Book Slides CH 5

5-1
From Partnership to Corp: Option 1

Assets & liabilities
Corp
Tax Impacts:
No gain or loss recognized Partnerships asset basis transfers to C corp
Stock
Partnership
Partnership terminated Owners stock basis equals basis in partnership interest (adjusted for debt transfers to corp) Owners not original issuees 1244 impact and potential S election impact in year 1
Owners
Stock in liquidation
Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com
5-2
Corp
Tax Impacts:
No gain or loss to Partnership or Corp
Assets & liabilities
Stock
Partnership terminated
Partnership
No gain or loss to owners unless money in excess of basis is distributed Owners basis in assets equal basis in partnership interests, which carries over to Corp and determines Owners basis in stock Owners original issuees of stock
Owners
Assets and liabilities in liquidation
5-3

Assets and liabilities in liquidation
Corp
Tax Impacts:
No gain or loss to Partnership or Owners
Partnership Interests
Stock
Partnership terminated
Partnership
No gain or loss to Corp unless money in excess of basis is distributed Owners basis in stock equals basis in partnership interests, which carries over to Corp and determines Corps basis in assets Owners original issuees of stock
Owners
5-4

Check The Box No need to form corp or transfer assets and liabilities Entity remains the same only tax status changes Reduces paperwork and third party hassles Tax consequences same as option 1- Partnership contribution followed by Partnership liquidation No corporate trappings benefits No S status capacity No tax-preferred employee benefits to owner/employees
5-5
From S status C status

Piece of Cake
No entity change nor need to transfer assets and liabilities Entity remains the same only tax status changes Revoke S election (takes majority) or cease to qualify as S Specify effective date to ease accounting and tax hassles. Default date is first day of next taxable year unless revocation before 15th day of 3rd month of current year Mid-year effective date creates short S year and short C year allocation options No election back into S status for 5 yrs Bailout S earnings that have already been taxed to shareholders 1371(e) one year bailout period
5-6
Problem 5-A: Colson Inc.

Common & Preferred Common & Preferred
C Corp
Big Loans Common & Preferred Common & Preferred
Three Golfer Owners
Two Golfer Owners
One Toiler Owner
Two Limited Partnerships
Challenge: Convert to Pass Thru Entity
5-7

Convert to LLC or Partnership? Prohibitively tax expensive Full recognition of all asset gains at corporate level Full recognition of capital gains at shareholder level S corp only viable option
5-8

Election Mechanics Election effective on first day of following year 2 month retroactive election not possible because not eligible shareholder on 1st day of current year Must be eligible for S at time of election no disqualified shareholders or 2nd class of stock S tax year calendar year unless sustain business purpose proof burden for fiscal year All shareholders must consent (Form 2553) community and joint interest owners
5-9

S Eligibility Problems Limited partnerships not eligible S shareholders Preferred stock not permitted with S status Shareholder loans could trigger one class of stock requirement Any stock options held by toiler owner or other owners could violate one class of stock requirement
5-10
C to S Conversion: Getting Eligible

Getting rid of ineligible shareholders: Partnership shareholders: Redeem stock or have stock distributed to eligible partners Corporate Shareholder: Redeem stock; merge or reorganize to eliminate corporate shareholder; have corporate shareholder distribute or sell stock to eligible S shareholders Non-qualified trusts and estates: Redeem stock or distribute to qualified S shareholders
5-11
C to S Conversion: Getting Eligible

Getting rid of second class of stock issues: Preferred stock: Redeem or E Reorg (Reclassification) Risky debt: Reform to fit within safe harbor of 1361(c)(5)(B) Options and warrants in the money: Buy back or have them exercised. Options and warrants not in money: Make sure strike price is at least 90% of FMV. May present too tough of a valuation issue. Best course may be to buy back or trigger exercise.
5-12
Debt Safe Harbor of 1361(c) (5) (B)

Nothing Too Tough: Written unconditional promise to pay on demand or at time certain Interest rate and payments not contingent on profits, discretion, etc. Debt not convertible to stock Creditor eligible S shareholder or party in business of loaning money
Note: Safe Harbor protects only S election has no impact on broader tax debt-equity issues
5-13
Potential Conversion Tax Traps

1. LIFO Inventory Trap LIFO inventory reserve recaptured over four years 2. C Corp E & P Trap Post-conversion distributions in excess of S corp accumulated adjustment account will trigger taxable dividends to shareholders to extend of C corp E & P 3. The Passive Income Trap of 1375 4. The BIG Tax Trap of 1374
5-14
S Passive Income Not Like the Other Passive

Royalties Dividends Interest Annuities Sales or exchanges of stocks or securities
Note: Looks more like portfolio income. But for 1375 purposes, called passive income DO NOT CONFUSE WITH 469 PASSIVE INCOME
Passive Income S Penalties

and passive S receipts more than 25% total receipts. S election terminated. 1362(d)(3)
5-15
Penalty One: S Corp has accumulated earnings and profits for three years
Penalty Two: S Corp has accumulated earnings and profits and passive S
receipts more than 25% total receipts. Entity level tax equal to 35% of excess net passive income. How to calculate: - First, net passive income = passive income less passive expenses - Second, ratio with numerator equal passive income over 25% of gross receipts and denominator equal to total passive income - Third, multiple net passive income by ratio to arrive at excess passive income - Limit excess passive income cant exceed corps taxable income
5-16
Stay Clear of Passive S Penalties

