14
Entity Chapter Operations and Distributions2010
Howard Godfrey, Ph.D., CPA UNC Charlotte
Copyright 2010, Dr. Howard Godfrey Edited October 30, 2010. T10-Chp-14-1-Entity-Choice-Operations-and-Dist2010 1
14. Entity - Operations and Distributions
Proprietorship Partnership Income reporting Net operating Loss Transaction w/ ptshp Basis Considerations Corporation Capital gains & losses Div. received deduction Charitable Contributions Net operating Loss Tax Credits Basis Considerations S Corporation Separate items Recapture No div. received deduction Net operating Loss Basis Considerations Entity Distributions Proprietorship Partnership Corporation S Corporation Tax Planning Income Splitting Children-Employees Family Entities 2
Partnerships
Income reporting Net operating Loss Transaction w/ partnership Basis Considerations
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Taxation of Operations The general formula for computing income tax is:
Gross Income less: Deductions Taxable Income times: Tax rate (for entity) Income tax less: Tax prepayments and Tax credits Tax (refund) due with return
Let's concentrate on the exceptions to the general formula common to each entity.
Sole Proprietorship Many items are reported elsewhere on the owner's return and not reported as part of the proprietorship's income Investment income and expense Capital gains and losses Section 1231 gains and losses Passive activity items Charitable contributions Owner's personal expenses Tax credits Net operating losses
Partnership Income & expenses are reported by the partners according to their ownership interests Items which would receive special treatment on a partner's return are reported separately
All items listed separately for sole proprietorships Amounts expensed under Section 179 Alternative minimum tax items Nondeductible expenses
John Mason and his brother Bennie are equal partners in Mason Enterprises, which operates as a partnership. How would they report the income and loss items from partnership operations? John and Bennie each invested $50,000 to start Mason Enterprises. Each has a 50% interest in the partnership. During the first year, the business had
Mason Enterprises
Consulting revenue $125,000 Travel expenses 40,000 Transportation 3,000 Advertising 7,000 Office expense 3,000 Telephone 1,000 Dividend Income 5,000 Interest Income 2,000 Charitable contribution 1,000 Political contribution 6,000 What is ordinary Income?
Mason Enterprizes Consulting rev. $125,000 Travel expenses 40,000 Transportation 3,000 Advertising 7,000 Office expense 3,000 Telephone 1,000 Dividend Income 5,000 Interest Income 2,000 Charitable cont. 1,000 Political cont. 6,000 Ordinary Income
Ordinary
$125,000 (40,000) (3,000) (7,000) (3,000) (1,000)
$71,000
Information Form 1065 Sch- K Mason Consult rev. $125,000 $125,000 Travel exp. 40,000 (40,000) Transport. 3,000 (3,000) Advertising 7,000 (7,000) Office exp. 3,000 (3,000) Telephone 1,000 (1,000) Dividends 5,000 5,000 Interest 2,000 2,000 Char. cont. 1,000 (1,000) Political cont. 6,000 (6,000) Ordinary Income $71,000
Information Form 1065 Mason Page 1 Enterprizes Consult rev. $125,000 $125,000 Travel exp. 40,000 (40,000) Transport. 3,000 (3,000) Advertising 7,000 (7,000) Office exp. 3,000 (3,000) Telephone 1,000 (1,000) Dividends 5,000 Interest 2,000 Char. cont. 1,000 Political cont. 6,000 Ordinary Income $71,000
Sch- K Both
Sch- K-1 John
J ohn reports (as required) the items below (in last column) on his personal Form 1040 on applicable schedules.
5,000 2,000 1,000 6,000
2,500 1,000 500 3,000 35,500
Partnership Losses are deductible subject to three limitations
Limited to the amount of a partner's basis (capital recovery concept) Limited to the partner's at-risk amount Limited by passive activity
Partnership Partner's basis is adjusted to reflect partnership income and losses reported
Increased for income or gains
Designed to prevent double taxation
Decreased for losses
Designed to prevent double
Problem. In computing the ordinary business income of a partnership, a deduction is allowed for: a. Net operating loss deduction. b. Depreciation Expense c. Short-term capital losses. d. Gifts to qualified charities.
