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CCH Federal Taxation Basic Principles Chapter 16 Partnerships, Corporations, and S Corporations

CCH Federal Taxation Basic Principles Chapter 16 Partnerships, Corporations, and S Corporations ©2004 , CCH INCORPORATED 4025 W. Peterson Ave. Chicago, IL 60646-6085 800 248 3248 http://tax.cchgroup.com Part IV: S Corporations Chapter 16 Contents

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CCH Federal Taxation Basic Principles Chapter 16 Partnerships, Corporations, and S Corporations

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  1. CCH Federal TaxationBasic PrinciplesChapter 16Partnerships, Corporations, and S Corporations ©2004, CCH INCORPORATED 4025 W. Peterson Ave. Chicago, IL 60646-6085 800 248 3248 http://tax.cchgroup.com Part IV: S Corporations

  2. Chapter 16 Contents 1. S Corporations—Treatment of Tax and Nontax Matters 2. S Corporations—Tax Years 3. S Corporations—Accounting Methods 4. S Corporations—Tax Model 5. S Corporations—Eligibility and Election 6. S Corporations—Revoking S Status 7. S Corporation Basis Accounts—Overview 8. S Corporation Basis Accounts—Outside Basis 9. S Corporation Basis Accounts—At-Risk Basis 10. S Corporation Basis Accounts—Accumulated Adjustment Account (AAA) 11. S Corporation Basis Accounts—Other Adjustment Account (OAA) Chapter 16, Exhibit Contents A CCH Federal Taxation Basic Principles

  3. Chapter 16 Contents 12. S Corporation Basis Accounts—Previously Taxed Income Account (PTI) 13. S Corporation Basis Accounts—Shareholder Loans to S Corporations 14. S Corporation Basis Accounts—Example on Effect of Operating Results on Basis 15. S Corporation Distributions 16. S Corporation Distributions—Effect on Shareholder 17. S Corporation Distributions—Example 18. S Corporation Penalty Taxes—Code Sec. 1374 Tax on Built-in Gains 19. S Corporation Penalty Taxes—Code Sec. 1374 Tax Example 20. S Corporation Penalty Taxes—Code Sec. 1375 Tax on Excess Net Passive Income 21. Code Sec. 1375 Tax on Excess Net Passive Income—Example Chapter 16, Exhibit Contents B CCH Federal Taxation Basic Principles

  4. S Corporations—Treatment of Tax and Nontax Matters The Conduit Concept. For most tax matters, S corporations are treated like partnerships. As in the partnership conduit concept, the taxable income of an S corporation flows through to the owners on a per-day and per-share basis. Income and losses are reported on Form 1120-S, allocated to each shareholder on a supporting K-1 schedule, and then transferred, via the K-1, to the individual owners’ 1040 returns. There, at the individual level, income is taxed and losses are deducted. Chapter 16, Exhibit 1a CCH Federal Taxation Basic Principles

  5. S Corporations—Treatment of Tax and Nontax Matters The Entity Concept. The character of income and losses is determined at the entity level, not at the shareholder level. For example, a long-term capital gain reported by the S corporation remains long-term to the shareholder, even if his ownership in the S corporation had been held for a short-term period. Chapter 16, Exhibit 1b CCH Federal Taxation Basic Principles

  6. S Corporations—Treatment of Tax and Nontax Matters Distributions of Cash or Property. Actual distributions of cash or property are generally not income to its shareholders. Two notable differences with partnerships are: • Owner salaries and payroll taxes. Deductible by S corporations, not by partnerships. • Gain on distribution of property. S corps must recognize gains (but not losses) on distributions of appreciated property to shareholders; partnerships escape this gain recognition. Chapter 16, Exhibit 1c CCH Federal Taxation Basic Principles

  7. S Corporations—Treatment of Tax and Nontax Matters Nontax matters. For most structural matters (e.g., formation, redemptions and terminations), S corporations are treated in much the same manner as C corporations. Chapter 16, Exhibit 1d CCH Federal Taxation Basic Principles

