DISTRIBUTIONS FROM S CORPORATIONS AND TAX PLANNING Accounting 551T - Lecture 10 Schlesinger: Chapters 10 and 11 Robert A. Scharlach Consequences to the Corporation of Property Gain recognition Losses are not recognized Consequences to the Corporation of Effect on Accumulated Adjustments Account Any S corporation with accumulated E & P must maintain an Accumulated Adjustments Account 1
Consequences to the Corporation of Effect on Accumulated Adjustments Account The AAA is the cumulative total of The ordinary income or loss, and The separately stated items for the period Consequences to the Corporation of Effect on Earnings and Profits Property distribution that results in a dividend reduces Earnings and Profits S Corporations without E & P are tax free unless they exceed basis in the stock Basis is determined at the end of the year Consequences of property distributions 2
S Corporations with E and P Four tiers in the S corp. distribution system Accumulated Adjustments Account Earnings and Profits Reduction of basis Capital gain Accumulated Adjustments Account Not a dividend Tax free to the extent of stock basis Amount in excess of basis is capital gain Accumulated Earning and Profits An S corporation will never have current E & P because there is a deduction for the income that flow through to the shareholders from accumulated E & P are dividends 3
in Excess of E & P Reduce basis of the stock first Excess over basis is capital gain from AAA AAA is used to keep track of how much post 1982 undistributed income has been tax to the shareholders from AAA are tax free Basis of stock is reduced in excess of basis is capital gain from Earnings & Profits Taxed the way they are with a C corporation S corporations formed after 1982 won t have any Earnings and Profits 4
Election to Treat Non Dividend as Dividends S corporation can elect to have distributions come out of E & P rather than out of AAA Election applies to all distributions during that year Computation of AAA Increased by income and gains Decreased by losses and deductions Decreased by distributions Computation of Earnings and Profits S Corp. Never Has Current E & P S Corp. Can Have Acc. E & P four ways The corporation may have been a C corporation in the past The E & P may have arisen during S corporation years before 1983 The S corporation may be the product of a tax free division The S corp. may have acquired the E & P of another corp. in a tax free reorganization 5
Post Termination Certain After S Corp. Status is Terminated Can Be Tax Free The distribution must be in money The distribution can be a regular distribution or a redemption The distribution must occur during a posttermination transition period Post Termination Election to Avoid Non Dividend Status Shareholder can elect not to have the distributions be tax free out of AAA of Corporation s Notes No Gain Recognized by the Corp. For the Shareholder, The FMV of the Note is the Amount of the Distribution Rules Relating to Post Do Not Apply 6
of Corporation s Stock No Gain Recognized When a Corporation Distributes Its Stock The Distribution of an S Corp. s Stock is Treated Just Like a Stock Dividend to a C Corp. Shareholder is Treated Constructive Dividends The Amount of Any Constructive Dividend is Treated as an S Corp. Distribution Subject to All the S Corp. Distribution Rules Social Security Benefits Income Pass Through From an S Corp. Is Not Earned Income 7
Self-Employment Tax An Income Distribution Is Not Subject to Self-Employment Tax Salaries and wages are subject to social security tax Shareholders Agreement Corporations Don t Typically Have Shareholders Agreements S Corporation Should Have a Shareholders Agreement Consistency of Treatment Shareholder Must Notify the IRS of Inconsistent Treatment 8