Gil and Bill partnership had book income of $37,000 this year which included the following: Dividend income $ 1,000 Shortterm capital loss (4,000) Section 1231 gain 7,000 Ordinary income (sec. 1245 recapture) 1,500 Interest income 1,000 They share profits and losses equally. What amount of partnership income (excluding all separately reported items) should each partner report on his
Gil & Bill partnership had book net income of $37,000 including:
Ordinary
Book income $37,000 Dividend income $1,000 ST capital loss (4,000) Section 1231 gain 7,000 Ordinary income (sec. 1245 recapture) 1,500 Interest income 1,000 Ordinary Income They share profits and losses equally. What is partnership ordinary income
Gil & Bill partnership had book income of $37,000 which included: Ordinary Book income $37,000 Dividend income $1,000 ($1,000) ST capital loss (4,000) 4,000 Section 1231 gain 7,000 (7,000) Ordinary income (sec. 1245 recapture) 1,500 Interest income 1,000 (1,000) Ordinary Income $32,000 They share profits and losses equally. What is partnership ordinary income
Andrew invested $10,000 for a 25% interest in XYZ Partnership on 12-31 of Year-1. In Year-2, XYZ had taxable income of $20,000. Partnership had nontaxable income of $8,000. XYZ Partnership made a cash distribution to Andrew of $12,000. Assuming no other transaction occurred, how much income is included on Andrew's tax return for Year-2? a. $-0 b. $5,000
Andrew invested $10,000 for a 25% interest in XYZ Partnership on 12-31 of Year-1. In Year-2, XYZ had taxable income of $20,000. It also had nontaxable income of $8,000. XYZ Partnership made a cash distribution to Andrew of $12,000. Assuming no other transactions occurred, what is Andrew's basis in the partnership at the end of Year-2? a. $-0 b. $5,000 c. $10,000 d. $17,000 IRS-1994
XYZ Partnership Investment or Beginning Basis Change in share of debt (+ or -) Add: Ordinary Income Separate Income & gains Tax-free income Contributions of Capital Less: Ordinary Loss Separate Exp. & Losses Non-deductible Expenses Partner Withdrawals Ending Basis
Andrew $ 10,000
XYZ Partnership Investment or Beginning Basis Change in share of debt (+ or -) Add: Ordinary Income Separate Income & gains Tax-free income Contributions of Capital Less: Ordinary Loss Separate Exp. & Losses Non-deductible Expenses Partner Withdrawals Ending Basis
Andrew $ 10,000 5,000 2,000
(12,000) $ 5,000
Partnership
Transactions between a partner and partnership are subject to related-party rules
Partner who has > 50% interest in a partnership is a related party
Corporations
Capital gains & losses Dividends received deduction Charitable Contributions Net operating Loss Tax Credits Basis
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Big Picture
Less: Equals: Times: Equals: Plus: Less: Equals: Gross Income - Sec. 61 Deductible expenses Taxable income Corporate tax rate Corporate income tax Additions to tax Tax credits Net corporate tax
Corporate Tax Rates 15% on first $50,000 25% on $50,001 - $75,000 34% on $75,001 - $100,000 39% (34% + 5% surtax) on $100,001 $335,000 34% on $335,001 - $10,000,000 35% on $10,000,001 - $15,000,000 38% (35% + 3%) on $15,000,001 $18,333,333
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PSC
Personal service corporation is a corporation that provides service in the fields of accounting, actuarial science, architecture, consulting, engineering, health, law, or performing arts and is substantially owned by its employees A flat 35% tax rate applies to its entire taxable income
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Corporation Taxable income is determined at the corporate level under the general formula Exceptions:
Net capital losses are not deductible Corporations must recapture additional depreciation for Sec. 1250 property = 20% of straight-line
Corporation
Passive activity losses
Corporations are not subject to the passive activity rules
Personal service corporations must follow them Closely-held corporations may use passive losses to offset active income but not portfolio income
Charitable contributions are limited to 10% of taxable income
Before dividend-received deductions and any carryovers Excess contributions may be carried forward 5 years
Corporation Net operating loss cannot be used in the current year or distributed to shareholders
May be carried back 2 years and forward 20 until used
Gross income
Less:
Deductions:
Except charity, Div. Rec., NOL & C-Loss Carryback For Charity Limit Before Div. Rec'd Ded. Before carrybacks
Equals Taxable IncomeLess: Less: Less: Equals Equals Taxable IncomeDiv. Rec. Deduct. Equals Taxable Income-
Charitable Cont. < = 10% of T.I. Above
NOL and/or Capital Loss carrybacks
Taxable Income
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Capital Losses- Baker
Baker Corp., had taxable income of $36,000 business operations in Year 1. Baker also had the following: Short term capital gain $8,600 Short term capital loss (9,600) Long term capital gain 1,500 Long term capital loss (3,500) What is taxable income for Year 1? a. $35,000 b. $33,000 c. $36,000 d. $35,500 CPA - Nov. 1995
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Capital Losses-Baker
Baker Corp., had taxable income of $36,000 business operations in Year1. Baker also had the following: Short term capital gain$8,600 Short term capital loss(9,600) Long term capital gain 1,500 Long term capital loss(3,500) What is taxable income for Year-1?
