Lesson 6.4.2 Operating: Applications

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En provenance du cours de University of Illinois at Urbana-Champaign

Taxation of Business Entities II: Pass-Through Entities

6 notes

University of Illinois at Urbana-Champaign

Taxation of Business Entities II: Pass-Through Entities

6 notes

Cours 4 sur 5 dans Specialization U.S. Federal Taxation

This course provides an introduction to the U.S. federal income taxation of pass-through business entities, including Subchapter S corporations, partnerships, and limited liability companies. The course focuses on the relevant provisions of Subchapters S and K of the Internal Revenue Code, as well as related Treasury Regulations and judicial opinions, governing the formation, operation, and termination of pass-through entities. Practical in-class study problems facilitate self-discovery of technical tax knowledge along with the development of a variety of professional skills and attitudes.

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Module 6 S Corporation Operations

In this module, we will further examine the specifications of electing S corporation status. We will explore income measurement and allocation methods followed in passing through the earnings to the shareholders; including the differentiation between ordinary items and separately stated items. Next, we will discuss the calculation of the shareholder’s basis in the S corporation and how it is adjusted in accordance with company earnings. We will also explore loss limitations with respect to the shareholder’s tax basis and at-risk basis. Accordingly, you will be introduced to the implications of distributions from the company to the shareholder with special tax consequences. Finally, we will discuss the exceptions that subject the pass-through to entity level tax.

Lesson 6.4.1 Operating: Concepts6:45

Lesson 6.4.2 Operating: Applications6:48

Lesson 6.4.3 Liquidating: Concepts1:28

Lesson 6.4.4 Liquidating: Applications2:55

Rencontrer les enseignants

Michael P Donohoe, PhD, CPA
Associate Professor of Accountancy and PwC Faculty Fellow
Department of Accountancy, Gies College of Business

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Let's now apply these concepts to Sunchaser Shakery.

Sunchaser Shakery, an S corporation, is owned entirely by Nicholas.

At the beginning of the year, Nicholas's basis in his Sunchaser stock was $20,000.

Sunchaser reported ordinary income of $5,000 and a capital loss of $10,000.

He received a cash distribution of $35,000 in November.

What are the tax effects of the distribution?

So his $20,000 of initial basis is increased by his share of ordinary income,

or $5,000, giving him a basis of $25,000 at the time of the distribution,

which we factor in next.

The distribution that was made to him though was $35,000,

which exceeds his basis by $10,000.

Because he has no basis available, then the capital loss, Is non-deductible.

Instead, it carries forward until such time that he does have sufficient basis.

Sunchaser Shakery, an S corporation since 2004,

reports accumulated adjustments account on January 1st of $30,000,

accumulated earnings and profits on January 1st of $75,000.

And ordinary income for the current year of $102,000.

Nicholas is the sole shareholder; his stock basis is $50,000 on January 1st.

During the year, Sunchaser distributed $150,000 to Nicholas.

What is the tax treatment of the distribution?

So recall that the portion of a distribution that does not exceed the AAA

reduces basis, and the remaining distribution is a dividend to the extent

of accumulated earnings and profits.

Finally, any remaining distribution is a recovery of basis, and

capital gain otherwise.

So at year-end, The AAA account is $132,000,

and that's its $30,000 beginning balance

plus the $102,000 of ordinary income.

Nicholas has a basis of 152,000,

Which is computed as his $50,000 beginning basis,

plus the $102,000 of ordinary income during the year.

So with respect to the $150,000 distribution to Nicholas,

the first $132,000 is from AAA,

And it reduces the basis down to $20,000.

The remaining $18,000 of distribution reduces his basis, To 2,000.

Thus, for this distribution, there is no capital gain to be recognized.

At the end of the year, Sunchaser Shakery, an S corporation,

distributed long-term capital gain property,

a fair market value of $24,000 and $15,000 basis, to each of the three shareholders.

At the time of the distribution, Sunchaser had no corporate E&P,

and Nicholas has a basis of $10,000 in his stock.

How much gain, if any, do Sunchaser and Nicholas recognize?

So let's start with Sunchaser.

Recall that those distributions were made to each of the three shareholders.

So we have $24,000 times 3 for each shareholder, or

$72,000, the fair market value of the total distribution.

Now consider the corporate basis in the distributed property,

Which is $15,000 times 3.

Three separate distributions to each shareholder, such that the corporation,

Sunchaser has a long-term capital gain of $27,000.

So that's the effect for Sunchaser.

Now let's consider Nicholas, who's obviously one of the shareholders.

Well, let's first start by looking at his share of that long-term capital gain

at the corporate level, because ultimately, it will pass through to him.

So $27,000, and he's one of three shareholders,

so $9,000 is allocated to him.

Therefore, his basis after this gain has been allocated to him,

Is his $10,000 initial basis plus the $9,000 of gain allocated to him,

or $19,000.

Now we can factor in the distribution itself,

which had a fair market value of $24,000.

And so, if his basis is 19,000, the distribution is $24,000,

then we know that his basis after the distribution, Is zero.

It has to be zero because basis can't be negative

But the distribution did exceed his basis by $5,000, and when this happens,

the shareholder must recognize a long-term capital gain on a distribution,

Because it exceeded his basis.

So the total long-term capital gain allocated to Nicholas is the $9,000 plus

the $5,000 due to the excess of basis situation, or 14,000.

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