » and LTCG of $36,500.

How much do A and B report?

13

Answer to Example 1:

A and B each report 50%.

14

Example 2:Pro rata

Now B sells 50% on 90th day.» B owned 50% for 89 days and 25% for 276

days » C owned 25% for 276 days

How much do B and C report?

15

Answer to Example 2: Ordinary Income:

B: $146K(.5)(89/365) + $146K(.25)(276/365) = $45,400

C: $146K(.25)(276/365) = $27,600

16

Answer to Example 2: LTCG

B: $36500(.5)(89/365) + $36500(.25)(276/365)=$11350

C:$36500(.25)(276/365) = $6900

17

Example 3: pro rata

A owns 10% through the year; nonseparately stated = $36500

How much does he report?

18

Answer to Example 3:

.10(36500) = $3650 Or:

» Daily: $36500/365= $100/day» Prorata:$100(.10)=$10/day» Yearly share: $10/day(365)=$3650

19

Example 4: prorata

Same as 3 but now A buys another 10% on the 201st day:

How much does he report?

20

Answer to Example 4:

10% for 200 days:$100/day(.10)(200)=$2000

20% for 165 days:$100/day(.20)(165)=$3300

21

Effect of cessation of ownership:

If no election: compute as above If election: compute as if two years Why relevant?

22

Relevancy of no election:

If income is NOT earned evenly throughout year, shareholders will not report their fair share

Similar election available when S terminates.

23

Distributions: irc 1368

An extension of the IRC 301 water faucet analogy in Subchapter C.

But 4 buckets or tiers instead of 3 buckets» Tier 1: From AAA: Tax free

– Simultaneously reduce AAA and AB

– Recognize gain after AB.

» Tier 2: In excess of AAA: dividend up to AEP» Tier 3: Remainder of AB tax free» Tier 4: Balance in excess of AB = gain

24

Therefore,

an S distribution has no impact on shareholders’ TI unless » After elimination of AAA, distribution is

sourced from EP» Distribution > Adjusted Basis

25

AAA: Accumulated Adjustments Account

Rationale: Tracks the source of distributions

Two sources of distributions» Undistributed and untaxed C’s EP = AEP» Undistributed but taxed S’s operations =

post-1982 undistributed earnings

26

AAA: Adjustments

Beginning balance on day 1 of S = 0» AAA = 0» AEP = $500 (leftover from C years)

Increase AAA by results of operations» If S has $100 earnings, then

– AAA= $100– AEP = $500

27

AAA adjustments:

Increase AAA» Results of operations

Reduce AAA by» Pass through losses/deductions» Nondeductible expenses, not charged to

capital account

28

Examples of nonded exp/not charged to cap.

expenses for tax free income illegal bribes, nondeductible fines &

penalties losses between related parties federal taxes during C years disallowed meal and entertainment

expenses

29

Treatment

Redemptions, distributions and operating results» Sub S corporations with C’s EP.» Sub S corporations (never were C

corporations)

30

Sub S corporations with C’s EP.

Dealing with the AAA

31

AAA Adjustments: Redemption

25% stock redemption; AAA = $160 Adjust AAA by 25%: $160 - .25(160) =

$120

32

AAA adjustments: Distributions

Timing Issue: » Which should be accounted for first?

– Results of operations?– Results of distributions?

33

General rule:

(1) Adjust S Corp’s balances (AAA, EP, AB) by the results of operations

(2) Adjust S Corp’s balances to account for the distribution.

34

Exception:

The order of adjustments is changed when there is an operating loss at EOY.» (1) Adjust for the distribution» (2) Adjust for the results of operations

35

Example 5: Operating Loss

Assume one owner EOY balance before adjustments for the

results of operations and distributions » AAA=400; » AEP=1000; » AB=2000;

EOY operating results:» LTCG=400; » Operating loss=(1800)

36

Order of Adjustments (the exception)

First: Distributions Then: LTCG and ordinary loss.

37

Recalling treatment for distributions:

Tier 1: From AAA: Tax free» Simultaneously reduce

– AAA and AB

» Recognize gain after AB. Tier 2: In excess of AAA: dividend up to

AEP Tier 3: Remainder of AB tax free Tier 4: Balance in excess of AB = gain

38

Example 6: Same facts as #5 but w/$1200 dist.

