Advanced Taxation Midterm

Tax Planning Strategy Types=

Timing, income shifting, Conversion

Timing Tax Planning Strategy

A dollar today is worth more than a dollar in the future-
***All Else equal- take deductions as early as early as possible and push income as far to the future as possible- accelerate deductions, defer income

Limitations-

Deductions usually can’t be accelerated without cash outflow accelerating, and have to continue investment to defer income most times

Constructive receipt- taxpayer must recognize income when it’s actually/constructively received

Tax Rate Changes- If tax rates change in the future- make sure to take that into consideration

Look at what would happen in each situation

Income Shifting Tax Planning Strategies

Transactions between family members- children generally have lower marginal tax rates- if you shift income to them- taxed at lower rate

Transactions between owner and business- if business can get a deduction for income shifted it allows the owner to avoid double tax

Shifting between countries or states

Judicial doctrines limit some income shifting strategies

Have to actually give up the income source for it to be shifted

Conversion Tax Planning Strategy

Tax rates can vary across different activities-

Ordinary income taxed at ordinary rates, LT capital gain taxed at preferred rates, some income is tax-exempt

Limitations- Judicial doctrines like business purpose, step transactions and substance over form- limit use of conversion

Lots of provisions to prevent changing nature

Judicial doctrines that get in the way of tax planning

Assignment of income- Requires income to be taxed to taxpayer who actually earns the income

Related party transactions- highly scrutinized because often not arms-length

Business Purpose doctrine- IRS can disallow business expenses for transactions that don’t have a business purpose

Step-transaction- IRS can collapse a series of transactions into one to determine tax liability

Substance over form- IRS can consider the substance of the transaction rather than the form of it

Legal vs tax classification

Legal- generally ahve to legally set up the entity, Corp (S corp and Corp_, LLC (can be taxed as anything), Limited Partnership vs General partnership (both taxed as Ptship_

Unincorporated Entities (non Corporate companies)

Taxed as partnerships if they have more than one owner, taxed as sole proprietorships if held by individual or as disregarded entities if held by some other entity, may elect to be treated as taxable corps

Flow through tax entities

Entity does not pay taxes

Owners pay income tax generally at ordinary rates

Other taxes may apply to an owner’s share of ordinary income

QBI Deduction for Owners of Flow Through entities

Applies to individual taxpayers with Qualified Business Income from Flow through entities (Ptsps, S corps, sole proprietorships),

** in general-taxpayer can deduct 20% of “Qualified Business income” allocated to them from the entity

**Essentially reduces the rate for flow through income, making it so pass through got a rate decrease similar to the 21% for corps

FICA and Self-Employment Tax

Owners of business entities may provide services to the entity for compensation.

Usually employee & shareholders pay 7.65% FICA tax on salary, so since not paid in passthrough- pay 15.3% Self Employment tax on compensation

**Guaranteed payments- ptsp- subject to SE tax, Business income to General partner- SE income, Business income to limited partner- Not SE income. Business income to LLC member- depends on how involved in business- more involved- SE income, not involved- not SE income,

S corp salaries- Not SE

You deduct the employer portion of SE income, so multiply income by 92.35% when finding the SE tax

Double Taxation

Income from flow through entities is only taxed once, income from taxable corporations is taxed twice

Flow through entity owners pay tax on their share of income as if they earned it themselves

Corps pay first level of tax on their taxable income at the corporate marginal tax rate

Current marg. tax rate- 21%

Shareholders are subject to double taxation when second level of tax is paid when dividend is received or shares are sold

Capital gains rates

max 20%, can be 0/15/20 depending on income bracket

Dividends received Deduction (DRD)

Can be claimed for dividends when a corporation is a shareholder- this is to prevent a third level of tax.

DRD percentage is 50,65 or 100% of dividend received depending on extent or corp’s ownership in the dividend paying corp.

Accounting Periods- Flexibility in choice between entities

S corps generally required to adopt calendar year end (unless business reason otherwise)

Partnerships- required to adopt year end consistent with year ends of partners

Sole proprietorships= adopt the same year end as individual proprietor

C Corps- flexible

Accounting methods between entities

Cash method of accounting gives more opportunity to defer income or accelerate deductions

Taxable corps are generally required to use accrual method of accounting

S corps- can choose cash or accrual

Partnerships- generally may use cash or accrual

C corp carry forward

Net operating loss (NOL) generated after 2020- no carryback, carry forward indefinitely, NOL limited to 80% taxable income in carryforward yrs.

