s corporation –partnership basis - · pdf filedifferent passive loss rules –irc...

S Corporation –Partnership Basis

Vicki H. Meyer CPA

Thomas Howell Ferguson, PA

[email protected] 850-668-8100

WHY

MECHANICS

STRATEGIES

FIRM RISK

What Basis Does …What Basis Does …What Basis Does …What Basis Does …

�Limits the amount of loss that can be deducted.

�Determines gain or loss on disposal.

�Determines the amount of tax-free distributions that can be received.

�For a partnership, may determine allocation of income and deductions among the partners.

Why all this headache?Why all this headache?Why all this headache?Why all this headache?

Liabilities

State Law

Tax Savings

LossLossLossLoss Limitations Limitations Limitations Limitations

A taxpayer can never deduct more than the amount that flows through from the prior limit.

BASIS

AT RISK

PAL

Deduction

Bucket O’ Loss

Basis – At Risk – Passive Loss Rules

ALL DIFFERENT

� Different basis rules - IRC Sec. 704(d) and 1361.

� Different at risk rules – IRC Sec. 465 Similar to basis, but disallows certain related party liabilities. Liabilities and related parties are defined differently, therefore different results.

� Different passive loss rules – IRC Sec. 469 . Material participation. Defined differently depending on state law treatment of LPs and LLCs.

S CorporationsS CorporationsS CorporationsS Corporations PartnershipsPartnershipsPartnershipsPartnerships

� Not technically considered basis but a device that can offset losses.

�Only direct loans, no guarantees.

� Special rules on open account debt.

� General partners and LLP holders get basis in recourse loans.

� Other partners can have basis with deficit. restoration obligations (DROs).

� Special rules for nonrecourse loans.

Liabilities

Back to back loans� This approach is termed a back-to-back loan, which in the S corporation context has caused some tax uncertainty. In a back-to-back

loan, a shareholder borrows the funds and then lends them to the S corporation. A number of courts have approved back-to-back loan arrangements where the loans are valid debt and the shareholder documents them appropriately and makes payments in a manner that is consistent with the loan documents. Therefore, if A had borrowed the funds from a bank, had documented the loan from the bank and the loan to B Inc. appropriately, and all payments were made in accordance with the loan documents (i.e., from BInc. to A and from A to the bank), it is likely (although not certain) that under current case law A would have debt basis in her loan to the S corporation.

� For example, in Raynor, the court allowed the shareholder basis for borrowed funds that the shareholder then lent to the S corporation. In Gilday,30 the shareholder obtained basis when he exchanged his note for the S corporation’s note with the lender bank. Nevertheless, the IRS has successfully attacked back-to-back loans in certain circumstances. The courts have found that a shareholder cannot claim basis credit where there is no actual economic outlay. This is most frequently the case where there arerelated-party debt restructurings that the taxpayer intends to create basis and where the form of the transactions is not consistent with the substance the taxpayer claims.31

� Restructuring existing debt increases the risk that the shareholders’ new debt basis will not be respected under Sec. 1366(d). In Oren,32 the court did not accept a circular flow of cash that the taxpayers intended to create basis because no one’s economic positionwas changed in the process.33 In Kaplan,34 the taxpayers accomplished the circular cash flow with a third-party bank, and the court disregarded the restructured loans. In Kerzner, however, the shareholder borrowed from a bank and contributed the proceeds to the S corporation, which then paid the proceeds to related entities, and the related entities lent the proceeds to the shareholder to repay the original bank loan.

� Thus, the story of basis comes full circle. Properly structured, the cost basis in the land (partially funded by debt) can be reflected in A’s S corporation basis (also partially attributable to debt). However, as was previously noted, basis can be elusive and can disappear if not carefully watched.

Open account loans

� Can be netted if less than 25K

� If net of advances and repayments, is more than $25,000 at the close of the S corporation's tax year, then beginning with the next tax year, the principal amount of the open account debt is no longer considered to be open account debt. Rather, it is treated as if it were indebtedness evidenced by a separate written instrument for purposes of the debt basis rules.

Must be real stock or debt…� The shareholder must experience an actual economic outlay to acquire stock or debt basis. This means that, before basis can be increased, “there must have occurred some transaction which when fully consummated left the taxpayer poorer in a material sense” (Rev. Rul. 81-187;

� Giving only a note to the corporation or subscribing for more stock without making payment does not increase basis.( Silverstein).

� The partner's basis generally is increased only as the contribution obligation is fulfilled (Rev. Rul. 80-235and Oden).

Ba

sis

Ca

lcu

lati

on

S CorporationS CorporationS CorporationS Corporation PartnershipPartnershipPartnershipPartnership

� BOY� Capital contributions� Income and gain items� Less distributions� Loss and deduction items not to exceed income

� EOY (cannot be below zero).

� BOY

� Capital contributions

� Income and gain items

� Increase in liabilities

� Less distributions

� Decrease in Liabilities

� Loss and deduction items

� EOY

Initial Basis if Purchased:


� Cost of the shares. � Carryover of selling partner's tax-basis capital account (inside basis) plus

� FMV difference (outside basis).

Co

ntr

ibu

tio

ns

Partnership Basis Accounts

Inside Basis

Outside

BasisEconomic

Basis

Inside and OutsideS CorporationsS CorporationsS CorporationsS Corporations PartnershipPartnershipPartnershipPartnership

� Just one basis. (Even though debt can be used to absorb losses after stock basis is reduced to zero.)

� Cannot amortize through current deductions the increase attributable to FMV over basis to the corporation.

� Inside basis carries over to new partner.

� Outside basis can be brought inside with Sec 754 and deducted. Large negative adjustments are required.

Initial capitalization with property

S CorporationsS CorporationsS CorporationsS Corporations

�Must have >80% ownership to be tax free.