EOY balance before adjustments for the results of operations and distributions » AAA=400 (from past results of S operations); » AEP=1000 (from results when business was

conducted as a C Corp); » AB=2000;

EOY results:» LTCG=400; » Operating Loss=(1800)» Distribution during the year: $1200

39

Effect on Tier 1: AAA

AAA = 400 - 400 = 0 » Note that $800 of the $1200 distribution has not

been accounted for as of this time.

Simultaneous reduction of AB » EOY AB before adjustments = 2000 - 400 AAA

reduction = 1600 AB balance

Results after dealing with 1st tier: » AB balance = $1600» ROC = $400

40

The balance of the $1200, e.g., the $800:

Effect on Tier 2: In excess of AAA, div. up to AEP.» AEP=1000-800 = 200

Results after Tier 2: » AEP balance= $200» $800 dividend

41

Results of the $1200 distribution:

ROC = $400; Dividend = $800 Balances

» AEP balance = $200» AAA balance = 0» AB balance = $1600

42

After treatment of the $1200 distribution,

proceed to account for the results of operations,» $400 LTCG » $1800 ordinary loss

43

Example 7:

AAA = Beginning balance $400 - $400 (because of distribution) + $400 LTCG - $1800 ordinary loss = - $1400 AAA negative balance

AB = Beginning balance $2000 - $400 (b/c of distribution) + $400 LTCG - $1800 loss = $200 ending balance

44

Note:

Even if AB not enough to reflect loss, AAA will reflect it.

Distribution is greater than AB but the distribution is not taxable.

45

Distributions under the “general rule”

(1) Adjust for results of operations (2) Adjust for distributions.

46

Example 8: Facts:

47

Results from operations

Non-separately stated income and deductions» $30K

Separately stated income and deductions

» LTCG: 15

» Municipal interest: 5

» Dividend income: 3

» Charitable contribution: -8

48

Example 8: Balances at BOY

AB 60 AAA 40 OAA 0 AEP 25

49

Example 8:

First question» What is the effect of operations on the

following accounts?– AB; AAA; OAA; AEP

Second question» What will be the effect of two $50K

distributions, one in June 1 and the other one in December 1?

50

SubSExample8.xls

51

Example 9: AEP and no AAA

Facts: After accounting for the results from operations Sub S Corp has the following balances: AEP=$10; AAA=0; and AB=$25. What is the effect of $50 distribution?

Effect on Tiers:» Tier 1: AAA: None» Tier 2: Div up to AEP = $10» Tier 3: Reduce AB = $25» Tier 4: Balance above AB = gain = $15

52

Distributions where there is no AAA nor EP

Tier 1: AAA: None Tier 2: EP : None Tier 3: Reduce AB Tier 4: Balance above AB = gain from

s/e.

53

Example 10:

Facts: Results from operations: OI=30; LTCL=(5). Sole shareholder has AB=20 at BOY and receives $35 in distributions during the year.

54

First compute EOY AB and before distributions :

AB BOY 20 + 30 OI -5 LTCL = 45 AB before distributions

55

Second: Compute effect of distributions:

Tier 1: AAA: None Tier 2: EP : None Tier 3: Reduce AB: 45 - 35 distribution =

10 AB balance at EOY Tier 4: Balance above AB = gain from

s/e = $0

56

Example 11:

Facts: Same as 10 but now assume that OI=5, and no LTCL.

57

First compute EOY AB and before distributions :

AB BOY 20 + 5 OI = 25

58

Second: Compute effect of distributions:

Tier 1: AAA: None Tier 2: EP : None Tier 3: Reduce AB: 25 - 25 distribution =

0 AB balance at EOY» Additional $10 has to be accounted as gain

Tier 4: Balance above AB = gain from s/e = $10

59

Example 12:

Facts: Same as 10 but now OI= (5), and no LTCL

First compute ending AB=20-5=15 Then 1st Tier: 15-15= 0 AB, 20 LTCG Is this correct?

60

NOT!

Operating loss (exception of general rule). » It requires a net negative adjustment

First: reduce BOY AB by dist of 35: 20-20=0 AB

Excess of dist. over AB= 15 LTCG gain; NOT 20.

61

AB Positive Adjustments: rationale

If earnings are up, stock value should be up.

If shdr sells, then substantial gain But as shdr pays for P/T, AB increases

to avoid double tax.

62

AB Negative Adjustments: rationale

If earnings are down, stock value should decrease.