NOL before 2018- carryback 2 yrs, carry forward upt to 20 yrs, NOL not limited to % of taxable income

NOL From 2018-2020- 5 yr carryback, carry forward indefinitely, NOL not limited to 80% of taxable income in carryback yrs. can elect to forego carryback

Disregarded Entity

consider an entity to be the same entity as the owner- generally if just one owner and it’s a corporation

How an entity is taxed

If corp- auto C corp, elect S corp. If not corp- 2+ owners- Ptsp, 1 owner (person)-sole prop., 1 owner (company)- disregarded ent.

Startup losses

Don’t flow to C Corp owners, can to Flowthrough owners

Normal transaction for stock in company

Without tax provision to contrary, transfers of property to corp in return for corp’s stock would be taxable if property was appreciated or depreciated

Gain/loss to transferor-

FMV of Stock received- Basis of property transferred= +gain/-loss

Loss disallowed if transferor is related to the corp (owns more than 50% after transfer)

Section 351- Allows for DEFERRAL of gain/loss when forming a company

Gain/Loss REALIZED in Property Transaction

Gain/loss Realized= Amount Realized (received)- Adjusted Tax Basis of Property Transferred

Amount Realized = Cash received + FMV of other property received+ Liabilities assumed by Transferee on transferred property - Selling expenses incurred in transaction- Liabilities assumed by transferor on any property received in exchange

Finding a property’s tax basis before contribution

Acquisition basis+capital improvements- depreciation

Transaction subject to 351 deferral (tax deferrral)

Only for transfer of PROPERTY to a C Corp- Services are excluded

Property Transferred to corp must be exchanged solely for stock

Receipt of boot will cause transferor to recognize gain (but not loss) recognized on exchange

Boot- adding additional property to equalize the exchange

****Transferor(s) of property to the corp must be in control in aggregate of the corporation immediately after transfer

Control for SEction 351

Ownership of 80% or more of corp’s voting stock And each class of Nonvoting stock

Stock received in exchange for services can be counted in the control test IF the transferor also receives stock in exchange for property with a FMV of 10% or more of services rendered

Tax Basis of Stock Received in a tax-deferred Section 351 transaction

Cash contributed+ Tax Basis of other property contributed - Liabilities assumed by the corporation on property contributed

When a shareholder receives other property(boot)

Shareholder recognizes gain NOT LOSS in an amount not to exceed lesser of

• gain realized

• FMV of boot received

Boot is allocated to the property exchanged on a pro rata basis using relative FMV of the properties- impacts character of the gain recognized by shareholder

Character of gain recognized depends on nature of asset transferred on which gain is recognized

Boot received has a tax basis equal to its FMV

Tax Basis of Stock when Boot is Received

Cash contributed + Tax Basis of Other Property Contributed + Gain Recognized on Transfer - FMV of boot received - Liabilities assumed by the corp on property contriubuted

Assumption of Shareholder Liability by corp

General rule- shareholder’s liability attached to property transferred- not treated as boot received

Exception- Tax avoidance transactions- all treated as boot

**Liabilities in excess of aggregate tax basis of property contributed

Tax basis of property received by the corp in a section 351 transaction

Cash contributed by shareholder+ Tax basis of other property contributed by shareholder+ Gain recognized on transfer by shareholder

Why don’t you want to transfer appreciated property to a corp?

Shareholder creates 2 assets with the same built in gain as the orignal property, so the federal government now collects taxes twice on the same gain- when the corp sells the property received and when the shareholder sells the stock

Section 1244 Stock

Corporation is Qualifying Small business Corp (capitalized for less than $1 million) AND Original holder of the stock

Corp must meet the aactive trade or business requirement for 5 years before the stock meets the 1244 requirements

IF requirements are met-

Shareholder can recognize up to $50,000 per year of loss ($100,000 for MFJ) on subsequent sale of stock as an ORDINARY Loss rather than capital loss.