  8. S Corporations—Tax Years An S corporation must generally use a calendar year end. However, it may elect a fiscal tax year under any of the following three conditions: • Three-Month Deferral OK. A fiscal tax year would result in income deferral of not more than three months and the shareholder-employee’s salary earned between fiscal year end and December 31 is both: • Paid during that period; and, • Proportionate to the salary paid during the preceding fiscal year. • Business Purpose. A business purpose can be demonstrated. • 1987 FYE. The S corporation retains the same fiscal tax year as was used in 1987, if in existence at that time. Chapter 16, Exhibit 2 CCH Federal Taxation Basic Principles

  9. S Corporations—Accounting Methods The accrual, cash and hybrid methods are available regardless of the size of the S corporation. Chapter 16, Exhibit 3 CCH Federal Taxation Basic Principles

  10. S Corporations—Tax Model Code Sec. 702(a)(8) Income Definition.As with partnerships, items that are always subject to ordinary treatment are lumped together in an amount called Code Sec. 702(a)(8) income or loss. Shareholders recognize Code Sec. 702(a)(8) income even if no cash is actually distributed. Accordingly, shareholders are generally not taxed on distributions. Chapter 16, Exhibit 4a CCH Federal Taxation Basic Principles

  11. S Corporations—Tax Model Code Sec. 702(a)(8) Income Computation. Sec. 702(a)(8) is generally operating income or loss computed as follows: • Ordinary Income “From Whatever Source Derived” (including Code Sec. 1245 recapture) • Less: Exclusions • Less: Cost of Goods Sold (resulting in gross income from business operations) • Less: Operating Expenses Chapter 16, Exhibit 4b CCH Federal Taxation Basic Principles

  12. S Corporations—Tax Model Rationale.Each shareholder of an S corporation reports her share of corporate net income based on her stock ownership. Any income, loss, deduction, or credit which could uniquely affect the tax liability of a shareholder is separately stated in the K-1 to the shareholder. Chapter 16, Exhibit 4c CCH Federal Taxation Basic Principles

  13. S Corporations—Tax Model Separately Stated Items • Passive income and losses from rental and other non-operating activities • Investment income and related expenses (e.g., dividends, investment interest, ad valorem tax on stock, investment counseling fees, etc.) • Code Sec. 1231 gain and loss • Capital gains and losses • Dividends eligible for a dividends-received deduction • Charitable contributions • Taxes paid to a foreign country or to a U.S. possession • Code Sec. 179 deduction • Recovery items (e.g., tax refunds, recovery of bad debts) • Tax-exempt income and related expense • Tax credits • Deductions disallowed in computing S corporation income Chapter 16, Exhibit 4d CCH Federal Taxation Basic Principles

  14. S Corporations—Eligibility and Election A corporation is treated as an S corporation only for those days for which each specific eligibility requirement is met and the required election is effective. Eligibility and election rules include: Unanimous Consent. 100% of the shareholders must consent to the S election. Deadline For Filing S Election. If a calendar year C corporation makes an S election by 3/15/x1, it is retroactive to 1/1/x1. If made after 3/15/x1, but before 3/15/x2, it is effective 1/1/x2. One Class of Stock.Only one class of stock is permitted. • Rights to profits and assets on liquidation must be identical. • Debt may be treated as a disqualifying second class of stock. Chapter 16, Exhibit 5a CCH Federal Taxation Basic Principles

  15. S Corporations—Eligibility and Election Maximum 75 Shareholders. The number of shareholders may not exceed 75. • A nonresident alien may not own shares. • Each shareholder must be an individual, an estate, or a qualified trust. • A husband and wife count as one shareholder; however, if they divorce, they count as two if they each own stock. Chapter 16, Exhibit 5b CCH Federal Taxation Basic Principles