$36,000
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Corp. Income Tax Prob. - 1
Gross receipts of $450,000 Cost of goods sold of 145,000 Deductible bus. expenses 276,000 Gain on sale of machine 20,000 Interest on Ohio bonds 500 What is its tax liability? a. $4,900 b. $7,350 c. $10,000 d. None of these
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Corporate Income Tax Problem - 2
A corporation has Gross receipts Cost of goods sold Facts Return $450,000 $450,000 $145,000 $145,000
Deductible bus. exp. $276,000 Gain-sale of machine $20,000 Interest- Ohio bonds $500 Taxable Income Fed. income tax liability at 15%
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Corporate Income Tax Solution-3
A corporation has Gross receipts Cost of goods sold Return $450,000 $145,000 $305,000 Deductible bus. exp. $276,000 ($276,000) Gain-sale of machine $20,000 $20,000 Interest- Ohio bonds $500 Taxable Income $49,000 Fed. income tax liability at 15% $7,350
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Facts $450,000 $145,000
Dividend Received Deduction
To relieve burden of multiple taxation DRD based on % ownership in paying corp 100% DRD for 80% or more owned affiliate 80% DRD for ownership of 20% up to 80% 70% DRD for ownership less than 20% DRD limited to percentage times lesser of taxable income or dividend income Unless deducting DRD % x dividend income creates or increases NOL
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Grant, Inc. acquired 30% of South Co.'s voting stock for $200,000 on January 1, 2010. Grant's 30% interest in South gave Grant the ability to exercise significant influence over South's operating and financial policies. During 2010, South earned $80,000 and paid dividends of $50,000. What amount of income should Grant include in its 2010 Federal income tax return as a result of the investment? a. $15,000 b. $24,000 c. $35,000 d. $50,000 e. $80,000 CPA Nov. 1995.
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Grant, Inc. acquired 30% of South Co.'s voting stock for $200,000 on January 1, 2010. Grant's 30% interest in South gave Grant the ability to exercise significant influence over South's operating and financial policies. During 2010, South earned $80,000 and paid dividends of $50,000. What amount of income should Grant include in its 2010 Federal income tax return as a result of the investment? This company will use equity method for GAAP and cost method for Tax Return.
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Div. Received- Green - 1
Green Corp. owns 25% of Cande Corp. This year, Green received $10,000 dividends on the Cande stock. Assuming no other limit applies, Green's dividends-received deduction is: a. $7,000. b. $8,000. c. $2,000. d. $ - 0 -. (IRS-2003)
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Div. Received- Green 12
Green Corp. owns 25% of Cande Corp. This year, Green received $10,000 dividends on the Cande stock. Assuming no other limit applies, Green's dividends-received deduction is: a. $7,000. b. $8,000. c. $2,000. d. $ - 0 -. (IRS-2003)
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Local Corp - 1. had the following: Revenue - operations Operating expenses Operating income (loss) Dividends from IBM Net income before DRD Dividend rec. deduction $500,000 (490,000) 10,000 50,000 60,000
Dividends Received Deduction
Limit 1:
Dividends Received DRD Percentage Deduction limit - 1
Limit 2:
$50,000 70% $35,000 $60,000 70% 42,000 $35,000
Taxable income (Adj) DRD Percentage Deduction limit - 2 Div. Rec. Deduction
Local Corp - 2. had the following: Revenue - operations Operating expenses Operating income (loss) Dividends from IBM Net income before DRD Dividend rec. deduction $ 500,000 (510,000) (10,000) 50,000 40,000
Dividends Received Deduction Limit 1: Dividends Received $50,000 DRD Percentage Deduction limit - 1 Limit 2: Taxable income (Adj) $40,000 DRD Percentage Deduction limit - 2 Div. Rec. Deduction
Dividends Received Deduction Limit 1: Dividends Received $50,000 DRD Percentage 70% Deduction limit - 1 $35,000 Limit 2: Taxable income (Adj) $40,000 DRD Percentage 70% Deduction limit - 2 28,000 Div. Rec. Deduction $28,000