Balance amount of loss is treated as CAPITAL Loss, which can offset other capital gains plus $3000 of ordinary income

Complete Liquidation of a Corp

When Corp Acquires all of its stock from its shareholders in exchange for “all” of its net assets after which time the corp ceases to do business

Form 966 needs to be filed by corp in order to inform IRS of intent to liquidate

Should be filed within 30 days after owners resolve to liquidate

Tax consequences to Shareholders in complete liquidation

Depends on shareholder’s identity, ownership percentage in the corporation

All non-corporate shareholders receiving liquidating distributions have a full taxable transaction

Shareholders treat property received as in full payment in exchange for stock transferred

Non corporate shareholder computes capital gain/loss by subtracting stock tax basis from money & FMV of property received

Corporate Shareholders in liquidation of Corp

Corp shareholders owning 80% or more of the stock don’t recognize gain/loss on receipt of distributions

This allows them to reorganize org structure without tax consequences

Taxable Liquidating Distributions

Liquidating corp recognizes all Gains adc Certain losses on taxable distributions of property to shareholders.

(for appreciated property distributed)

Don’t recognize loss if the property is-

Distributed to Related party AND

Either Distribution to SH is non-pro rata OR asset distributed is disqualified property (acquired within 5 yrs of date of distribution in tax deferred 351 transaction)

second one prevents you from dumping in property with built in loss to double recognize it

Nontaxable Liquidating Distributions

Liquidating Corp doesn’t recognize gain/loss on tax free distributions of property to an 80% corp. SH

Liquidating corp recognizes gain but not loss on distr. to minority SH

Liquidation related expenses are deductible by liquidating corp

Deferred or capitalized expenditures are deductible

Basic tax effects of distributions for C corp shareholders

Portion of distribution that is a dividend- included in gross income

Portion of distribution not a dividend- Reduces Shareholder’s Tax Basis

Portion of distribution not a dividend in excess of stock basis- Treated as a capital Gain

Definition of a dividend

Any distribution of property made by a corp to shareholders out of its ****Earnings and Profit (E&P) account.

Two Separate E&P Accounts to be maintained-

Current E&P, Accumulated E&P

Current E&P not distributed to SH is added to accumulated E&P at beginning of next taxable yrC

Computing E&P

Begins with Taxable income/loss, then make adjustments- Inclusion of income excluded from taxable income, disallowance of certain expenses that are deducted in computing taxable income but don’t require economic outflow, deduction of certain expenses excluded from taxable income but that DO require economic outflow, deferral of deduction/acceleration of income due to separate accounting methods used for E&P

Additions to E&P not included in taxable income and deductions that are not included

exclusions from income- tax exempt bond int, life insurance proceeds, federal tax refunds.

Deductions for tax but not e&P- dividends received deduction

NOL deduciton carryback/forward, Net capital loss carryback/fwd, contribution carryforwards

Income deferred for Tax purposes but not e&P

deferred gain on installment sales

deferred gain on completed contract method of accounting

increase in cash surrender value of corporate owned life ins. policies

Deductions Deferred for E&P purposes (add back)

regular tax depr. in excess of e&P depr.

Percentage depletion in excess of cost depletion, capitalized contstruction period int. taxes and carrying charges

You get the picture

Deductions allowed for E&P but not tax

federal income taxes paid/accrued

expenses of earning tax exempt income

charity

nondeductible life ins. policy premiums

penalties and fines, entertainment, lobbying, lifo recapture, etc

Distribution of Noncash property to Shareholder - c corp

Money received+ FMV Of other property received- liabilities assumed by shareholder on property received

If Accumulated and Current E&P are the same

Both positive- Dividend income to the extent of current E&P and balance of accumulated E&P

Negative- Distributions are just return of capital/or capital gain

If accumulated and current E&P are different

Current positive, acc. negative- Distributions are dividend income **TO THE EXTENT OF CURRENT E&P

Current Negative, Accumulated Positive- ***Look at the date of the DISTRIBUTION- pro rate the yearly amount to find how much negative happend to that point in year, then net it against accumulated E&P and use that amount to determine dividend amount