  16. S Corporations—Eligibility and Election Ineligible Corporations. The corporation must be domestic but not a bank or insurance company. Eligible Subsidiaries. • S corporations can own C corporations, but C corporations cannot own S corporations. • S corporations can own qualified subchapter S subsidiaries (QSubs). A QSub is an electing domestic corporation that qualifies as an S corporation and is 100% owned by an S corporation parent. Chapter 16, Exhibit 5c CCH Federal Taxation Basic Principles

  17. S Corporations—Revoking S Status The S election will be terminated upon one of the following events: 1.Over 50% consent. Over 50% of the shareholders agree to the revocation. The deadline for revoking S status is the same as the deadline for electing it. 2. Prior C life AND passive investment income over 25%. If an S corporation had a prior life as a C corporation and its passive investment income is over 25% of its total income for three consecutive years, it loses the S election at the start of the fourth year. Chapter 16, Exhibit 6a CCH Federal Taxation Basic Principles

  18. S Corporations—Revoking S Status 3. Violation of qualifications. If any of the qualifications mentioned above are violated (e.g., stock is sold to a C corporation, or a second class of stock is issued), the S election is terminated on the date of violation, and the period before the violation is considered a “short-year.” 4.Majority shareholder revocation. If a new shareholder owning more than 50% takes affirmative action to terminate the election, the election dies as of the date of action. After revocation or termination of an election, a new election cannot be effectively made for 5 years without IRS consent. Chapter 16, Exhibit 6b CCH Federal Taxation Basic Principles

  19. Outside (Stock) Basis At Risk Basis AAA Basis To determine gain or loss when the stock is ultimately sold. [Also will limit tax-free distributions if stock basis is lower than AAA basis.] To determine how much of shareholder’s allocations of Sec. 702(a)(8) losses and separately stated expenses are deductible. To determine how much of cash and property distributions are tax-free. Primary Purpose: S Corporation Basis Accounts—Overview Chapter 16, Exhibit 7a CCH Federal Taxation Basic Principles

  20. (“Yes” means the item to the left is used in the computation of basis): Outside (Stock) Basis At Risk Basis AAA Basis + Original basis (e.g., purchase, inheritance, gift) Yes Yes No  Sec. 702(a)(8) TI or Loss Yes Yes Yes  Separately stated items that are taxable or deductible to s/h Yes Yes Yes  Tax-exempt income and non-deductible exp. Yes Yes No + Company debt for which s/h is personally liable No Yes No S Corporation Basis Accounts—Overview Chapter 16, Exhibit 7b CCH Federal Taxation Basic Principles

  21. (“Yes” means the item to the left is used in the computation of basis): Outside (Stock) Basis At Risk Basis AAA Basis + Non-recourse financing from qualified lenders No No (unlike the normal at-risk rules for individuals) No + Shareholder (S/H) loans to S Corp No (unlike partnerships debt basis is held separately from equity basis.) Yes No (unlike partnerships, debt basis is held separately from equity basis.) S Corporation Basis Accounts—Overview Chapter 16, Exhibit 7c CCH Federal Taxation Basic Principles

  22. (“Yes” means the item to the left is used in the computation of basis): Outside (Stock) Basis At Risk Basis AAA Basis - Fair market value (FMV) of distributions Yes (distributions reduce basis before current year losses) Yes (distributions reduce at risk amount before current year losses) Yes (distributions reduce AAA before current year losses) S Corporation Basis Accounts—Overview Chapter 16, Exhibit 7d CCH Federal Taxation Basic Principles

  23. S Corporation Basis Accounts—Outside Basis General Rule. A shareholder’s outside basis is his/her stock basis. Outside basis is computed in much the same manner as a partner’s outside basis in a partnership interest. Exception. One notable exception is that the basis of stock in an S corporation is not affected by the corporation’s liabilities. This seems reasonable because, unlike a general partner, an S corporation shareholder is not personally liable for the debts of the corporation. Chapter 16, Exhibit 8 CCH Federal Taxation Basic Principles