Local Corp - 3. had the following: Revenue - operations Operating expenses Operating income (loss) Dividends from IBM Net income before DRD Dividend rec. deduction $ 500,000 (520,000) (20,000) 50,000 30,000
Dividends Received Deduction Limit 1: Dividends Received $50,000 DRD Percentage 70% Deduction limit - 1 $35,000 Limit 2: Taxable income (Adj) $30,000 DRD Percentage 70% Deduction limit - 2 21,000 Div. Rec. Deduction $35,000
Page Corp. Div. Received Ded. Page owns 15% of company Gross Profit $200,000 Expenses ($300,000) Operating loss ($100,000) Dividends Received $180,000 Tax. Inc. before DRD DRD Net operating loss
Page Corp. Div. Received Ded. Page owns 15% of company Gross Profit $200,000 Expenses ($300,000) Operating loss ($100,000) Dividends Received $180,000 Tax. Inc. before DRD $80,000 DRD ($126,000) Net operating loss ($46,000)
Spring Corp's has income from business of $500,000 & expenses of $750,000. Spring also received dividends from the Acme Corp. of $100,000. Spring owns 25% Acme. What is Spring's NOL for the year? a. ($150,000) b. ($0). c. ($220,000) d. ($230,000). (IRS Exam
2003)
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Spring Corp. Div. Received Ded. Spring owns 25% of company Gross Profit $500,000 Expenses ($750,000) Operating loss ($250,000) Dividends Received $100,000 Tax. Inc. before DRD DRD Net operating loss
Spring Corp. Div. Received Ded. Spring owns 25% of company Gross Profit $500,000 Expenses ($750,000) Operating loss ($250,000) Dividends Received $100,000 Tax. Inc. before DRD ($150,000) DRD ($80,000) Net operating loss ($230,000)
Spring Corp's has income from business of $500,000 & expenses of $750,000. Spring also received dividends from the Acme Corp. of $100,000. Spring owns 25% Acme. What is Spring's NOL for the year? ($230,000)
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This year, Pack Corp. had gross income from operations of $350,000 and operating expenses of $400,000. Pack received dividends of $100,000 from Smith Inc., of which Pack is a 20% owner. The NOL carryover from last year is $20,000. What is Pack's NOL for the current year? a. $50,000 b. $30,000 c. $20,000 d. $10,000 IRS-1995
This year, Pack Corp. had gross income from operations of $350,000 and operating expenses of $400,000. Pack received dividends of $100,000 from Smith Inc., of which Pack is a 20% owner. The NOL carryover from last year is $20,000. What is Pack's NOL for the current
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Pack Corp. Net Operating Loss Gross Profit $350,000 Expenses ($400,000) Operating loss ($50,000) Dividends Received $100,000 Tax. Inc. before DRD $50,000 DRD (80% ) ($80,000) Net operating loss ($30,000)
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Maple Corp. had the following for Year 1:
Gross Sales $340,000 Cost of Goods Sold $150,000 Depreciation - Books 60,000 Charitable Contribution 10,000 Salaries 130,000 Meals & entertainment 20,000 Total Expenses 370,000 Net income (loss) per books ($30,000) Maple's tax deprec. for the year is $75,000. Taxable income (loss) for the year?
a. $(5,000) b. $(35,000) c. $(25,000) d. $(20,000)
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Maple Corporation
Gross Sales Cost of Goods Sold Depreciation - Books Depreciation - Tax Charitable Contribution Salaries Meals & entertainment Total Expenses Net income (loss)-books Taxable income?
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Facts
$340,000 150,000 60,000 10,000 130,000 20,000 370,000 ($30,000)
Return
Maple Corporation
Facts
Return
Gross Sales $340,000 $340,000 Cost of Goods Sold 150,000 150,000 Depreciation - Books 60,000 Depreciation - Tax 75,000 Charitable Contribution 10,000 Salaries 130,000 130,000 Meals & entertainment 20,000 10,000 Total Expenses 370,000 365,000 Net income (loss)-books ($30,000) Taxable income? ($25,000)
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Tax vs. GAAP Numbers
Gross revenue from sales Cost of sales Gross margin Section 179 deduction (GAAP Deprec. = $5,000) Operating expenses Gain on sale of machine (Gain is $14,000 for GAAP).
