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Business Entity Issues Chapter 12 pp. 399-444

Explore S Corporation fringe benefits including health insurance, HSA contributions, and tax implications for shareholders. Discover strategies for maximizing benefits and minimizing tax liabilities in S Corporation structures.

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Business Entity Issues Chapter 12 pp. 399-444

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  1. Business Entity IssuesChapter 12 pp. 399-444 2016 National Income Tax Workbook™

  2. p. 399 Business Entity Issues • S Corporation fringe benefits • S Corporation built-in gains tax • S Corporation issues – Death of a SH • S Corporation elections • Partnership § 751(b) regulations • New partnership audit rules • SE tax for limited owners

  3. p. 399 Business Entity Issues • Partnerships owning disregarded entities • Partnership § 754 basis adjustments • Tax-exempt organization update

  4. Issue 1 p. 400S Corporation Fringe Benefits • Health or accident insurance • HSA contributions • Disability insurance • Group term life insurance • Meals & lodging – employer convenience • Cafeteria plans • Educational assistance • Dependent care assistance

  5. Issue 1 p. 400S Corporation Fringe Benefits • Generally excludable by employee • May be taxable to 2% shareholder ( > 2%) • If treated as self-employed, not an employee • Stock owned directly or indirectly through: • Spouse, children parents, grandchildren • Stock held by estate or trust

  6. Issue 1 pp. 400-401Health and Accident Insurance • Employer pays and deducts premiums • Employee excludes premiums & benefits • 2% SH includes in income • No withholding or FICA if plan for employees • Include in W-2 Box 1 and Box 14 • Example 12.1 – 2% shareholder • $86,400 wages, $9,600 premiums • W-2 in Figure 12.1

  7. Issue 1 p. 4022% Shareholder • Self-employed health insurance deduction • Not eligible for other ER subsidized plan • Limited to wages from S corporation • Claim in year premiums in W-2 income • S corp must make payments directly or SH pays and proves for reimbursement • S corp must include in SH W-2 wages

  8. Issue 1 p. 4032% Shareholder • Uninsured or self-insured plan • 2% not considered an employee • All reimbursements tax – income, FICA, FUTA

  9. Issue 1 p. 403Health Savings Account • Contributions deductible (with limit) • Distributions nontaxable if for medical • Must have HDHP • Employer or employee contributes • 2016 max total: Family - $6,750, Self - $3,350 • Over 55 – additional $1,000 per year • EE: Nontaxable, W-2 Box 12, Code W, no FICA • 2% SH: Taxable, no FICA/FUTA, may deduct

  10. Issue 1 p. 403Disability Insurance • S corp deducts – short or long term • Employee – Generally nontaxable • 2% SH • Taxable • No deduction for premiums in income

  11. Issue 1 pp. 403-404Life Insurance • Employer as owner • Employer gets proceeds or names beneficiary • No taxable income to employee • No employer deduction for premiums • Employee as owner • Premiums = compensation, fully taxable • Group term life – exclude up to $50,000 • No exclusion for 2% SH

  12. Issue 1 p. 404Meals and Lodging - § 119 • Employee – excludable if • Meals for employer benefit served on employer’s premises • Lodging for employer benefit, on employer’s premises and is a condition of employment • 2% SH – both taxable • Meals/lodging for business travel with accountable plan not taxable

  13. Issue 1 p. 404Cafeteria Plan - § 125 • Employee chooses fringe benefit or cash • No constructive receipt of foregone cash • 2% SH cannot participate • 2% SH participation disqualifies plan • Remove 2% SH from plan if C to elect S

  14. Issue 1 p. 404Educational Assistance - § 127 • Employer contributions deductible • Distributions tax free to employee • Maximum benefit: $5,250/year • 2% SH = employee, exclude benefits • No discrimination – highly compensated • 5% shareholder or compensation > $120,000 • Cannot receive > 5% total benefits/year

