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Business Entities Chapter 13 pp. 477-534

Business Entities Chapter 13 pp. 477-534. 2012 National Income Tax Workbook™. Business Entities pp. 477-534. S corporation basis § 1244 losses Abandonments Personal service corporations Business under common control Distributions from business entities.

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Business Entities Chapter 13 pp. 477-534

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  1. Business EntitiesChapter 13 pp. 477-534 2012 National Income Tax Workbook™

  2. Business Entities pp. 477-534 • S corporation basis • § 1244 losses • Abandonments • Personal service corporations • Business under common control • Distributions from business entities

  3. Learning Objectives pp. 477-478 • Determine whether S corporation shareholder obtains debt basis • Calculate § 1244 loss • Identify act of abandonment • Determine if corporation is PSC • Explain common control concerns • Describe taxation of distributions

  4. S Corporation Basis p. 478 • Shareholder loss deductions limited to basis in stock and debt • Maguire allowed shareholders to shift stock basis between corporations • Proposed regulation clarifies requirements for creating debt basis

  5. Maguire case pp. 478-480 • S corporation borrowed from its sister • Shareholders took the debts as distributions and contributed them back to the debtor corporation • Distributions decreased stock basis in lending corporation and increased stock basis in debtor corporation • Court said there was economic outlay

  6. Provisions in Debt Basis Regulation p. 480 • There must be a bona fide debt • Debt must run directly to the shareholder • Basis starts with I.R.C. § 1011 and is adjusted under I.R.C. § 1367 • Guarantee of third-party loan does not create basis, but payment does

  7. Debt Basis pp. 480-481 • No basis for contributing unsecured promissory note • Loan made by disregarded entity runs directly to owner (Example 13.1) • Payment on guaranteed debt creates basis (Example 13.2) • Back-to-back loans can qualify (Examples 13.3 and 13.4)

  8. Prior Litigation pp. 482-486 • Economic outlay (Maloof, Selfe, Perry, Hitchins) in loan guarantees • Form as well as substance (Spencer, Yates) in back-to-back loans • Circular lending arrangements fail when funds end up where they started (Bergman)

  9. Debt or Equity? pp. 486-487 • 13 factors distinguish bona fide debt from contribution to capital • Name of document. Maturity date. Source. Right to enforce. Management right. Status as creditor. Intent. Thin capitalization. Identity of interests. Interest payments. Creditworthiness. Use of funds. Failure to repay timely.

  10. § 1244 Losses pp. 487-489 • Qualified individual shareholders may claim ordinary loss • Original owner, with acquisition by purchase from corporation (Example 13.5: No fresh infusion of capital) • $50,000 ordinary loss limit is doubled for joint return (Example 13.6)

  11. § 1244 Stock Defined pp. 489-490 • Stock issued for money or property by small business corporation • Small < $1,000,000 in capital • Assumed liabilities reduce FMV of contributed property (Example 13.7) • Subsequent basis decreases do not reduce § 1244 amount (Example 13.8)

  12. § 1244 Stock Defined pp. 490-491 • Distributions of property do not reduce § 1244 capital • Retained earnings do not increase §.1244 capital (Example 13.9) • Capital from nonqualified owners is counted (Example 13.10)

  13. Transitional Year p. 491 • Corporation may designate which shares are § 1244 stock • If no designation, allocation is made pro rata (Example 13.11)

  14. Business Qualification pp. 491-492 • Corporation must be operating company (not pocketbook) for 5 years before stock is sold at loss or becomes worthless • No more than 50% of total gross receipts can be investment income • If no receipts, look at principal activity

  15. Other Restrictions p. 492 • Stock received for services ineligible • Built-in loss does not qualify • S corporation income does not qualify (Example 13.12) • § 1244 loss is business loss for NOL • Loss is reported on Form 4797

  16. Abandonment of Property pp. 493-494 • Loss is ordinary loss, rather than capital loss, if no sale or exchange • Two-pronged test (A.J. Industries) • Evidence of intent to abandon • Identifiable event of abandonment • Treas. Reg. § 1.168(i)-8T(d)(2): Intent to discard asset irrevocably

  17. Personal Service Corporations p. 495 • State law professional corporations are often, but not invariably, PSCs • Goal of tax rules: Prevent use of corporation to defer or shelter payments for personal services • Most drastic: I.R.C. § 269A allows the IRS to ignore the corporation

  18. I.R.C. § 269A Definition pp. 495-496 • Substantially all services are performed for one other entity • Principal activity is personal services performed by employee-owners • Employee-owner owns at least 10% of stock, directly or indirectly • Example 13.13 (5% rule)

  19. Court Cases p. 496 • Keller spurred enactment of 269A; doctor established PC to adopt retirement and medical benefit plans, which court said were not illegal • Robucci used LLC structure to reduce self-employment tax; court held that PC had no business purpose

  20. PSC Tax Year pp. 496-497 • Broader definition of PSC (no 10% floor for owner-employee, services can be provided to multiple entities) • Calendar year generally required but fiscal year can be elected (Examples 13.14 and 13.15) • Election results in limit on deductions for payments to owner-employees

  21. Fiscal Year Price pp. 497-498 • Applicable amount equals salaries, rents, etc., paid to employee-owners • Pass 1 of 2 minimum distribution tests • Preceding year test • 3-year average test • If neither test is passed, deductions may be deferred (Example 13.16) • NOL cannot be carried over

  22. Accounting Methods pp. 498-499 • Qualified PSC may use cash method regardless of level of gross receipts • Accrual method PSC must match deductions to income inclusions for all employee-owners and related parties (Example 13.17) • Qualified PSC: 8 types of services, including law, accounting, consulting