Tax
$289,000 (98,000) 191,000 (20,000) (122,000) 21,000
GAAP
$289,000 (98,000) 191,000
Taxable Income Income GAAP before tax
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Tax vs. GAAP Numbers
Gross revenue from sales Cost of sales Gross margin Section 179 deduction (GAAP Deprec. = $5,000) Operating expenses Gain on sale of machine (Gain is $14,000 for GAAP).
Tax
$289,000 (98,000) 191,000 (20,000) (122,000) 21,000
GAAP
$289,000 (98,000) 191,000 (5,000) (122,000) 14,000
$70,000 Taxable Income GAAP Income before tax $78,000 Impact on def. tax account (40% tax rate)?
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Bard-Inc. Reported the following this year:
Info. Book net income before tax Included in this $450,000 were: Tax $450,000 $450,000 $4,000 $15,000 ($20,000)
State corp. income tax refunds Life insurance - officer's death Loss-stock bought for investment in 2001
Bard's taxable income for the year
a. $435,000 b. $451,000 c.$455,000 d.$470,000 (CPA-87)
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Bard-Inc. Reported the following this year:
Info. Book net income before tax Included in this $450,000 were: Tax $450,000 $450,000 $4,000 $15,000 ($20,000)
($15,000)
State corp. income tax refunds Life insurance - officer's death Loss-stock bought for investment in 2001
Bard's taxable income for the year
$20,000 $455,000
a. $435,000 b. $451,000 c.$455,000 d.$470,000 (CPA-87)
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Compute Tax. Income Debit Credits Sales $700,000 Cost of sales $400,000 Mun. bond interest 2,000 Compensation 100,000 Meals (gross) 20,000 Other Expense 140,000 Subtotal 660,000 702,000 Net Income before tax
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Debit
Sales Cost of sales $400,000 Mun. bond interest 2,000 Compensation 100,000 Meals, entertain. (Gross) 20,000 Other Expense 140,000 Subtotal 660,000 702,000 Net Income before tax Add: one half of entertain. Less: Mun. bond interest Taxable income Income Tax Compute E & P (Similar to Retained Earnings)
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Credits $700,000
Debit
Sales Cost of sales $400,000 Mun. bond interest 2,000 Compensation 100,000 Meals, entertain. (Gross) 20,000 Other Expense 140,000 Subtotal 660,000 702,000 Net Income before tax 42,000 Add: One half of entertain. 10,000 Less: Mun. bond interest (2,000) Taxable income 50,000 Income Tax 7,500 Compute E & P (Similar to Retained Earnings)
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Credits $700,000
Charlotte Corp. was organized 1-1-Yr-1 Income per books for Year-1 $400,000 Book Income includes: Municipal bond Interest 8,000 Meals & entertain. Exp. 20,000 Prem. Paid on officers' life ins. (corporation is beneficiary) 3,800 Capital losses 1,000 Fines 200 What is taxable income?
a. $400,000 b. $408,000 c. $426,000 d.
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Char. Corp.-organized 1-1-Yr-1 Income per books - Year 1 Book Income includes: Municipal bond Interest Meals & entertain. Exp. Prem. - officers' life ins. (corp. is beneficiary) Capital losses Fines What is taxable income?
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Return $400,000
$400,000 8,000 20,000 3,800 1,000 200
Char. Corp.-organized 1-1-Yr-1
Income per books - Year 1 Book Income includes: Municipal bond Interest Meals & entertain. Exp. Prem. - officers' life ins. (corp. is beneficiary) Capital losses Fines What is taxable income?
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Return $400,000 (8,000) 10,000 3,800 1,000 200 $407,000
$400,000 8,000 20,000 3,800 1,000 200
S Corporations
Separate items Recapture No Div. received deduct Net operating Loss Basis for shareholder
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S Corporation
Income and expenses are reported by the shareholders according to their ownership interest Items which would receive special treatment on a shareholder's return are reported separately Losses are deductible subject to the three limitations faced by partnerships S corporations are also subject to the corporate depreciation recapture rules for Section 1250 property
S Corporation May not use take the dividendreceived deduction NOLs are subject to three limitations Basis limitation At-risk limitation Passive activity loss limitation
MaxSCorp -income statement- Slide 1
Sales Less cost of sales Gross profit on sales Interest expense Charitable contributions Advertising expenses Other expenses Operating income Add: Municipal interest Dividend income LT capital gain Less: ST capital loss Net income per books $40,000 (23,000) 17,000 1,200 400 1,500 2,000 300 200 500
(5,100) 11,900
1,000 (150) $12,750
MaxSCorp-Slide 2 Net income per books Separate items Less: Mun. interest Div. income LT capital gain Subtotal Add: Charitable cont. ST capital loss Taxable income
$ 12,750 300 Section 200 1363(b) 500 (1,000) 11,750 400 150 550 $ 12,300
Distributions
Proprietorships Partnerships Corporations S Corporations
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Entity Distributions
The tax treatment of distributions to an owner depends on the amount and kind of the distribution and the entity making the distribution. Distributions are either Liquidating Nonliquidating
What are the effects of nonliquidating distributions made by each entity?