� Possible gain if liabilities are in excess of basis (IRC Sec. 357).

� Do not have to keep track of built in gain.

� No disguised sale rules.

Co

ntr

ibu

tio

ns

Contributions - Initial capitalization

with property

PartnershipsPartnershipsPartnershipsPartnerships

� Can have any ownership and be tax free.

� Typically no gain if liabilities exceed basis.

� Do have to keep track of built in gain IRC 704(c).

� Disguised sale rules if distributed within 2 yrs.C

on

trib

uti

on

s

Basis acquired by Gift


� Donor's basis

� Plus Gift tax attributable

� Limited to FMV for Loss Purposes.

� The transferee partner assumes the transferor's tax-basis capital account.

� Section 754 basis adjustments, mandatory for large built in losses.

Co

ntr

ibu

tio

ns

Basis acquired by Inheritance


� FMV at date of death � The transferee partner assumes the transferor's tax-basis capital account.

� Section 754 basis adjustments, mandatory for large built in losses.

Co

ntr

ibu

tio

ns

Basis acquired for services


� Stock’s FMV rather than FMV of services

� Liquidation value of the capital interest received.

� Future profits in exchange for contributing services is generally not a taxable event.

Co

ntr

ibu

tio

ns

Conversion from a C Corp


� C corporation electing S status. Initial basis in S stock is the basis in C stock at the time of conversion. Some immediate tax (LIFO reserves) but typically built in gains can be deferre.)

� Considered a taxable liquidation followed by a contribution of net assets to the partnership.

Co

ntr

ibu

tio

ns

Income and Gain Items


� Includes page 1 and separately stated items on K-1

� Tax Exempt Income-increase basis.

� Special depletion rules.

� Same

Ne

t in

com

e

Increases in Liabilities


�Only increases in direct loans, not entity loans.

� Increases in liabilities as determined under IRC Sec. 752, based on a zero value liquidation, who would perform on the debt.

Distributions S CorporationsS CorporationsS CorporationsS Corporations

PartnershipsPartnershipsPartnershipsPartnerships

� Cannot be disproportionate (second class of stock rules).

� Taken into effect at the end of the year.

� Should not be “draws” but follow corporate form,

� Can be disproportionate.

� Reduce basis for a distribution made on the date it is made

� If nonliquidating, can be EOY to the extent of the parnter's share of income for the year (advance or draw rule).

Decreases in Liabilities


� Can trigger income in in xcess of basis..

� Decreases in liabilities as determined under IRC Sec. 752.

� Can trigger income if in excess basis.

STOP HERE


� If after distributions and decreases in liabilities, the number is negative, than income to shareholder.

� No gain on distributions unless distributions are in cash or marketable securities.

Loss and Deduction Items


� Includes page 1 and separately stated items on K-1

� Tax Exempt Income-increase basis.

� Same

Ne

t in

com

e

Non Deductible Expenses


� Decrease basis to ensure that expenditures that, for income tax purposes, are neither deductible nor capitalizable, cannot be deducted when the interest is disposed.

� Same

STOP HERES CorporationsS CorporationsS CorporationsS Corporations PartnershipsPartnershipsPartnershipsPartnerships

� If after negative items the number is negative, than losses carry forward to future years.

� Loss is prorated over the the character of income.

� Special election for treatment of nondeductible items.

� Same.

� Same

� Check rules.

Loss carryovers


� Lost if (1)the shareholder S corporation election is terminated; (2) the shareholder disposes of all of his or her stock to someone other than a spouse or former spouse incident to a divorce; or (3) the shareholder dies.

� Allocated to each share of stock.

� Sennett v. Commissioner 80

A partner’s suspended deductions under IRC section 704(d) expire upon the sale of his partnership interest.

Allocations When a Interest ChangesAllocations When a Interest ChangesAllocations When a Interest ChangesAllocations When a Interest Changes


� per-share, per-day basis allocated equally to each day of the tax year and then are allocated equally among the shares of stock outstanding on each day of the tax year.

� special rules required when the S election terminates or an election to use specific accounting is made.

� interim closing of the booksmethod.

� proration of annual income

� any other reasonable method.

Other S Corporation items� Gain on Sale of S Corporation Stock Does Not Increase Basis� If a shareholder with a suspended loss carryover sells his S corporation stock, he will

have a gain reportable from the disposition. However, gain on the disposition of stock does not increase basis for purposes of using S corporation carryover losses. (See Key Issue 30D.) The adjusted basis of stock sold or otherwise disposed of during the year is determined immediately prior to the sale or disposition, as discussed in Key Issue 19D.Domestic Production Activities Deduction Does Not Affect Basis

� Information necessary to calculate the Section 199 domestic production activities deduction is reported on each shareholder's Schedule K-1. The deduction is claimed by the shareholder and does not affect the shareholder's stock basis [Reg. 1.199-9(c)(1)(i)]. The Section 199 deduction is covered in Key Issue 18A.Effect of Credits on Basis

� The basis limitations do not apply to credits. For example, an S corporation shareholder with a zero stock basis who receives a $3,000 disabled access credit pass-through on Schedule K-1 can claim the credit even though his stock basis is zero. (See Key Issue 28D.)

Responsibility


� The shareholder's (not the corporation's)

� AAA, PTI, and AE&P maintained at the corporate level.

� The partners. As a practical matter, partnership return preparers have a responsibility to make it as easy as possible for partners to do so.

Slow down…invest time upfront

Firm Best Practices


� Copy of debt instruments.

� Basis schedules.

� Copy of partnership agreement.

� Copy of debt instruments and underlying guarantees.

� Basis schedules.

s corporation –partnership basis - · pdf filedifferent passive loss rules –irc...

Documents