S Corporation Tax Update

Transcription

1 S Corporation Tax Update Fifty Third Annual Arkansas Federal Tax Institute Jillian G. Yant, CPA Overview S Corporation Basis Tax Extenders Net Investment Income Tax Reasonable Compensation Late S Elections 1

2 Basis in S Corporation Proposed regulations from 2012 were made final on July 23, 2014 Treasury Decision 9682 Final regulations clarify when a shareholder can increase basis in the S corporation s indebtedness to the shareholder Two standards: Shareholder loan to S corporation must be bona fide Guarantee of S corporation debt actual cash outlay Treasury Decision 9682 Bona Fide Debt Determined under general federal tax principles Must consider all facts and circumstances Final regulations state that the debt must run directly from the S corporation to the shareholder If loan is bona fide, shareholder s basis of indebtedness can be increased by the loan amount Back to back loan transactions 2

3 Treasury Decision 9682 Guarantee of Debt Under final regulations, shareholder does not obtain basis of indebtedness by merely guaranteeing debt to the S corporation by a third party If shareholder makes a payment on a bona fide loan of the S corporation that the shareholder guaranteed, basis can be increased by the amount of each payment. Comments on TD 9682 Be cautious of circular flow of funds Potential abuse if loans aren t actually bona fide, but final regulations don t require documentation of such Courts have been inconsistent with defining economic outlay, so the final regulations don t rely upon this test 3

4 Tax Extenders Congress s lame duck session will address over 60 tax extenders Over 50 expired on December 31, 2013, for individuals, businesses and energy tax incentives What s up for consideration? Reduced recognition period for S corp built in gains tax attributable to prior C corporation status from 10 years to 5 years ( 1374) S corp making charitable contribution of property ( 170) Tax Extenders What s up for consideration? 179 expense has reverted to a $25,000 deduction with a $200,000 limit Extender would provide a $500,000 deduction with a $2 million investment limit Bonus depreciation has expired and extender would put 50% bonus depreciation in place Some are pushing for permanent bonus depreciation 4

5 Tax Extenders What s up for consideration? Work Opportunity Tax Credit ( 51) Extension of New Market Tax Credit ( 45D) Research Tax Credit at 20% level ( 41) Some support for this to be permanent 15 year straight line recovery period for qualified leasehold/retail improvements and restaurant property ( 168) Net Investment Income Tax NII has definitely impacted our planning and recommendations to taxpayers Passive v. Active IRS issued final regulations (TD 9644) in November 2013 to interpret 1411 Apply to tax years beginning January 1, 2014, and can be retroactively applied to 2013 Because 469 doesn t provide sufficient guidance as it pertains to 1411, proposed regulations have been issued and are still pending. 5

6 Net Investment Income Tax Three general categories of NII Category 1 portfolio income not from a T or B Category 2 passive income from a T or B Category 3 net gains from the sale of property If the property sold is a nonpassive interest in a S corp, gain from the sale is NII only to the extent that income from a deemed sale of the entity s property would be NII IRS has totally rewritten the regs for disposition of interests in a partnership or S corp and reissued them in the pending proposed regs 469 applies to all three categories of NII Net Investment Income Tax Trade or Business 1411 does not explain when an activity is a trade or business IRS has declined to provide bright line examples, but refers taxpayers to 162 The IRS s position is that this is a factual question Investment activities are not a trade or business 6

7 Net Investment Income Tax Real Estate Professionals 469 states that rental income is per se passive, and this rule applies to 1411 to determine if an activity is passive Exception for real estate professionals who materially participate, which is defined as a taxpayer in real property business ( 469(c)(7)) Some relief is given in (g)(7) with a safe harbor if the professional participates in rental real estate activities for more than 500 hours per year Net Investment Income Tax Grouping and Regrouping NII may cause taxpayers to reconsider previous groupings Final NII regulations give taxpayers the opportunity to regroup their activities once, in the first tax year beginning after in which the taxpayer meets NII income threshold and has NII This may already be a moot point for some taxpayers, and an outstanding opportunity for others 7

8 Reasonable Compensation S corporations must pay reasonable compensation to a shareholder employee in return for services provided by the employee before any non wage distributions may be made. To determine reasonable compensation we need to know what the shareholder employee has done for the S corporation Reasonable Compensation Need to look to the source of S corp gross receipts Three major sources Services of the shareholder Services of non shareholder employees, or Capital and equipment If gross receipts and profits arise from items 2 and 3, then it should not be associated with shareholderemployee s personal services and it s reasonable that distributions would be received along with wages 8

9 Reasonable Compensation Evaluating the main sources of gross receipts: If most of the S corporation s gross receipts are associated with the shareholder s personal services, then most of the profit distribution should be allocated as compensation Shareholder employee should also be compensated for administrative work performed by other income producing employees or assets Reasonable Compensation Factors to Consider: Training and experience Duties and responsibilities Time and effort devoted to the business Dividend history Payments to non shareholder employees Timing and manner of paying bonuses to key people What comparable businesses pay for similar services Compensation agreements Use of a formula to determine compensation 9

10 Reasonable Compensation Definitely a prevalent issue in IRS exams IRS Inspector General found that in 2000 about 440,000 single shareholder S corporations paid no salary to their owners, costing the government billions in lost payroll taxes IRS has stepped up audits as a result and enforcement on S corps that paid owners little or no salary This can now be easily identified on Form 1125 E if an entity has total receipts of $500,000 or more Reasonable Compensation Several court cases support the IRS s authority to reclassify other forms of payment to a shareholderemployee as wages, which are then subject to employment taxes (and penalties and interest ) Joly vs. Commissioner, 211 F. 3d 1269 (6 th Cir., 2000) Veterinary Surgical Consultants, P.C. vs. Commissioner, 117 T.C. 141 (2001) Joseph M. Grey Public Accountant, P.C. vs. Commissioner, 119 T.C. 121 (2002) David E. Watson, PC vs. U.S., 668 F. 3d 1008 (8 th Circ. 2012) 10

11 Late Elections Rev. Proc supersedes Rev. Proc and (effective ), which provide late filing relief for the following elections: S corporation Electing Small Business Trust Qualified Subchapter S Trust Qualified Subchapter S Subsidiary Late corporate classification elections Requires more informative statements completed by both the corporation and individual shareholders Late Elections Rev. Proc includes four flow charts to aid in determining if the entity is eligible for simplified relief Copies follow the slides Must satisfy the general requirements of Section 4 and the specific requirements applicable to the taxpayer under Sections 5 through 7 of the revenue procedure 11

12 Late S Elections Include statement on the top of Form 2553 FILED PURSUANT TO REV. PROC Must attach a reasonable cause/inadvertence statement with a dated declaration that states: Under penalties of perjury, I (we) declare that I (we) have examined this election, including the accompanying documents, and, to the best of my (our) knowledge and belief, the election contains all of the relevant facts relating to the election, and such facts are true, correct, and complete. Late S Elections Must attach a separate statement for each shareholder of the S corporation stating that his/her pro rata portion has been properly reported on all affected tax returns. Must also include the same perjury statement as the attachment for the S corporation Strong recommendation to have a power of attorney signed specifically for Form

13 Questions? Thank you for attending! Jillian G. Yant, CPA JPMS Cox, PLLC 13