Sole Proprietorship Distribute cash
No tax consequences to owner / entity
Distribute property
No gain or loss recognized until owner sells the property
Partnership
Distribute cash
Partner recognizes no gain unless amount exceeds partner's basis; excess is capital gain No tax consequences to partnership
Distribute property
Partner recognizes no gain or loss; Basis is the lesser of carryover
The adjusted basis of Jody's partnership interest was $50,000 immediately before Jody received a current distribution of $20,000 cash and land with an adjusted basis to the partnership of $40,000 and a FMV of $35,000. What amount of taxable gain must Jody report as a result of this distribution?
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The adjusted basis of Jody's partnership interest was $50,000 immediately before Jody received a current distribution of $20,000 cash and land with an adjusted basis to the partnership of $40,000 and a FMV of $35,000. What is Jody's basis in the land ? a. $0 b. $30,000 c. $35,000
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The adjusted basis of Jody's partnership interest was $50,000 immediately before Jody received a current distribution of $20,000 cash and land with an adjusted basis to the partnership of $40,000 and a FMV of $35,000. What is Jody's basis in her partnership interest after this distribution? a. $0 b. $30,000 c. $35,000 d. $40,000 CPA 11-93
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Non-liquidating Distributions - Sec. 731-33 Solution for Jody's Partnership Dist.
1 Partner's outside basis (Include debt) 2 Less: cash distributed to Partner 3 Gain recognized by Ptnr (Ln 2-Ln 1)
Gain only if cash exceeds outside basis
$ 50,000 20,000
4 Ptnr's remain. outside basis (Ln 1-Ln 2) 5 Pthp's inside basis - Other prop. dist. 6 Ptnr's basis for other prop (< Ln 4 or 5) 7 Partner's outside basis (Ln 4 - Ln 6)
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Non-liquidating Distributions - Sec. 731-33 Solution for Jody's Partnership Dist.
1 Partner's outside basis (Include debt) 2 Less: cash distributed to Partner 3 Gain recognized by Ptnr (Ln 2-Ln 1)
Gain only if cash exceeds outside basis
$ 50,000 20,000 30,000 40,000 30,000 -
4 Ptnr's remain. outside basis (Ln 1-Ln 2) 5 Pthp's inside basis - Other prop. dist. 6 Ptnr's basis for other prop (< Ln 4 or 5) 7 Partner's outside basis (Ln 4 - Ln 6)
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Ben is a partner in the Success Partnership. The adjusted basis of Ben's partnership interest was $25,000 immediately before Ben received a liquidating distribution of $20,000 cash and land with an adjusted basis to the partnership of $40,000 and a fair market value of $50,000. What is Ben's basis in the land received in this distribution? a. $0 b. $5,000 c. $10,000 d. $15,000 CPA 11-93
Liquidating Distributions - Sec. 731-33 Distribution to Ben
1 Ben's outside basis (Include debt) 2 Less: Cash distributed to Ben 3 Gain recognized by Ben (Ln 2-Ln 1) 4 Ben's remain. outside basis (Ln 1-Ln 2) 5 Ben's basis for other property Line 4 6 Ben's loss (Excess of Line 4 over 5) (Loss can be recognized only if no property is distributed other than cash, unrealized receivables and inventory.) 7 Ben's remaining partnership basis 25,000
$-0-
Liquidating Distributions - Sec. 731-33 Distribution to Ben
1 Ben's outside basis (Include debt) 2 Less: Cash distributed to Ben 3 Gain recognized by Ben (Ln 2-Ln 1) 4 Ben's remain. outside basis (Ln 1-Ln 2) 5 Ben's basis for other property Line 4 6 Ben's loss (Excess of Line 4 over 5) (Loss can be recognized only if no property is distributed other than cash, unrealized receivables and inventory.) 7 Ben's remaining partnership basis 5,000 5,000 25,000 20,000
$-0-
C Corporation Distribute cash
Shareholder reports Dividend income to the extent of earnings and profits or corporation, then Return of capital to the extent of basis, then Capital gain No tax consequences to corporation
Distribute property
Shareholder reports same as cash (FMV of Prop.) Corporation reports gain "as if the property
Newell Corporation-1
Debit
Sales Cost of sales $400,000 Municipal bond interest Compensation 100,000 Meals & entertainment (Gross) 20,000 Payroll taxes, & Misc. Expense 140,000 Subtotal 660,000 Net Income (GAAP) before taxes 42,000 Add: One half of entertainment 10,000 Deduct: Mun. bond interest (2,000) Taxable income 50,000 Income Tax 7,500
Credits $700,000 2,000
702,000
Newell Corporation-2
Compute E & P (Similar to Retained Earnings) Taxable Income 50,000 Add Tax-exempt income 2,000 Subtract Federal income taxes (7,500) Nondeductible entertainment Subtract (10,000) Current Earnings & Profits 34,500 Add: Accum E&P at first of year 100,000 Subtotal 134,500 Less: Dividends paid Earnings and Profits at End of Year 134,500
Note: E & P is reduced by nondeductible expenses that reduce dividend paying ability such as non-deductible entertainment expense.