  15. Issue 1 p. 405Educational Assistance - § 127 • Example 12.2 • Herb owns 100% Treeco • Rose, Herb’s wife, is employee • Rose constructively owns 100% • Studying for degree • For max exclusion for Rose, Treeco must pay out total of $105,000 (105,000 x 5% = $5,250)

  16. Issue 1 p. 405Dependent Care - § 129 • Employee excludes $5,000/yr (MFS 2,500) • 2% SH may exclude • Limit on benefits to principal SH • Principal SH owns > 5% • Benefits to 5% cannot exceed 25% total paid • Example 12.3 • $5,000 exclusion to sole SH if $20,000 for all

  17. Issue 2 p. 406S Corporation Built-in Gains Tax • Corporate level tax on sale of assets • Applies if • Previously a C corporation • Received assets from C in tax-free reorg, subsidiary liquidation or Qsub election • 5-year recognition period (See note, p. 407) • Tax on gains accrued in C corp • Tax at flat 35% rate

  18. Issue 2 p. 406Net Unrealized Built-in Gain • NUBIG = net gain if liquidated on day of S election (built-in gain net of built-in loss) • FMV of all assets less adjusted basis • Allowable deductions (e.g. cash A/P) • May include items not on balance sheet • Reported annually on Form 1120S • Limits built-in gain for recognition period

  19. Issue 2 pp. 406-407Net Unrealized Built-in Gain • Example 12.4 LGU Corporation • Cash basis professional C corporation • $5,000 investment by each SH • Double tax if sell as C corporation • Elects S status as of 1/1/2017 • Figure 12.2 – Balance Sheet at 1/1/2017 • Figure 12.3 – NUBIG calculation

  20. Issue 2 pp. 407-408Net Recognized Built-in Gain • Net Recognized BIG = Base for tax = Lowest of: • Prelimitation amount (PLA) • Taxable income limitation (TIL) • Net unrealized built-in gain limitation (NUL) • Prelimitation amount • C taxable income with current year recognized built-in gains/losses only

  21. Issue 2 p. 408Prelimitation Amount • Example 12.5 LGU of Example 12.4 • Collects $124,000 receivables • Pays $49,000 accounts payable • Pays SH $21,000 bonuses by March 15 • Figure 12.4 - Prelimitation Amount $54,000 • $54,000 to F1120S, Sch D, Part III, line 6

  22. Issue 2 p. 408Taxable Income Limitation • Complete pro-forma Form 1120 as if a C • Example 12.6 LGU of Ex. 12.4, 12.5 • Figure 12.5 – Income and Expenses • Prepares dummy 1120, lines 1-28, all items • $15,000 to F1120S, Sch D, Part III, line 17 • Determine base for tax • Lowest of the PLA, TIL, or NUL

  23. Issue 2 p. 408Net Unrealized Built-in Gain Limitation • Net unrealized built-in gain determined for first day of S election (conversion date) • If net unrealized BIG is less than PLA or TIL, it limits the BIG tax • After first year of S election, NUL reduced by prior S election year net recognized BIG

  24. Issue 2 pp. 408-409Calculating Built-in Gains Tax • Apply highest corporate rate • Example 12.7 LGU of Ex. 12.4, 12.5, 12.6 • No unused NOL carryforward • Compute on lowest of PLA, TIL and NUL • Figure 12.6 • Tax = $15,000 x 35% or $5,250 • Can offset with C corp credit carryovers

  25. Issue 2 p. 409BIG Tax Effect on SHs and AAA • SH share of income reduced by BIG tax • Treated as loss corresponding to taxed gain • Ordinary income → taxes and licenses • Capital gain → loss of same character • Example 12.8 LGU Corp. • Figure 12.7 $9,750 total income for the year • AAA increased by $9,750

  26. Issue 2 pp. 409-410Year-End Calculations • NUL for following year = Current year beginning balance less current year net recognized BIG • If TIL used for BIG tax comp, lesser of PLA or NUL less TIL = BIG carryforward • Treated as part of next year’s PLA • Unused C corp NOL or capital loss carryforwards offset net recognized BIG