  24. S Corporation Basis Accounts—At-Risk Basis General Rule. At-risk rules are applied at the shareholder level. The amount of S corporation losses that the shareholder can deduct may not exceed the lesser of: • At-risk amount or • Sum of a shareholder’s stock basis and debt basis. Chapter 16, Exhibit 9a CCH Federal Taxation Basic Principles

  25. S Corporation Basis Accounts—At-Risk Basis Computation of At-Risk Basis. At-risk basis is equal to the sum of: • Cash and basis of property contributed to the S corporation (to the extent unencumbered) • Outstanding shareholder loans to the S corporation • Loans for which the shareholder has personal liability or has pledged as security for repayment property not used in the activity of the corporation. (However, this does not include other debts of the corporation to third parties, even if the repayment is guaranteed by the shareholder.) • Allocated portion of income • Less: Allocated portion of losses • Less: Distributions at fair market value (not at partnership basis) Chapter 16, Exhibit 9b CCH Federal Taxation Basic Principles

  26. S Corporation Basis Accounts—Accumulated Adjustment Account (AAA) Purpose.Records and information pertaining to each shareholder’s accumulated adjustment account (AAA) are needed by S corporations only for purposes of helping shareholders determine taxability of distributions when the S corporation has earnings and profits (E&P). • The C corporation connection.An S corporation has E&P only if it was classified as a C corporation in the past or acquired a C corporation. Tax effect of distributions. The fair market value (FMV) of distributions to shareholders are tax-free to the extent of the lesser of (1) AAA balance and (2) stock basis. Chapter 16, Exhibit 10a CCH Federal Taxation Basic Principles

  27. S Corporation Basis Accounts—Accumulated Adjustment Account (AAA) Computation.A shareholder’s AAA balance is INCREASED only by taxable income. It is REDUCED by all deductible losses/expenses, by cash distributions and by the fair market value (FMV) of property distributions. • Same-year losses and distributions. Shareholders are allowed to reduce the AAA basis by the amount of current year distributions BEFORE applying current year losses against bases. This rule enables tax-free distributions to the extent of AAA, BEFORE AAA is reduced by the amount of losses. While the effect is favorable for tax-free distributions, it can also result in higher suspended losses, since distributions reduce all bases, dollar for dollar, thus lowering the limits of loss deductions and increasing suspended losses. • Tax–exempt income. No adjustment to the AAA account is made for tax-exempt income such as municipal bond interest and life insurance proceeds (reduced by related expenses). Chapter 16, Exhibit 10b CCH Federal Taxation Basic Principles

  28. S Corporation Basis Accounts—Accumulated Adjustment Account (AAA) Negative AAA balance OK. The AAA basis (unlike the stock basis) can have a negative balance. However only losses, (not distributions) can make the AAA negative or increase a negative balance. Transferability of AAA account.If the shareholder disposes of stock, the AAA associated with the stock passes to the new owner. Chapter 16, Exhibit 10c CCH Federal Taxation Basic Principles

  29. S Corporation Basis Accounts—Other Adjustment Account (OAA) Other Adjustments Account (OAA).The OAA represents another form of accumulated adjustments account (AAA) in that: • The OAA is a balance sheet account in the capital section. • The OAA is needed by S corporations only for purposes of helping shareholders determine taxability of distributions when the S corporation has earnings and profits (E&P). • Any distributions from OAA are tax-free to shareholders. Chapter 16, Exhibit 11a CCH Federal Taxation Basic Principles

  30. S Corporation Basis Accounts—Other Adjustment Account (OAA) Timing of distributions. Tax-free distributions from OAA cannot be made until after all accumulated E&P are paid out. Computation.The OAA balance is increased for tax-exempt income or decreased for nondeductible expenditures not properly chargeable to the AAA. Chapter 16, Exhibit 11b CCH Federal Taxation Basic Principles

  31. S Corporation Basis Accounts—Previously Taxed Income Account (PTI) Timing of distributions. Tax-free distributions from the PTI account are made after tax-free distributions reduce the OAA balance to zero. Computation.The PTI account represents a balance of undistributed net income on which the shareholders were already taxed prior to 1983. Chapter 16, Exhibit 12 CCH Federal Taxation Basic Principles

