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Check figures: S Corporations (2014 edition) 24. a. Book income Add: Long-term capital loss Deduct: Dividend revenue Tax-exempt interest revenue Sec. 1231 gain Recovery of bad debt* S-corp. taxable income b.

updated: October 29, 2013

$100,000 6,000 $106,000 $9,000 3,000 7,000 5,000

(24,000) $ 82,000

Billings share of S-corp. taxable income is $20,500 ($82,000 4).

*Note: The short-term capital loss, dividends received, tax-exempt interest, Sec. 1231 gain are reported as separately stated items. There is some uncertainty regarding the recovery of the bad debt. Treasury Reg. 1.702-1(a)(8)(i) includes the recovery of bad debt as a separately stated item, while IRS Publications list it as other income (part of ordinary S-corp. taxable income). 26. a. Sales Less: Cost of goods sold Gross profit Add: Sec. 1245 ordinary income Less: Administrative expenses MACRS depreciation S-corp. taxable income $100,000 (40,000) 60,000 25,000 5,000 10,000

(15,000) $ 70,000

b.

Separately stated items include: LTCG ($11,000); STCL ($6,000);, Sec. 1231 gain ($21,000), and charitable contributions ($4,500). AAA $ 2,000 2,000 $4,000 (4,000) $ 0 (10,000) ($10,000) Stock Basis $10,000 2,000 $12,000 (4,000) $ 8,000 (8,000) 2 $ 0 AEP $6,000 0 $6,000 1 (2,000) $4,000 No effect $4,000

27. Beginning balance LTCG Balance Distribution ($6,000) Balance Loss ($10,000) Ending balance Notes:
1 2

Taxable dividend $2,000 suspended loss; cannot have negative stock basis

30.

Tiger Corporation recognizes a long-term capital gain of $80,000 [$240,000 fair value) $160,000 (adjusted basis)] on the assumed sale of the appreciated property (as if the property is sold at its fair value). A $20,000 LTCG flows thru to each S shareholder ($80,000 x 25%). Davids stock basis is reduced to $50,000 [$270,000 (beginning basis) + $20,000 (capital gain) $240,000 (fair value of land)]. Davids adjusted basis in the land is $240,000 (fair value) and his holding period starts tomorrow.

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34. Beginning balance Tax-exempt interest revenue Life insurance proceeds Life insurance premiums Ending balance OAA 6,700 4,012 100,000 (3,007) 107,705

Note: The nondeductible penalty reduces AAA. 35. a. Ordinary S-corporation income Add separately stated items: Dividends received Tax-exempt interest Recovery of state taxes LTCG Less separately stated items: Charitable contributions LTCL STCL Book income b. and c. AAA 31,000 80,000 5,000 5,000 14,000 (6,000) (7,000) (6,000) 116,000 OAA Stock basis (40%) 32,000 32,000 1,200 2,000 2,000 5,600 9,000 (2,400) (2,800) (2,400) 76,200 $ 80,000 $ 5,000 3,000 5,000 14,000

27,000 $107,000

$ 6,000 7,000 6,000

(19,000) $ 88,000

Beginning balance Ordinary income Tax-exempt interest Dividend revenue Recovery of state taxes LTCG Additional investment Charitable contributions LTCL STCL Ending balance 36.

3,000

Money, Inc., recognizes a capital gain of $200,000 [$1M (fair value) $800,000 (basis)] on the distribution of the appreciated property (as if the securities are sold for their fair value). The capital gain ($200,000) and operating income ($100,000) both increase AAA. Each shareholder reports operating income of $50,000 and a capital gain of $100,000. Both items increase their stock basis. AAA $300,000 200,000 100,000 600,000 (300,000) (300,000) AE&P $600,000

Beginning balances Capital gain Operating income Balances before the distribution Tax-free distribution to shareholder 1 Tax free distribution to shareholder 2 Taxable dividend to shareholder 1 Taxable dividend to shareholder 2 Ending balances

600,000

$0

(200,000) (200,000) $200,000

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Each shareholder receives a distribution of $500,000 (1/2 the fair value of the securities). Each shareholder reports taxable dividend of $200,000 from AE&P and $300,000 tax-free distribution from AAA. Each shareholder s ending stock basis is $250,000. Basis $400,000 100,000 50,000 550,000 (300,000) $250,000

Beginning stock basis Capital gain Operating income Basis before the distribution Tax-free distribution from AAA Ending stock basis 37.