  27. Issue 2 p. 410Year-End Calculations • Example 12.9 LGU • Used TIL to calculate BIG in 2017 • Figure 12.8 - $39,000 carryforward • Lower of PLA or NUL less $15,000 (TIL) • Becomes recognized BIG for 2018 (PLA) • Figure 12.9 – NUL Reduction • NUL adjusted for net BIG recognized

  28. Issue 3 p. 411Death of S Corp Shareholder • S eligibility affected by who inherits • Terminates if nonresident alien or corporation • No effect if: • Estate of deceased • Individual who is US citizen or resident • Certain trusts – grantor, beneficiary controlled, testamentary trust, qualified subchapter S trust (QSST), electing small business trust (ESBT)

  29. Issue 3 p. 414Allocations in Year of Death • Decedent’s share up to date of death reported on decedent’s final return • Example 12.13 Fiscal-Year S corporation • 3/31 year end, 4/6 date of death – 6 days • Pro Rata Allocation – per share/per day • Weighted average • Closing of the Books

  30. Issue 3 p. 415Allocations in Year of Death • Closing of the books • Requires consent of all affected SHs • Attach statement to 1120S • Per share/per day within each part of year • Sales, gifts, transfers at death, redemptions, divisive reorgs., conversion of a trust • Transferor treated as owner on day of transfer

  31. Issue 3 pp. 415-416Allocations in Year of Death • Example 12.14 Merle, 100% SH died 4/6/16 • Estate transferred shares to trust 9/23/16 • Figure 12.11 – weighted average • S corporation options (Figure 12.12, p. 416) • Allocate based on % in Figure 12.11 • Close the books at 4/6 • Close the books at 9/23 • Close the books at 4/6 and 9/23

  32. Issue 3 pp. 416-417Basis after Death of Shareholder • Date of death or alternate valuation date FMV • Gift to decedent w/1 year of death, decedent’s basis used if passes to donor/donor’s spouse • Example 12.15 Basis = FMV = $ 6,000,000 • Income in respect of a decedent (IRD) • Successor SH reduces basis to extent value attributable to IRD • Example 12.16 Basis = $4M (6M - 2M IRD)

  33. Issue 4 pp. 417-418S Corporation Election – Form 2553 • Sole Proprietorship cannot make S election • LLC or Partnership (PS) • Form 8832 – corporation first (+ Form 2553) • 12 mos before to 75 days after effective • Must have EIN to file • Form 2553 only if corporate & S for same day • If S terminates, reverts to C, not PS • Note (p. 418) agreement revision necessary

  34. Issue 4 p. 418S Corporation Election • Form 2553 due 15th day of 3rd month of tax year to be in effect – send certified • C corp can file in year before effective date • No electronic option for filing • CP261 sent to confirm acceptance • Retain copy in permanent corporate records • After 60 days, no CP261, contact IRS

  35. Issue 4 pp. 418-419Late or Defective Elections • Inadvertence Relief, timely 2553 - § 1362(f) • Failed to meet eligibility requirements • Met eligibility but misstated info on 2553 • Will be treated as an S corporation • Relief by National Office – Letter Ruling • If Service Center lacks relief jurisdiction • Submit with Power of Attorney + fee

  36. Issue 4 p. 419Inadvertence Requirements • Admission of a problem • Statement about corrective action • Representation: • All affected unaware of defect • Not using as retroactive tax planning • Officer signs – penalties of perjury • SHs sign – penalties of perjury – Agree with statement – have & will file consistently with S

  37. Issue 4 p. 419Reasonable Cause Requirements • Less stringent that inadvertence • Officer & SHs sign – penalties of perjury • Cause: Did not file form 2553 • Cure: File form 2553 and have SH returns consistent with existence of S corporation