1. Be aware keep an eye on receipts 2. Bail accumulated C Corp E & P at 15% rate with 1368(e)(3) election 3. Distribute or sell investments that trigger passive S to get below 25% 4. Increase active receipts relative to passive do more business or stick additional operation or active business in S
5-17
C to S: The BIG Tax Trap

Huge exception to no entity tax rule Applies only when C corp has converted to S corp Purpose is to limit ability to convert and then sell and strip income with no double tax hit BIG stands for Built-in-Gain May also have built-in loss Major factor in converting from C to S corp. Although BIG tax can be rough, nothing compared to going from C Corp to partnership or LLC
5-18
How BIG Trap Works

Determine built-in gain or loss at time of conversion for all assets. This is gap between FMV and basis. Requires appraisals If asset sold during 10 years after conversion (recognition period), any gain or loss recognized up to Built-in amount taxed at corporate level Tax rate is highest corporate rate 35% Income still taxed at shareholder level, but BIG tax treated as loss. 1366(f)(2) BIG income may not exceed corp income for year if taxed as C corp. Carry forward any excess
5-19
How BIG Trap Works

BIG income from any sale may not exceed total BIG income at conversion less BIG income previously recognized. Carry-over BIG income potential in non-recognition transactions (i.e. 1031, 1034), tax-free corporate reorgs. Installment sales during 10 year period that defers income beyond ten year window doesnt help. Recognition period extended. Recognized BIG losses during 10 year window can offset recognized BIG income.
Strategies to Mitigate BIG Tax

Convert early, carefully document assets at conversion
5-20
Pre-conversion hang onto losers, but watch out for loss stuffing Collect zero basis receivables before conversion. May require factoring Accrue bonuses and similar expenses prior to conversion counts in reducing total built-in amount at conversion Match BIGs and BILs during 10 year recognition period to extent possible Use non-recognition transaction (1031, 1033) to get through non-recognition period Work goodwill/going concern valuation
5-21
From Partnership to LLC Status (Rev. Rule 95-37)

No termination of partnership for tax purposes under 708 No sale, exchange or liquidation of owners interests No close of the entitys tax year No tax year close with respect to any owner No need to obtain new federal tax ID number
5-22
Problem 5-B: Larson Electronics, LLC

Admit two new partners each 10% 20% of Assets Tax status of entity converts from sole proprietorship to partnership. Joel deemed to have sold 20% of each asset in taxable transaction. Recognizes gain. Joel and new partners deemed to have made tax-free 721 transfers to a new partnership New partners basis in partnership interest is amount paid Joel. Joels basis is basis in assets deemed transferred. LLC takes carryover basis and tacked holding period
LLC
20% LLC Interests 80% of Assets 80% LLC Interests
New Partners
Joel
20% of Assets Cash & notes
5-23
Problem 5-B: Larson Electronics, LLC

LLC
Assets in Liquidation Stock Conversion to C Status Joel and New Owners make 351 tax free transfer of LLC interests to new C corp for stock. Stock Joel and New Owners stock basis equal to LLC basis. Tacked holding period. On liquidation of LLC, C corps basis in assets equals basis in LLC interests received from Joel and New Owners. No gain or loss to C corp. unless money in excess of basis received. No gain to LLC. Joel and New Owners original issuees of C corp stock
New C Corp
80% LLC Interests
20% LLC Interests
Joel
New Owners

Book Slides CH 5

Cargado por

Información del documento

Descripción original:

Título original

Derechos de autor

Formatos disponibles

Compartir este documento

Compartir o incrustar documentos

Opciones para compartir

¿Le pareció útil este documento?

¿Este contenido es inapropiado?

Copyright:

Formatos disponibles

Book Slides CH 5

Cargado por

Copyright:

Formatos disponibles

5-1

From Partnership to Corp: Option 1

From Partnership to Corp: Option 2

Assets & liabilities

Assets and liabilities in liquidation

From Partnership to Corp: Option 3

From Partnership to Corp: Option 4

From S status C status

Problem 5-A: Colson Inc.

Three Golfer Owners

Two Golfer Owners

One Toiler Owner

Two Limited Partnerships

Challenge: Convert to Pass Thru Entity

Problem 5-A: Colson Inc.

Problem 5-A: Colson Inc.

Problem 5-A: Colson Inc.

C to S Conversion: Getting Eligible

C to S Conversion: Getting Eligible

Debt Safe Harbor of 1361(c) (5) (B)

Potential Conversion Tax Traps

S Passive Income Not Like the Other Passive

Passive Income S Penalties

Stay Clear of Passive S Penalties

C to S: The BIG Tax Trap

How BIG Trap Works

How BIG Trap Works

Strategies to Mitigate BIG Tax

From Partnership to LLC Status (Rev. Rule 95-37)

Problem 5-B: Larson Electronics, LLC

20% of Assets Cash & notes

Problem 5-B: Larson Electronics, LLC

20% LLC Interests

También podría gustarte