Finding Accumulated E&P after a distribution

Accumulated E&P beginning of the year ± Current E&P - dividend paid

Distribution of Noncash Property to SH- Consequenct to Corp making dist

Taxable Gains (not losses) are recognized by a corp on the distribution of noncash property as a dividend

Corp recognizes a taxable gain on the distribution to the extent the FMV of property distributed as a dividend exceeds the corps’s tax basis in the property

If the FMV of the property distributed is less than the corp’s tax basis in the prop, the corp doesn’t recognize a deductible loss

Liabilities-

If property’s FMV is less tahn amount of liability assumed ,the property’s FMV is deemd to be the amount of the liability assumed by the shareholder. IF liability assumed is less than property’s FMV gain recognized on distribution is Excess of property’s FMV over Tax basis

Effect of Noncash Prop Distribution on E&P

E&P is reduced by distributions as Follows-

Cash distributed, E&P BASIS of noncash unappreciated property (FMV <= E&P Basis), FMV of noncash appreciated property, noncash property distributions are reduced by any liabilities assumed by the SH on property received. E&P Reductions for distributions can’t cause E&P to drop below zero

Stock Dividend

Increases the number of shares outstanding- reduces the value/price of the share.

Usually a stock split- 2 for 1 stock dividend

tax consequences-

Stock dividends generally do not provide shareholders any increase in value

To be nontaxable need to-

1. Be made with respect to corp’s common stock

2. Must be pro rata with respect to all shareholders

Adjsuted basis of New stock= FMV of stock received * Adjusted basis of Old stock/Total FMV of all stock

Non pro rata stock dividends usually are taxable as dividends

Stock Redemption

An acquisition by a corp of its stock from shareholder in exchange for property, whether or not the stock so acquired is canceled, retired, or held as treasury stock

Shareholder exchanges stock in corp for property-usually cash

Without restriction could get around dividends with this

Stock Redemptions that are substantially disproportionate with respect to the shareholder

3 stock ownership tests to be met

Immediately after exchange, shareholder owns less than 50% of total combined voting power of all classes of stock entitled to vote

Shareholder’s percentage ownership of voting stock after redemption is less than 80% of their ownership before redemption

Shareholder’s percentage ownership of aggregate FMV of corp’s common stock after redemption is less than 80% of their ownership before redemption

ATTRIBUTION-

Remember to include option attribution, attribution from owners to entities or other way around and FAMILY- specifically Parents, spouse, children, grandchildren (siblings NOT FAMILY)

****REMEMBER**** When doing these tests CHANGE THE DENOMINATOR finding 80% of the ownership percentage NOT 80% of the number of shares

Redemptions in Complete Termination of All Stock of corp owned by shareholder

Complete termination test

Redemptions that are not essentially equivalent to a divident

Complete Termination Test

Triple I agreement- An individual can make an agreement with the IRS to say they won’t own any shares in the company for a certain amount of time when getting rid of all their shares.

Makes it so you don’t count family ownership anymore- allows them to treat their sale as an exchange rather than a dividend

**can’t be actively involved in the compnay at all- if you have a triple i agreeemtn but are still involved, it would just count as a dividend- you can only be a creditor- nothing else

Redemptions taht are not essentially equivalent to a dividend

Treated as an exchange- last resort if you don’t meet the other 2

generally someone with marginal ownership sells some of their stock- allows them to treat as an exchange

Tax consequences to SH if treated as Exchange

Gain is ALWAYS RECOGNIZED

Loss- Recognized unless the SH is a related person to the corp (owns 50% of stock’s VALUE

Consider Attribution rules (family, etc)

Family attribution now includes taxpayer’s brothers, sisters, ancestors, etc

Basis of property received is FMV

Tax Consequences to the Corp if treated as exchange

If Shareholder treats redemption as dividend- corporation reduces E&P By cash Distributed + FMV other property dist.

If SH treats red. as exchange- corp reduces E&P at date of distribution by % of stock redeemed- not to exceed FMV of property distributed

Reduces E&P by any dividend distributions made during the year before reducing E&P for redemptions treated as exchange

A corp cannot deduct expenses incurred in stock redemption

Partial Liquidations

Corps can contract their ops by either distributing the sotck of a subsidiary to shareholders or by selling the business

A corp may distribute the proceeds from the sale to its SH in partial liquidation of their ownership interests

Distribution may require SH to tender shares of stock back to corp or may be Pro Rata to all SH without actual exchange.