Dahl Corp. (Slide 1)
Accum. E&P at 1-1-09 $120,000 E&P for 2009 160,000 Cash distributions to individual stockholders during 2009 360,000 What is the amount of dividend income taxable to Dahl's stockholders in 2009? a. $0 b. $160,000 c. $280,000 d. $360,000 CPANov1995
Dahl Corp. (Slide 2)
Accum. E&P at 1-1-09 $120,000 E&P for 2009 160,000 Cash distributions to individual stockholders during 2009 360,000 What is the amount of dividend income taxable to Dahl's stockholders in 2009? a. $0 b. $160,000 c. $280,000 d. $360,000 CPANov1995
Cole Corp.-1 Cole Corp. distributes $75,000 in cash along with land having a $50,000 adjusted basis and a $60,000 FMV to its shareholder. E&P is not a limiting factor. What is the amount of dividend income recognized by shareholder? a. $75,000. b. $125,000. c. $ 135,000. d. $ - 0 .
Cole Corp.-2 Cole Corp. distributes $75,000 in cash along with land having a $50,000 adjusted basis and a $60,000 FMV to its shareholder. E&P is not a limiting factor. What is the amount of dividend income recognized by shareholder? a. $75,000. b. $125,000.
c. $ 135,000. d. $ - 0 .
Cole Corp.-3
Cole Corp. distributes $75,000 in cash along with land having a $50,000 adjusted basis and a $60,000 FMV to its shareholder. What is the shareholder's basis in the non-cash property? a. $0. b. $50,000. c. $60,000. d. $125,000.
Cole Corp.-4 Cole Corp. distributes $75,000 in cash along with land having a $50,000 adjusted basis and a $60,000 FMV to its shareholder. What is the shareholder's basis in the non-cash property? a. $0. b. $50,000.
c. $60,000.
d. $125,000.
Property Distributions
Property distributions corporation recognizes gain on distribution of appreciated property (but not loss) Value of distribution is net FMV (net of any liabilities assumed) and basis to shareholder is FMV Like cash dividends, property dividends taxable only to extent of E&P
Cole Corp.-5 Cole Corp. distributes $75,000 in cash along with land having a $50,000 adjusted basis and a $60,000 FMV to its shareholder. What gain must Cole Corp. recognize? a. $10,000. b. $75,000. c. $ 25,000. d. $ - 0 . (IRS Exam 2003)
Cole Corp.-6 Cole Corp. distributes $75,000 in cash along with land having a $50,000 adjusted basis and a $60,000 FMV to its shareholder. What gain must Cole Corp. recognize? a. $10,000. b. $75,000. c. $ 25,000. d. $ - 0 . (IRS Exam 2003)
S Corporation Distribute cash
Shareholder recognizes no gain unless amount exceeds basis; excess is capital gain No tax consequences to corporation
Distribute property
Same as for cash Corporation reports gain "as if the property was sold" for its FMV. No loss allowed.
If corporation has been a C corporation and has earnings and profits, the
Beth invested $25,000 in a new Corp on January 1, 2010. Beth does not borrow from the Corp or make loans to the Corp. The Corp elected S Status on January 1, 2010. The Corp had net income of $50,000 in 2010. On December 31, 2010 the Corp distributes $80,000 to Beth. How much income does Beth recognize as a result of the cash distribution?