  23. PSC Tax Rate pp. 499-500 • Flat 35% on all taxable income • Goal: Encourage PSC to pay out all net income as compensation to owner-employees • PSC in controlled group gets share of each corporate tax bracket (unless election is made), but cannot use it

  24. Businesses Under Common Control pp. 500-502 • Shared ownership (direct or indirect) of disparate businesses can present unexpected tax issues • Example 13.18 points out potential problems • Example 13.19 tests relationships under I.R.C. § 267(b)

  25. Related Party Sale (Timing of Loss Deduction) pp. 502-503 • Related seller cannot recognize loss; related buyer starts with cost basis, but can reduce later gain by first seller’s loss (Example 13.20) • If buyer and seller are in controlled group, seller’s loss deduction is deferred until later sale outside of group (Example 13.21)

  26. Related Party Sale (Character of Gain) pp. 502-503 • Related seller’s gain is ordinary if property is depreciable by related buyer (Example 13.22)

  27. Fringe Benefit Rules pp. 503-504 • Businesses operating through multiple entities are treated as single employer for nondiscrimination rules • Common control embraces all business structures, using capital and profits interests for ownership • Example 13.23: C and S corporations

  28. Affiliated Service Group p. 504 • Organization with principal business of providing services, plus • Organizations that are shareholders or partners in the service provider, plus • Organizations that regularly provide services to the service organization • Example 13.24: PCs and partnership

  29. Controlled Groups pp. 504-505 • Parent-subsidiary or brother-sister relationship between corporations • Component members are treated as single taxpayer for many tax benefits • S corporations are excluded for some purposes • Constructive ownership rules apply

  30. Controlled Groups pp. 507-508 • Parent-subsidiary: One owns at least 80% (by vote or value) of the other (Example 13.25: Indirect ownership) • Brother-sister: Five or fewer individuals own at least 80% of two or more corporations, and minimum common ownership is more than 50% • Example 13.26, Figures 13.10–13.13

  31. Family Attribution p. 508 • Spouses with direct ownership in multiple corporations are treated as one shareholder (Example 13.27)

  32. Spousal Attribution p. 509 • Escape hatch for separate businesses • No spousal attribution for stock if: • No direct ownership • Not an employee or director • < 50% investment income • No required consent for sale • Example 13.28: No common control

  33. Child as Tax Trap p. 509 • Minor child treated as owning shares in both parents’ corporations • Separate corporations become a controlled group • Example 13.29: Baby complicates business tax situation

  34. Applying Tax Benefit Limits pp. 509-510 • Benefits are divided evenly unless group agrees on allocation formula • Equal shares are not beneficial if income is unequal (or one is PSC) • Example 13.30: Empty lower brackets • Schedule O (Form 1120) is filed with each component member’s tax return

  35. Applying Tax Benefit Limits pp. 510-516 • Alternative minimum tax exemption • I.R.C. § 179 deduction • Work opportunity credit • General business credit ($25,000) • Eligibility to use cash accounting • Rev. Proc. 2001-10 • Rev. Proc. 2002-28

  36. Common Paymaster pp. 516-517 • Controlled group of corporations with shared employees can use paymaster to aggregate wages for FICA and FUTA tax purposes • Separate employees are not included • Other business forms are excluded

  37. Consolidated Tax Returns pp. 517-519 • Option for affiliated group (Example 13.40 and Figures 13.18 and 13.19) • Gains and losses of different members can offset each others • Gains on sales within groups are deferred • Only one return to file

  38. Distributions from Business Entities p. 519 • C corporation─worst for desirable tax treatment of distributions, best for simplicity • S corporation occupies middle ground • Partnership─best for desirable tax treatment of distributions, worst for complexity

  39. C Corporations p. 520 • Corporation can never deduct value of distribution • Corporation must recognize gain if FMV of distribution exceeds basis • Corporation cannot recognize loss if FMV is less than basis • Shareholder must include distribution of earnings and profits in income

  40. Examples 13.41, 13.42 pp. 521-523 • Cash, building with liability (gain property), securities (loss property) • Corporation recognizes gain (not loss), and adjusts E&P for gain plus income • Shareholders have taxable dividends, and basis equal to FMV of property • Corporate tax is $176,800 and total tax is $251,800 (Figure 13.25)

  41. S Corporations pp. 523-525 • Corporate gain/loss rules apply • Difference: Income passed through to shareholders when corporation earns it is not taxed again when distributed • Ordering of distributions • AAA 3. PTIA • AE&P 4. OAA

  42. Example 13.44 pp. 525-527 • Same properties distributed and same effect on corporation’s income • S corporation recognizes gain but not loss, and cannot deduct distribution • No corporate-level tax in example • Shareholders’ total tax is $158,000 (assuming highest potential tax), $93,800 less than C corporation total

  43. Partnerships pp. 527-528 • All income flows through to partners • Generally, no gain or loss recognized on distributions (but many exceptions) • Reduction in share of liabilities treated as distribution of cash • Partnership’s basis transfers unless partner’s basis in partnership is lower

  44. Example 13.45 pp. 531-532 • Same distributions as corporations, with no complications (e.g., hot assets) • Partnership recognizes no income on distributions • Partners’ tax on flow-through income is $122,500 (at highest potential rate) • Liability shift creates distributions in addition to property distributions

  45. Example 13.45 pp. 532-533 • Whether partner recognize gain on distribution depends on outside basis • Distributions to 2 partners exceed current-year Schedule K-1 income; if adjusted basis is less than distribution, partner recognizes gain • Partner’s basis in property is not FMV

  46. Comparison p. 533

  47. Questions?

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