  38. Issue 4 pp. 419-420Relief Granted by Service Centers • Rev. Proc. 2013-30 • Late S elections • Late entity classification elections • Late QSub elections • Late QSST elections • Late ESBT elections • Grant relief if ≤ 3 years, 75 days from start • Relief not necessarily automatic

  39. Issue 4 p. 420Late Election – Return Not Filed • SHs must have reported S income/loss • Effective date: Intended date • If never filed, attach 2553 to 1st 1120S • Not within 3 years, 75 days → Nat’l Office

  40. Issue 4 p. 420Late Election – Return Filed • All SHs must state they filed consistent with S existence • SH should file before relief request • SH amending could be a problem • Requires IRS acceptance of amended return • Address status of SH returns in relief request

  41. Issue 5 pp. 420-421Partnership Proposed Regs §751(b) • § 751(b) Hot Assets • Unrealized receivables (includes recapture) • Substantially appreciated inventory – FMV exceeds 120% of adjusted basis • Disproportionate Distribution • PN does not receive pro rata share hot assets • Current: Gross value of assets • Proposed (10/31/14): Hypothetical sale

  42. Issue 5 pp. 421-422Partnership Proposed Regs §751(b) • Gross Value – compares PN’s share of PS hot assets before to share after distribution • Hypothetical Sale – compares • Ordinary income of each partner if assets sold for FMV immediately before distribution & • Ordinary income of each partner if assets sold for FMV immediately after distribution (including distributee) • No difference – no § 751(b)

  43. Issue 5 p. 422Partnership Proposed Regs §751(b) • Any reasonable approach to determine adjustment • Gross Value – Hot Asset Sale Approach • Deemed distribution and sale back to PS • Deemed Gain Approach – • PS recognizes income and allocates to PNs with reduced interest in hot assets • Basis in hot assets adjusted for income recognized

  44. Issue 6 p. 422New Partnership Audit Rules • Partnership Audit History • Pre-TEFRA • Changes appealed at partner level • Varying results • Statute of limitations controlled @ PN • TEFRA (1982) • Changes appealed at partnership level • Statute of limitations controlled @ PS

  45. Issue 6 p. 423New Partnership Audit Rules • Small partnership – Pre-TEFRA procedures • 10 or fewer partners, no flow-thru partners • Can elect TEFRA – Form 8893 • TEFRA – Unified Audit Procedures • > 10 partners or any flow-thru partners • Changes made to PNs for year of PS audited • Electing large partnerships • Changes made to PNs in year of the audit

  46. Issue 6 p. 423New Partnership Audit Rules • Bipartisan Budget Act of 2015 (BBA) • Repealed TEFRA audit regime and electing large partnership audit procedures • Amended §§ 6221-6241 • Effective for tax years beginning > 12/31/2017 • Entity level audit rules apply to all PSs • Some qualify to elect out of the BBA rules • May elect BBA provisions to apply earlier

  47. Issue 6 p. 423New Partnership Audit Rules • Entity level audit will always apply to • PS with more than 100 partners • PS with either a trust or partnership as a PN • Counting partners • If S corp is a PN, all shareholders in the count • Example 12.19, Figure 12.14

  48. Issue 6 p. 424New Partnership Audit Rules • PS appoints a Partnership Representative • PR or P.REP • Only person who can represent the PS • Can bind all PNs for tax matters/adjustments at audit level and in judicial matters • Must be individual with substantial presence within the U.S. • Does not have to be a partner

  49. Issue 6 p. 424New Partnership Audit Rules • Notice of Administrative Proceeding to PR & PS • Conduct and complete audit • Notice of Proposed PS Adjustmt (PPA) to PR/PS • PS level assessment • Highest individual rate + • Interest factor (audit year to date of audit) • PR has options to reduce assessment

  50. Issue 6 p. 424New Partnership Audit Rules • PR options to reduce PS assessment – within 270 days of PPA • Request PNs amend, pay, provide proof • Provide summary of tax exempt PNs • Request change: C corp/lower income PNs, cap gain rate

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