Money, Inc., recognizes a capital gain of $200,000 [$1M (fair value) $800,000 (basis)] on the distribution of the appreciated property (as if the securities are sold for their fair value). The capital gain ($200,000) and operating income ($100,000) both increase AAA. Each shareholder reports operating income of $50,000 and a capital gain of $100,000. Both items increase their stock basis. AAA $300,000 200,000 100,000 600,000 (200,000) (200,000) AE&P $600,000

Beginning balances Capital gain Operating income Balances before the distribution Tax-free distribution to shareholder 1 Tax free distribution to shareholder 2 Taxable dividend to shareholder 1 Taxable dividend to shareholder 2 Ending balances

600,000

$200,000

(300,000) (300,000) $0

Each shareholder receives a distribution of $500,000 (1/2 the fair value of the securities). Each shareholder reports taxable dividend of $300,000 from AE&P and $200,000 tax-free distribution from AAA. Each shareholder s ending stock basis is $350,000. Basis $400,000 100,000 50,000 $550,000 (200,000) $350,000

Beginning stock basis Capital gain Operating income Balance before the distribution Tax-free distribution to shareholder 1 Ending stock basis 40.

Whenever the S-corporation reports a net increase for the year, the taxpayer first restores note basis, then stock basis (Sec. 1367(b)(2)(B)). There is no net increase in the current year [$11,000 (income) $15,000(distribution)]. Therefore, Jeffs stock basis is increased by $11,000 and the corporations AAA is increased by $11,000. The $15,000 distribution is treated as $11,000 tax-free distribution from AAA and $4,000 capital gain. The adjusted basis in the stock and the note are still $0. Whenever the S-corporation reports a net increase for the year, the taxpayer first restores note basis, then stock basis (Sec. 1367(b)(2)(B)). Therefore, Jeffs note basis is increased by $10,000 to its original basis. Jeff recognizes no income when the corporation repays the $10,000 note under the recovery of capital doctrine. In this case, the loan basis is only restored to $8,000. Therefore, Jeff recognizes a $2,000 capital gain ($10,000 $8,000) when the corporation repays the $10,000 note. If no corporate note exists, Jeff recognizes $2,000 ordinary income.

41.

42.

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47.

Taxable income (less than net built-in gain) Less: NOL carryover Tax base Highest corporate tax rate BIG tax liability

$65,000 (8,000) $57,000 35% $19,950

48.

The excess net passive income (ENPI) is computed as follows: Passive income 25% GR Passive income [$390,000 (25% * $800,000)] $390,000 X Net Passive income

X ($390,000 $150,000)

Thus, the Sec. 1375 penalty tax is $40,923 (35% x $116,923) 49. The family is trying to lower their federal income tax and avoid paying payroll taxes on salaries. Without any salaries, the $180,000 ordinary S-corporation income is split equally between Bonnie, Clyde and their 13-year old daughter. However, under the kiddie tax, the daughters unearned income (her pro rata share of S corporation ordinary income) is taxed at the parents marginal rate. Therefore, there is no Federal income tax savings under this plan. The family is avoiding payroll taxes. Additionally, the ordinary S-corporation income is not subject to self-employment taxes. With the reasonable salaries proposed (required) by the IRS agent, Bonnie, Clyde, and their 13-year old daughter will be subject to payroll taxes. The corporation will also have to pay the employers share of the payroll taxes. The salary payment to the daughter results in an increase in her earned income and a decrease in her unearned income. This would result in a reduction in the amount of income subject to the kiddie tax. This would reduce the familys Federal income tax burden. 50. Key elements of the tax memo include: liquidation of an S-corp. follows the C-corp. rules. if the assets are sold, both gains and losses are recognized by the S-corp. if the assets are distributed to shareholders, both gains and losses are recognized by the S-corp. as if the property is sold at its fair value. Exceptions: distribution to a related party & the distribution is not pro-rata property has a built-in loss

the S-corp. incurs no corporate-level tax, the recognized gains (losses) flow-thru to the shareholders.

52.

The reduced salary will save Blue and the corporation $9,180 in payroll taxes [$60,000 (reduced salary)15.3% (FICA rate)]. Pete can deduct $6,020 of his share of the S-corporations loss in 2013 ($43,000 x 25% = $10,750). The remainder ($4,730) is suspended under the basis limitations. The 2012 NOL of $74,000 is trapped inside the C-corporation. It can be used in the BIG tax computation.

53.