SURGENT S ADVANCED CRITICAL TAX ISSUES FOR S CORPORATIONS ACTS/14/01

SURGENT S ADVANCED CRITICAL TAX ISSUES FOR S CORPORATIONS ACTS/14/01

Table of Contents What is New... 1 Basis and Distribution Rules and Problems... 2 S Corporation Compensation Planning... 3 Selling the S Corporation... 4 Redemptions and Liquidations of S Corporations... 5 Estate-Planning Issues... 6 One Class of Stock and Partnerships... 7 Taxable Year and Accounting Methods... 8 This product is intended to serve solely as an aid in continuing professional education. Due to the constantly changing nature of the subject of the materials, this product is not appropriate to serve as the sole resource for any tax and accounting opinion or return position, and must be supplemented for such purposes with other current authoritative materials. The information in this manual has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. In addition, Surgent McCoy CPE, LLC, its authors, and instructors are not engaged in rendering legal, accounting, or other professional services and will not be held liable for any actions or suits based on this manual or comments made during any presentation. If legal advice or other expert assistance is required, seek the services of a competent professional. Revised May 2014

What is New I. Cases and rulings 1 A. S corporations 1 1. Miscalculating basis of S stock 1 2. Basis in S corporation to claim loss 3 3. Health plans 4 4. Deducting health insurance premiums 6 5. Life insurance premiums and proceeds 8 6. Amortizing proprietor goodwill 9 7. Prospective S corporation rental income not passive 10 8. No more than one class of stock 12 9. Discretionary payments 14 10. Capital contributions 15 11. Professional service businesses 20 12. Roth IRA ineligible S corporation shareholder 21 13. S corporation basis limitation on losses 22 14. Debtor company had no property interest in QSub status 25 B. Final regulations on cancellation of indebtedness income of S corporations 28 1. In general 28 2. Final regulations 30 C. S corporation basis issues 32 1. What is the current state of loans as a means to generate tax basis? 32 2. Restructuring into a back-to-back loan 33 3. Debt between S corporations 37 4. Open account debt advances -- the Brooks case 40 5. Planning for repayments of loans against which losses have reduced the basis from the face amount 41 6. Final regulations -- in general 42 7. What is open account debt? 43 8. Multiple debts 43 9. Timing issues 43 10. Basis adjustment for charitable contributions 45 11. Planning issues 46 D. S corporation built-in gains tax 48 1. Pre-ARRA law 48 2. Temporary reduction in the recognition period 48 E. Employees of S corporations 49 1. Wages 49 2. Family employees 50 3. S corporation planning 50 4. Transfers to family member 52 5. Recent cases -- JD & Associates 52 6. Recent cases -- Watson 54 7. IRS Fact Sheet on wage compensation for S corporation officers 55 8. Identifying the factors 57 F. 2013 NEW relief procedures for late filing of Form 2553 58 1. Rev. Proc. 2013-30 58 2. Late corporate classification elections 59 3. Relief where all returns have been filed as an S corporation 60 4. How to file Form 2553 under Rev. Proc. 2013-30 62 5. Supplemental procedural requirements when seeking relief for multiple late elections 63 1-i

Basis and Distribution Rules and Problems I. Basis adjustment for shareholders 1 A. In general 1 1. Formation and capital contributions 1 2. Gift 2 B. Operations 2 1. Allocating shares of items of an S corporation to shareholders 2 2. Character of items in pro rata share 4 3. Gross income of a shareholder 5 4. Net-operating-loss deduction 5 5. Special rules limiting the pass-through of certain items of an S corporation 6 C. Basis adjustments 6 1. Increases in basis 6 2. Decreases in basis 7 3. Adjustment priority 8 4. Adjustments for items of income in respect of a decedent 10 5. Uses 10 D. Shareholder loans and basis 10 1. In general 10 2. Guarantees 10 3. Piggyback loans 11 4. Nonrecourse debt and the at-risk rules 12 5. Discharge of guarantee 13 E. Basis restoration in indebtedness 13 1. In general 13 2. Restoration of basis 13 3. Ordering 14 4. Allocation 14 F. S corporation debt basis final regulations 14 1. In general 14 2. What is open account debt? 14 3. Multiple debts 15 4. Timing issues 15 II. Distributions 17 A. Distribution by corporation without accumulated earnings and profits 17 1. Two-tier system 17 2. Timing of computation of basis 17 3. Allocation of distribution among shares 18 B. Distributions by a corporation with accumulated earnings and profits 19 1. In general 19 2. Accumulated earnings and profits 19 3. Obtaining earnings and profits 19 4. Four-tier priority system 19 5. Computation of accumulated adjustments account 20 6. The negative accumulated adjustments account 23 7. Timing of adjustments to AAA 23 8. Adjustment to AAA for distributions in excess of basis 24 9. Allocation among distributions 24 10. Distribution of tax-exempt income 25 11. Redemptions and AAA 25 12. Impact of AAA on sale of stock 27 C. Tax treatment to corporation on distributions of property 27 1. C corporation rules 27 2. Ordinary income 27 3. Gain passed through 27 2-i