Tax treatment depends on identity of SH receiving distr.

**Corp SH- determine tax consequences using change in stock ownership rules that apply to stock redemptions

Non corp SH- get exchange treatment

If you give up shares but its treated as dividend

allocate the basis of those shares to the remaining shares- total basis remains the same

Entering Partnership through Contribution of Services

Capital interest represents a current economic entitlement

**Service Partners Receiving Capital Interests Report ORDINARY income

Service partner’s tax basis in cap interest= amount of ordinary income recognized

Profits interest-

No liquidation value, so don’t recognize income. Non service partners don’t get deduction

Purchase interest

Tax Basis of Purchased partnership interest= Purchase price + Ptsp debt Allocated to partner. Holding period begins on purchase date

***Keep sthe same debt allocation and capital % as previous partner

Organization, start up and syndication costs

Some costs are capitalized rather than expensed at start up- syndication costs are not capitalized

Entering ptsp through cont. property

outside basis= basis of contributed property- debt relief+debt allocation +gain recognized

Holding period- if property contributed is a 1231 asset- holding period includes HP of contributed property- otherwise begins on date int received.

Entering ptsp throgh cont services

Outside basis= basis of contributed property + debt allocation. Equals debt allocation if only given profits interest

Holding period- begins on date int received

Gain/Loss Recognized on partnership formation

General rule- don’t recognize gain/loss

Exception- If property contributed basis< debt attached to it.

Gain recognized- if you end up with negative number for basis after allocating the debt. Amount recognized = difference between negative amount and 0

Nonrecourse debt-not possible

recourse debt- possible

Allocating Debt to Partners

2 types of debt-

Recourse debt- lender could come after partner and partner would be required to pay if ptsp/ other ptnrs don’t pay debt

**Recourse debt- Allocated to ptnr with ultimate responsibility for paying liabilitiy

Nonrecourse debt- No partner is legally liable (ex LLC)

ALlocate nonrecourse debt by PROFIT sharing Percentage

Determining A partnership’s Year end

1. If multiple ptnrs with same year end own majority- use that

2. Do all principal partners have the same tax year? IF so use that. Principal ptnrs- ptnrs with 5% or more capital/profits interest

3. If not, ptsp uses tax year with least aggregate deferral (don’t have to do test- just know to do it)

What happens if service partner receives capital interest

service partner recognizes ordinary income,

Other partners will ahve a deduction because their capital interest percentage in the partnership is reduced

What is the nature of gain/loss from sale of partnership interest

Capital Gain/loss

Partnership’s Inside basis in property contributed

Partnership takes a carryover basis in property contributed- no adjustment for gain recognized or anything

Holding period carries over

Partnership accounting Method

Ptsps are generally eligible to use cash method unless avg gross receipts >$29M and have corporate partners

If no corporate ptnrs- doesn’t matter how big you are

Separately Stated Items vs Ordinary Business Income/Loss

Like on K1- Ordinary inc is all items except separately stated.

separately stated- items that are taxed differently than ordinary income

Common separately stated items- interest inc, guaranteed pmts, net earning/loss from SE, tax-exempt inc., rental/real estat inc., investment int. exp., 179 deduction

Guaranteed Payments

Fixed amounts paid to ptnrs regardless of profit/loss earned by ptsp.

Treated as ordinary income by ptnr receiving. Generally deducted in computing ptsp’s ordinary income/loss for year

separately stated to ptnr receiving them

LLC members classification as general partner for SE tax

Members with personal liabilities for debts of llc by reason of being an llc member, authority to contract on behalf of llc or participated in >500 hrs of llc trade/business

Adjustments to Partnership interest Annually

In this order-

Increase for actual/deemed cash contributions to partnership during year

Increase for partner’s share of ordinary business income AND separately stated income/gain items AND TAX-EXEMPT income

Decrease for Actual and Deemed cash distributions Decrease for partner’s share of NONdeductible expenses (fines, penalties, etc), ordinary business los and separately stated expense/loss