If shdr sells,then substantial loss But b/c P/T losses reduce other income,

losses reduce AB to avoid a double benefit.

63

AB Adjustments done at EOY

NOTE: If shareholder sells during the year, gain/loss not determined until EOY.

64

Pecking Order for AB Adjustments

1. Increase for income items 2. Decrease for nondeductible,

noncapital expenses 3. Decrease for losses and deductions

(could precede 2) 4. Decrease for distributions

65

Example 13: AB adjustments:

Note: Previous examples involved a 100% shareholder

S reports $50 profit and distributes $20K to 50% shareholder who has $10 AB at BOY » AB BOY 10 + 25 (50% of profits) - 20

distribution = 15 AB EOY and after distributions

66

Example 14: AB Adjustments

Multiple years; equity and debt: » S reports 15K loss in Yr1 and 25K profit in

Yr2.» At BOY YR 1: Stock AB=5; Debt AB = 5K

(material participation) » S distributes $8K in Yr2 to 50%

shareholder Tax effect of distribution?

67

Answer to Example 15: Year 1

Yr1: $15K loss: Reduce shareholder’s AB by 50% of $15K» Decrease AB stock: BOY 5 - 5 = 0 EOY 1

(Stock AB cannot fall below 0) » Decrease AB of debt: BOY 5 - 2.5 (bal. not

used by stock AB) = 2.5 EOY Yr 1

68

Answer to Example 15: Year 2

Yr.2: $25K profit; Increase shareholder’s AB by 50% of $25K» Restore debt AB: BOY Yr 2: 2.5 + 2.5

(Debt AB cannot go over original AB) = 5K at EOY 2 and before distributions

» Restore stock AB: BOY Yr 2: $0 + $10K = $10 EOY Yr 2 AB before distributions

69

Answer to Example 15: Effect of $8K distribution

in Yr 2:

Stock AB EOY Yr 2 10 - 8 dist = 2 ending AB after dist.

As distribution did not exceed stock AB, it is a tax free distribution.

70

Example 16:

A, B, and C equal owners. A’s AB=25 OI=36.5; muni=14.6; A sells on 1/31 for

$30K Compute A’s gain/loss.

71

Answer Example 16:

AB= 25 + [36.5(1/3)(30/365)] + [14.6(1/3)(30/365)=26.4

Gain from sale of stock: 30 - 26.4 = $3.6

72

Debt Basis

Use stock AB first, then debt’s AB, not below 0.

Eligible “debt”: B/E fn 115, 116. Unused loss/deduction carried forward

indefinitely Upward adjustments in reverse

73

Example 17: Debt AB

1/1/00: 50% shdr, AB stock=40K, secured debt AB=20K

2000: S reports (100K). Thus ABs=0, ABd=10K

2001: S reports 10K. ABdebt=15K. S pays $20K note. Shdr reports $5K gain on

debt. Unsecured note would have resulted in $5K

OI.

74

ENPI: Example 18

ENPI = NPI [ (PII-.25 GR) / PII ] Nonpassive= 35K; PII=65K; exp for

PII=10K; other exp=25» NPI = 65-10 = 55

ENPI= 65-10 [(65-.25(35+65) / 65 = $33,486

$33486 at highest rate (assume 35%) = $11,486

75

Built-In Gains Tax

Recognizes any C’s BIG during 10 years after S election.

Taxes gain at highest rate, e.g., 35% If BIG imposed, it is treated as a loss for

the year. Character of loss: look at the asset

causing BIG

76

Definitions

NUBIG: Excess of FMV over AB on Day 1 of S

NRBIG: Lesser of net of BIG and BIL or TI Recognized BIG: gain from sale of any asset. Exceptions:

» Asset sold not held in Day1, or» if held on Day 1, actual gain exceeded NUBIG

77

Additional Limitations

NRBIG < NUBIG-NRBIG to date: top = NUBIG

C’s NOL carryforwards used v. BIG

78

Example 19: BIG

1/1/96:FMV/AB: Inv(FIFO)=75/60;Mach1(1245:18/11, Mach2 (1231):15/19

Inv sold for 85: 85-60=25 OI, but 15 is BIG Mach 1 sold for 19: 19-11=8 OI, but 7 is BIG. Mach 2 (1231) sold or 16: 16-19=3 1231 loss

PT, and 3 BIG Yearly: 15+7-3=19 at 35% = $6,650 in BIG

taxes


Recommended