4. Distributions of loss property 27 D. Adjustments to earnings and profits 28 1. General rule 28 2. Exceptions 28 E. Election to change dividend priority 28 1. Consent of shareholders 28 2. Effect of election 28 F. Distributions after termination of election 28 1. In general 28 2. Post-termination transition period 28 3. Cash 29 4. Election to treat post-termination distributions as dividends 29 III. Loss limitations 30 A. Basis 30 1. Limitations on deduction of pass-through items of an S corporation to its shareholders 30 2. Carryover of disallowed losses and deductions in liquidations, reorganizations, and divisions 32 3. Discharge of indebtedness 32 B. At risk 33 C. Basis reduction 33 1. Limitations on deduction pass-through items 33 2. Ordering 36 3. Election 36 4. Allocation 37 5. Debt basis reductions 37 D. Character of gain on repayment of debt 38 1. Uncertainty 38 2. Gain on repayment 38 3. Ordering 38 4. Cancellation-of-debt income 38 E. Excess losses 38 1. Carryover 38 2. Character 39 F. Excess loss in post-termination transition period 39 1. In general 39 2. Post-termination transition period 39 3. Loans 39 4. Timing 39 G. At-risk consideration 39 H. Tax planning for loss basis 40 1. An additional stock purchase 40 2. A capital contribution 40 3. A shareholder loan to the corporation 40 2-ii

S Corporation Compensation Planning I. General compensation planning 1 A. S corporations -- No E&P 1 1. Getting money out 1 2. Tax consequences of distributions 1 3. Tax consequences of compensation 1 4. Cash distributions versus cash compensation payments 2 B. S corporations -- With accumulated E&P 5 1. Tax consequences of distributions 5 2. Tax consequences of compensation 6 3. Cash distributions versus cash compensation payments 6 II. Reallocation of income among family members 9 A. Power of reallocation 9 1. In general 9 2. Reasonably low compensation 9 3. Reasonably high compensation 10 4. Persons to whom allocated 10 5. Reasonableness 10 6. JGTRRA changes -- In general 12 3-i

Selling the S Corporation I. Special problems with S corporations 1 A. Asset acquisitions by S corporations 1 1. In general 1 2. Subsidiary issue 1 3. Allocation 1 4. Built-in gains tax 1 B. Stock acquisitions by S corporations 2 1. In general 2 2. Immediate liquidation 2 3. Section 338 2 4. No 338 election 2 C. Sale of assets by the S corporation 4 1. Continuation of the S election 4 2. Accounting issues 4 3. Built-in gains tax 4 D. Sale of stock of an S corporation 5 1. In general 5 2. Allocations 5 3. Basis adjustments 5 4. Post-sale distributions 5 5. Pre-sale distribution 6 6. Double tax 6 7. Acquisition of an S corporation by a consolidated group 6 8. Net investment income tax 8 9. New proposed regulations 11 10. Allocation of gain or loss on the disposition of a pass-through interest 14 11. Optional simplified reporting 19 12. Deferred recognition transactions 22 13. Information reporting 22 E. Section 338(h)(10) transactions involving S corporations 23 1. In general 23 2. Final regulations 23 3. Nonselling minority shareholders 24 4. Consent 24 5. QSub target 25 6. Installment sales 26 7. Final 336(e) regulations 27 4-i