Cash Distributions in operating partnership

Partners are taxed on income when ptsp earns it, but NOT When distributed

If cash is distributed when ptnr has a positive tax basis in ptsp int, the distribution represents-

Distribution of profits that have been previously taxed, return of capital previously contributed or distribution of cash the ptsp ahs borrowed (or some combination)

Cash distributions in EXCESS of partner’s basis are taxable and are treated as capital gains

Debt Relief from partner to parntership

Treated as a distribution***** Debt lowering will decrease the basis

Loss Limitation for partnerships

Operating losses can generate current tax benefits when partners can deduct them against other sources of taxable income- losses are deductible only when they clear 3 hurdles- (I think its 4 but idk)

Tax Basis

At risk amount

Passive activity loss hurdles

Excess Business losss limitation

Can’t deduct more than what passes through from the prior limit

Tax Basis limitation- Loss limitation- ptsp

Partner’s basis represents the amount a partner has invested in a ptsp or may have to invest to satisfy their debt obligations. Partners can’t utulize partnership losses in excess of their outside basis in partnerhsip interests.

Losses allocated in excess of basis must be suspended and carried forward indefinitely until partners have sufficient basis to utilize losses

Partners can create additional tax basis by making capital contributions

At-risk limitation- loss limitation- ptsp

More restrictive when compared to tax basis limitation

Limit’s partner’s losses to their AT RISK amount

Can’t include non-recourse debt unless specifically liable because real estate mortgage called qualified nonrecourse financing

At risk amount- Amount equal to cash and tax basis of property contributed to partnership AND Recourse debt and qualified nonrecourse financing allocated to them

Passive activity loss limitation - Partnership

Limits ability of partners in rental real estate partnership/other ptspss that they don’t actively manage from using their ordinary loss to reduce other sources of taxable income

Passive activity- activity which involves the conduct of a trade or business, and in which the taxpayer does not “materially participate”

Excess Business Loss Limitation

Applies to Active trade or business losses remaining after prior 3 limitations

Can’t deduct “Net business losses in excess of threshold amounts-

Single $270,000 , MFJ- $540,000

Can net active trade/business loss with other active trade or business income sources

Disallowed loss is carried forward as NOL- can offset up to 80% of taxable income in future yrs

Partnership Operating vs liquidating distribution

Operating- routine distribuiton to partner- ownership stays the same

Liquidating- giving up some of the ownership- possibly all

Seller Issues in Sale of Partnership Interest

Primary tax concern is calculating the amount and character of gain/loss on the sale

Selling partner determines gain/ loss as the difference between amount realized and their outside basis

Hot assets- Unrealized Receivables include the right to receive payments for goods delivered or to be deliverred, services rendered or to be rendered

Hot Assets

Cash method taxpayers- unrealized receivables include amounts earned but not received/recognized

for accrual- accounts receivable are not considered because they already realized and recognized as ordinary income

Inventory items- classic inventory (property held for sale to customers in ordinary course of business) Inventory also includes any assets that are NOT capital or 1231 assets

Sellers issues- sale of ptsp int- HOT ASSETS

process for determining gain/loss

1. total gain/loss= amount realized- Outside basis

2. Calculate partners share of gain/loss from hot assets as if the partnership sold those assets at FMV. Represents ORDINARY gain/loss

3. Capital gain/loss= step1 - step 2

Buyer' and Partnership issues- sales of partnership interests

New investor’s outside basis= cost of ptsp interest

share of ptsp liabilities increases outside basis

Varying interest rule- partner’s interest increase contributing property to partnership, decrease when they receive partnership distributions or sell all/portion of ptsp interests

Two methods for allocating income/loss ot ptnrs when interests change-

Allows the ptsp to prorate income or loss to partners with varying interests

Sanctions an interim closign of partnership books

Operating Distributions Ptsp

Usually paid to distribute business profits to the partners but can also reduce a partner’s ownership

Could be money only

Could include property other than money

Operating Distributions of Money only

Ptnrs generally DO NOT recognize gain/loss on distribution of property/money

One exception is when the distribution is greater than the partner’s outside basis. Partner will recognize capital gain in this case

*Partner simply reduces their outside basis in ptsp int by the amount of the distribution