  32. S Corporation Basis Accounts—Shareholder Loans to S Corporations Using loan basis for deductions.Once stock basis is zero, any additional basis reductions (losses or deductions, but NOT distributions), decrease (but not below zero) the shareholder’s basis in loans made to the S corporation. Suspended losses/deduction.Any excess of losses or deductions over both stock and debt bases is suspended until subsequent items of income or contributions arise to restore basis in debt. Restoring debt basis. Once the basis of any debt is reduced, it is later increased (only up to the original face amount of the loan) by the subsequent net increase resulting from all positive and negative basis adjustments. The debt basis is adjusted before any increase is made in the stock basis. Chapter 16, Exhibit 13a CCH Federal Taxation Basic Principles

  33. S Corporation Basis Accounts—Shareholder Loans to S Corporations Distributions. A distribution in excess of stock basis does not reduce any debt basis. Same-year losses and distributions. If a loss and a distribution occur in the same year, the loss reduces the debt basis before the distribution. (This rule favors the taxpayer.) Repayment of shareholder loan with reduced basis. If an S corporation repays a shareholder loan when the debt basis is below the loan amount, the difference is treated as a capital gain. An allocation is required for partial repayments. Chapter 16, Exhibit 13b CCH Federal Taxation Basic Principles

  34. S Corporation Basis Accounts—Shareholder Loans to S Corporations Example: A shareholder lends an S corporation $100,000. Subsequent losses eliminate the shareholder’s stock basis and reduce a portion of the debt basis. The S corporation repays $20,000 of the $100,000 loan when the shareholder’s basis in the loan is $75,000. The shareholder must report a capital gain in the amount of $5,000 on the receipt of $20,000, since 25% of the face value was not supported by debt basis [$20,000 x ($100,000 – $75,000)  $100,000]. Chapter 16, Exhibit 13c CCH Federal Taxation Basic Principles

  35. S Corporation Basis Accounts—Example on Effect of Operating Results on Basis FACTS: David, an individual, owns all of the shares of an S corporation throughout 20x1. The corporate books show the information for 20x1 on the following slides. QUESTION: (1) Compute 20x1 Code Sec. 702(a)(8) taxable income (2) Compute David’s stock basis at 12/31/x1. (3) Compute David’s “at risk” amount at 12/31/x1. (4) Compute David’s AAA balance at 12/31/x1. (5) Compute David’s debt basis at 12/31/x1. Chapter 16, Exhibit 14a CCH Federal Taxation Basic Principles

  36. Facts Solution Corp. Books: (1) Sec. 702(a)(8) TI (2) Stock Basis (3) At Risk Basis (4) AAA Basis (5) Debt Basis Initial bases, from $10m stock purchase on 1/1/x1 10,000 10,000 10,000 0 0 200,000 200,000 200,000 200,000 200,000 Net sales Cost of goods sold (100,000) (100,000) (100,000) (100,000) (100,000) Overhead expenses (10,000) (10,000) (10,000) (10,000) (10,000) Sec. 1245 gain 10,000 10,000 10,000 10,000 10,000 S Corporation Basis Accounts—Example on Effect of Operating Results on Basis Chapter 16, Exhibit 14b CCH Federal Taxation Basic Principles

  37. Facts Solution Corp. Books: (1) Sec. 702(a)(8) TI (2) Stock Basis (3) At Risk Basis (4) AAA Basis (5) Debt Basis Sec. 1231 loss (10,000) (sep’ly. stated) (10,000) (10,000) (10,000) Charitable contributions (10,000) (sep’ly. stated) (10,000) (10,000) (10,000) Short-term capital loss (10,000) (sep’ly. stated) (10,000) (10,000) (10,000) Long-term capital gain 10,000 (sep’ly. stated) 10,000 10,000 10,000 Tax-exempt interest income 15,000 (sep’ly. stated) 15,000 15,000 S Corporation Basis Accounts—Example on Effect of Operating Results on Basis Chapter 16, Exhibit 14c CCH Federal Taxation Basic Principles