Redemptions and Liquidations of S Corporations I. Redemptions 1 A. Distribution or exchange 1 1. Distribution 1 2. Exchange 1 3. Consequences of exchange treatment 2 4. Carryover of unused losses by shareholders 3 5. Investment-credit recapture by shareholders and S corporation 4 B. Effect of redemption on income and loss of S corporation 5 1. In general 5 2. Property distributions 5 3. Interest expense 6 4. Allocation of S corporation items in year of redemption 7 5. Effect on accumulated adjustments account 8 6. Effect on accumulated earnings and profits 9 II. Liquidations 10 A. In general 10 1. Subchapter C rules 10 2. Procedural limitations 10 B. Consequences to the S corporation 10 1. In general 10 2. Liquidation of a qualified Subchapter S subsidiary 10 3. Effect of pass-through 10 4. Liabilities in excess of basis 11 5. Exceptions to the rule of recognition 11 6. Investment credit 13 7. Built-in gains tax 13 8. Allocation of income and loss 13 9. Passive-investment income 14 C. Consequences to the shareholder 14 1. In general 14 2. Basis of property 14 3. Unused losses 15 4. Investment-tax credit recapture 15 D. Use of installment sales of assets 15 1. In general 15 2. Installment obligations for sale of inventory 16 3. Related-party rules 18 4. Characterization of gain 20 5. Recognition of built-in gains 21 E. Tax planning 22 1. Liquidation versus continued corporate existence 22 2. Allocation of purchase price proceeds 27 5-i

Estate-Planning Issues I. Basis step-up of S stock 1 A. In general 1 1. Section 1014 1 2. Nonelective 1 3. Applicable stock 1 B. Income in respect of a decedent (IRD) 2 1. In general 2 2. Partnerships 2 3. Prior rulings 3 C. Effect of basis adjustment on transfers and ownership 5 1. Marital transfers 5 2. Transfers to children 5 3. Losses and distributions 6 D. Redemption of S corporation stock 6 1. Binding buy-sell agreement 6 E. Eligibility 7 1. A domestic corporation 7 2. No more than 100 shareholders 7 3. Type of shareholder 7 4. QSST 9 5. Electing small-business trust 11 6. Electing small-business trusts -- Guidance 13 7. One class of stock 16 II. Life insurance and buy-sell agreements 17 A. Basic tax principles 17 1. Use of basis 17 2. AAA 18 B. Corporate-owned policies 18 1. Premiums 18 2. Basis adjustment 18 3. Effect on AAA 19 4. Proceeds 19 C. Split-dollar life insurance and nonqualified deferred compensation 20 1. In general 20 2. Double tax 20 3. Third-party split-dollar 21 4. Shareholder split-dollar 21 5. Contributory plans 21 6. Deferred compensation 22 D. Buy-sell agreements 23 1. Critical nature 23 2. Cross-purchase agreements 24 3. Redemptions 24 6-i

One Class of Stock and Partnerships I. Revised one-class-of-stock regulations 1 A. Background 1 1. Final regulations 1 2. Differences 1 3. General rule 1 4. Section 83 2 B. Terms of the governing provisions 2 1. Binding agreements relating to distribution and liquidation proceeds 2 2. Exceptions to identical-rights rule 3 3. Routine commercial contractual arrangements 4 4. Buy-sell and redemption agreements 4 5. Debt instruments 5 II. Uses of partnerships with S corporations 6 A. Advantages of a partnership of S corporations 6 1. Special allocations and preferential distributions 6 2. Investor participation in management 6 3. Passive-loss rules 6 4. Classification concerns 7 5. Receipt of interest for services 7 6. Formation of the entity 7 7. Later transfer of interest in entity 7 8. Avoidance of Subchapter S limitations 8 B. Disadvantages of a partnership of S corporations 8 1. Administrative costs 8 2. Limitation on owners 8 3. Basis in ownership interest 9 4. Conduit nature of entity 9 5. Distributions 9 6. Section 754 adjustment 10 7. Unitary basis in interest 10 8. Liquidation in accordance with capital-account balances 11 9. Validity of a partnership of S corporations 11 C. Alternatives to use of partnership of S corporations 12 1. Limited partnerships 12 2. Limitation on number of shareholders 12 3. Special allocations and preferential distributions 13 4. Receipt of interest for services 14 5. Disregarded entities 14 7-i

Taxable Year and Accounting Methods I. Taxable year 1 A. General rule 1 B. Section 444 election 1 1. When the election is not required 1 2. Which taxable year can be elected 1 C. How to make the 444 election 2 1. In general 2 2. Back-up election 2 3. Tiered structures 3 D. Termination of the 444 election 3 E. Required payments under 7519 3 1. In general 3 2. Payment formula 4 3. Net base-year income 4 4. Five-hundred-dollar rule 5 5. Refunds and interest 5 6. Penalties 5 F. General estimated tax reports requirement 6 1. In general 6 2. Computation of estimated tax obligations 6 G. Adopting, changing, or retaining a taxable year 6 1. Automatic approval procedures 6 2. Nonautomatic approval procedures 8 II. Adoption of accounting methods 11 8-i