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Beth
Cost of stock Net income for year Total Stock Basis Amt. of Distribution Gain
103
Basis $25,000
Basis Cost of stock $25,000 Net income for year $50,000 Total Stock Basis $75,000 Amt. of Distribution $80,000 Gain $5,000
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Beth
Repeat preceding slide. What is Beth's basis at the end of the year?
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What are the effects of liquidating distributions made by each entity?
Sole Proprietorship Distribute cash
No tax consequences to owner / entity
Distribute property
When property is sold; gain or loss = FMV less basis
Partnership
Distribute cash
Partner recognizes No gain unless amount exceeds partner's basis; excess is capital gain If only cash is distributed, loss may be recognized No tax consequences to partnership
Distribute property
Partner recognizes no gain or loss; Basis is the lesser of carryover basis or partner's basis No tax consequences to the entity
Brody is a partner in the Success Partnership. The adjusted basis of Brody's partnership interest was $25,000 immediately before Brody received a liquidating distribution of $20,000 cash and land with an adjusted basis to partnership of $40,000 and a fair market value of $50,000. What is Brody's basis in the land received this distribution?
Liquidating Distributions - Sec. 731-33 Distribution to Brody
1 Partner's outside basis (Include debt) 2 Less: cash distributed to Partner 3 Gain recognized by Ptnr (Ln 2-Ln 1) 4 Ptnr's remain. outside basis (Ln 1-Ln 2) 5 Ptnr's basis for other property Line 4 6 Partner's loss on distribution (Line 5) (Positive amount on line 5 is the loss, if no property distributed other than cash, unrealized receivables and inventory.) 7 Remaining Outside Basis $-025,000
Liquidating Distributions - Sec. 731-33 Distribution to Brody
1 Partner's outside basis (Include debt) 2 Less: cash distributed to Partner 3 Gain recognized by Ptnr (Ln 2-Ln 1) 4 Ptnr's remain. outside basis (Ln 1-Ln 2) 5 Ptnr's basis for other property Line 4 5,000 5,000 25,000 20,000
6 Partner's loss on distribution (Line 5) (Positive amount on line 5 is the loss, if no property distributed other than cash, unrealized receivables and inventory.) 7 Remaining Outside Basis $-0-
C Corporation
yDistribute cash
3Shareholder reports capital gain or loss = amount less basis 3No tax consequences to corporation
yDistribute property
3Shareholder reports same as cash 3Corporation reports gain or loss "as if the property was sold" for its FMV
L Corp. adopted a plan of liquidation on Jan. 31. L sold its property, paid its income taxes and distributed cash of $900,000 to its only stockholder in complete liquidation. E & P before the distribution were $600,000. Stockholder's adjusted basis in L Corp. stock was $700,000. Tax effects of the liquidation to stockholder? [Sec. 331(a)] Dividend income? ____________
L Corp. adopted a plan of liquidation on Jan. 31. L sold its property, paid its income taxes and distributed cash of $900,000 to its only stockholder in complete liquidation. E & P before the distribution were $600,000. Stockholder's adjusted basis in L Corp. stock was $700,000. Tax effects of the liquidation to stockholder? [Sec. 331(a)] Dividend income? 0 Capital gain of? $200,000 E&P not relevant for liquidation.
Sue owns all of the stock in Big Corp.
Sue has a basis of $5,000 in the stock. Big adopts a plan of liquidation, pays all tax liabilities for the year, and distributes two assets to Sue: (1) Cash of $10,000 and (2) Land: Basis of $30,000 & FMV of $70,000. Income or gain recognized by Sue? [Sec. 331(a), 1001] Dividend income? ____________ Capital gain of? ____________
Sue owns all of the stock in Big Corp.
Sue has a basis of $5,000 in the stock. Big adopts a plan of liquidation, pays all tax liabilities for the year, and distributes two assets to Sue: (1) Cash of $10,000 and (2) Land: Basis of $30,000. FMV of $70,000. Income or gain recognized by Sue? [Sec. 331(a), 1001] Dividend income? 0 Capital gain of? $75,000
S Corporation yDistribute cash
3Shareholder recognizes capital gain or loss equal to distribution amount less basis 3No tax consequences to corporation
yDistribute property
3Shareholder reports same as for cash 3Corporation reports gain or loss "as if the property was sold" for its FMV
Tax Planning
Income Splitting Child-Employee Family Entities
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Tax Planning With proper tax planning, owners of entities can minimize their overall tax liability by taking full advantage of the progressive tax rate structure.
Income splitting Children as employees
The End