  38. Facts Solution Corp. Books: (1) Sec. 702(a)(8) TI (2) Stock Basis (3) At Risk Basis (4) AAA Basis (5) Debt Basis Lobbying expense - state officials (not deductible) (10,000) (sep’ly. stated) (10,000) (10,000) David’s loan to S corp. 10,000 10,000 10,000 S corp borrowings from banks— recourse to David 10,000 10,000 S Corporation Basis Accounts—Example on Effect of Operating Results on Basis Chapter 16, Exhibit 14d CCH Federal Taxation Basic Principles

  39. Facts Solution Corp. Books: (1) Sec. 702(a)(8) TI (2) Stock Basis (3) At Risk Basis (4) AAA Basis (5) Debt Basis S corp borrowings from banks— NONrecourse to David. 10,000 David’s additional stock purchases of S corp. stock 10,000 10,000 10,000 10,000 Cash distribution to David (10,000) (10,000) (10,000) (10,000) Balances, 12/31/x1 125,000 100,000 95,000 115,000 80,000 10,000 S Corporation Basis Accounts—Example on Effect of Operating Results on Basis Chapter 16, Exhibit 14e CCH Federal Taxation Basic Principles

  40. S Corporation Distributions Does an S corporation recognize gain or loss on the distribution of cash to shareholders? No, never. Does an S corporation recognize gain or loss on the distribution of other property (other than its own stock)? • Gains: Yes (compute gain in the same way as if the property were sold) • Losses: No (except in complete liquidation). Chapter 16, Exhibit 15a CCH Federal Taxation Basic Principles

  41. S Corporation Distributions What is the character of the entity’s gain on distribution of property to owners? • If a shareholder owns no more than 50% of the S corporation, then the character of the entity’s gain is the same as the character of the property distributed. • If a shareholder owns more than 50%, then the entity’s gain is ordinary. Chapter 16, Exhibit 15b CCH Federal Taxation Basic Principles

  42. S Corporation Without C Corporation E&P Shareholder Distribution Tax Result To extent of stock basis Tax-free; reduces stock basis In excess of stock basis Taxed as a capital gain S Corporation Distributions—Effect on Shareholder Chapter 16, Exhibit 16a CCH Federal Taxation Basic Principles

  43. S Corporation With C Corporation E&P Shareholder Distribution Tax Result To extent of accumulated adjustments account (AAA) Tax-free; reduces AAA and stock basis To extent of C corporation E&P Taxed as an ordinary dividend; does not reduce stock basis To extent of other adjustments account (OAA) and previously taxed income (PTI) account Tax-free; reduces OAA, PTI, and stock basis To extent of any remaining stock basis Tax-free; reduces stock basis. In excess of stock basis Taxed as a capital gain S Corporation Distributions—Effect on Shareholder Chapter 16, Exhibit 16b CCH Federal Taxation Basic Principles

  44. S Corporation Distributions—Example FACTS: An S corporation reports the following balances for its sole shareholder as of 1/1/x1: • Capital balance per corporate books: $125,000 • Stock basis: $95,000 • At-risk basis: $115,000 • AAA basis: $80,000 • Shareholder loan to S corporation: $10,000 (basis also $10,000) The S corporation reports a ($200,000) ordinary loss in 20x1. Chapter 16, Exhibit 17a CCH Federal Taxation Basic Principles