Ptsp’s basis in remaining assets remains unchanged

Partner never recognizes a loss from an operating distribution

Operating Distributions that include property other than money

Partners must reallocate their outside basis to distributed assets- including money- and their continuing ptsp interest

Carryover basis- Partner takes a basis in distributed property equal to the partnership basis in the property

Order in which to allocate outside basis to bases-

First Money, then outside basis after distribution, then remainder is outside basis

When PTsp distributes property other tahn money with basis taht EXCEEDS remaining outside basis, the partner assigns remaining outside basis to distributed assets, and the partner’s outside basis is reduced to zero

Liquidating Distributions

issues- to determine whether terminating partner recognizes Gain or Loss and

Reallocate their entire outside basis to distributed assets

Rationale behind rules- simply to replace outside basis with underlying partnership assets distributed to terminating partner

In theory- no gain/loss, and carryover basis

Gain/loss recognition on Liquidating Distributions

General rule-- no gain/loss recognized, and carryover basis

Exception- If partner receives cash/cash equivalents that exceed partner’s outside basis hten recognize capital gain

***DEBT RELIEF IS CONSIDERED THE SAME AS RECEIVING CASH

Loss- Partner recognizes loss when 2 conditions are met- Distributions consist of ONLY CASH AND HOT ASSETS and Partner’s outside basis exceeds the sum of bases of distributed assets- Capital loss recognized

If receiving “cold/other” assets- no loss recognized

Allocating basis to distribution property- liquidating distr.

1. Start with cash-

Reduce basis by cash received

2. Then Hot assets-

**Give hot assets the same basis they had inside the partnership, if outside basis is smaller- decrease the basis of the hot assets.

***Never assign a higher basis to the hot assets- can only keep the same or reduce.

3. Then other property, "cold" assets-

Assign whatever is leftover in the basis to the "cold" assets

Don't worry about the basis it held inside the ptsp

 

Character and holding period of distributed assets in liquidating distribution

Generally character stays same to partner as it was in Ptsp

**Inventory retains the "Taint" of Ordinary income for five years after distribution--

****If you sell a hot asset within 5 years of distribution, the gain/loss recognized is ordinary income***

Prevents people from "cleaning" their assets and making them capital assets by just doing a liquidating distribution

Partner's holding period includes the Partnership's holding period

S corp Elections

Formation- Same as C corp- 351

Qualification requirements- Have to make an actual election, be a legal corp

Limit 100 Shareholders (families count as same shareholder if you have a common ancestor going back 6 generations)

type of shareholder- have to be US Resident or Citizen- no nonresident

Can NOT have a Corporation SH

Can only have 1 class of stock- voting differences ok within classes

Filing S Corp Election & Timing

Need 100% of SH to agree to elect to be S corp- even 1 dissenter makes invalid

If electing 2.5 months or earlier in yr- counts as S corp for entire year

If Past 2.5 month into yr- counts as S corp NEXT year- C corp this yr.

***IF you elect in the right window but didn’t meet the requirements for the entire year- have to wait until next year

**Anyone who was a shareholder during the year needs to consent even if they aren’t anymore on date of election-

S corp terminations

Voluntary Terminations- Elected by Shareholders with >50% stock. Effective Date- same as elections- before March 15 (2.5 months in)

Involuntary-If you fail to meet S corp requirements in any way s corp terminates

Timing- happens on the DAY you failed to meet S corp requirements- split tax yr between s and c corp

passive investment income in excess of 25% of gross receipts for 3 yrs

restricted to S corps with E&P- if lots of passive income from time they wre a C corp

Involuntarily terminates s corp if happens for 3 years-

Timing- beginning of next year***

S corp accounting period and methods

Elected at entity level, methods carryover from c corp years, may choose cash, accural or hybrid

****must use CALENDAR year end unless establish business purpose otherwise

S corp income and loss allocation

Allocate profit and lsos pro rate ******BASED ON SHARES OWNED EACH DAY OF THE YEAR

If sell shares during year- pro rata, per day allocation

If all shareholders with changing ownership percentages agree- S corp can use normal accounting rules to allocate income and loss to the SPECIFIC PERIODS in which realized income/loss