  45. S Corporation Distributions—Example QUESTIONS: (a) What is the maximum tax-free nonstock distribution the shareholder can receive in 20x1? (Hint: The tax-free distribution is not affected by the 20x1 loss. Use the 1/1/x1 balance in AAA and any excess stock basis. Answer: $95,000 = $80,000 AAA + $15,000 excess stock basis) (b) Assuming that a $95,000 cash distribution is made to the sole shareholder in 20x1, what are the 12/31/x1 balances in stock basis, at-risk basis, AAA and debt basis? (c) What portion of the ($200,000) loss is deductible in 20x1 under the at-risk rules? (d) What portion of the $200,000 loss is suspended in 20x1 under the at-risk rules? Chapter 16, Exhibit 17b CCH Federal Taxation Basic Principles

  46. S Corporation Distributions—Example QUESTION: If the S corporation repays the $10,000 shareholder debt in year 20x2, what are the tax consequences if: • S corporation has income of $10,000 in year 20x2? (If the S corporation has income in year 20x2, the first $10,000 must restore the debt basis back to $10,000. Any income in excess of $10,000 increases the following simultaneously: (a) the stock basis, (b) at-risk basis, and (c) AAA balance. A subsequent repayment of the $10,000 shareholder loan does not result in capital gain.) • S corporation has a loss in year 20x2? (Answer: A $10,000 capital gain passes through to the shareholder since the debt basis is zero.) Chapter 16, Exhibit 17c CCH Federal Taxation Basic Principles

  47. SOLUTION: Tax Effect of a $200,000 loss and a $95,000 distribution in 20x1 Cap. Bal. per Books Sec. 702(a)(8) income (loss) Stock Basis At Risk Basis AAA Basis Debt Basis Balances, 1/1/x1 125m 95m 115m 80m 10m 1st: Apply dist’n. against bases: Tier 1 Distribution: (i.e., Tax free: Lesser of, (1) $80m AAA balance, or (2) $95m stock basis) (80m) (80m) [tax-free] (80m) [tax-free] (80m) [tax-free] 0 [Debt basis is never reduced by distributions] S Corporation Distributions—Example Chapter 16, Exhibit 17d CCH Federal Taxation Basic Principles

  48. SOLUTION: Tax Effect of a $200,000 loss and a $95,000 distribution in 20x1 Cap. Bal. per Books Sec. 702(a)(8) income (loss) Stock Basis At Risk Basis AAA Basis Debt Basis Balances, 1/1/x1 125m 95m 115m 80m 10m Tier 2 Distribution: (i.e., taxable to extent of accumulated E & P from prior life as a C corp. None here.) 0 0 0 0 S Corporation Distributions—Example Chapter 16, Exhibit 17e CCH Federal Taxation Basic Principles

  49. SOLUTION: Tax Effect of a $200,000 loss and a $95,000 distribution in 20x1 Cap. Bal. per Books Sec. 702(a)(8) income (loss) Stock Basis At Risk Basis AAA Basis Debt Basis Balances, 1/1/x1 125m 95m 115m 80m 10m Tier 3 Distribution: (i.e. tax free to extent of any stock basis surviving the 1st tier distribution (15m = 95m - 80m) (15m) (15m) [tax-free] (15m) [tax-free] 0 [Dist’ns cannot create neg. AAA bal.] 0 [Debt basis is never reduced by distributions] Subtotals 30m 0 0 20m 0 10m S Corporation Distributions—Example Chapter 16, Exhibit 17f CCH Federal Taxation Basic Principles

  50. SOLUTION: Tax Effect of a $200,000 loss and a $95,000 distribution in 20x1 Cap. Bal. per Books Sec. 702(a)(8) income (loss) Stock Basis At Risk Basis AAA Basis Debt Basis Subtotals 30m 0 0 20m 0 10m 20x1 DEDUCTIBLE LOSSES UNDER AT-RISK RULES [Apply 200m Sec. 702(a)(8) loss against bases and determine the amount deductible under the at-risk rules.] (200m) (10m) [Note: Only (10m) is deductible, because loss deductions are limited to the lesser of 1. $10m (i.e., stock basis of $0, + debt basis of $10m); or $20m at risk basis] 0 (20m) (200m) (10m) S Corporation Distributions—Example Chapter 16, Exhibit 17g CCH Federal Taxation Basic Principles

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