To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 12 S CORPORATIONS SOLUTIONS TO PROBLEM MATERIALS Question/ Problem Learning Objective 10 11 12 13 LO LO LO LO LO LO LO LO LO LO LO LO 2, 11 LO 2, 14 15 16 17 18 19 20 21 22 23 *24 25 26 *27 28 LO LO LO LO 6, 11 LO 6, LO LO LO 1, 11 LO 10 LO 6, 11 LO 5, LO 5, LO 5, LO 6, 8, LO Topic S corporation characteristics Distributions Favorable treatment of S corporation Advantages of S corporation Impact of NOLs Charitable contribution deduction S status requirements Second class of stock Straight debt Second class of stock Qualified shareholders S corporations and like-kind exchanges Nonresident alien and making the election Reelection after termination Availability to S corporation Schedule M-2 AAA bypass election AAA versus stock basis Stock basis Loss passthrough C corporation NOL and S election Section 1244 stock Bypass election Subchapter S ordinary income Subchapter S ordinary income Subchapter S ordinary income AAA, stock basis, AEP Income allocation Status: Present Edition Q/P in Prior Edition New New New Unchanged New New New New New New Modified Unchanged Unchanged Modified Unchanged Modified Unchanged Modified Unchanged Unchanged Unchanged Unchanged New New New New Unchanged Unchanged 10 11 12 13 14 16 18 20 23 26 27 Instructor: For difficulty, timing, and assessment information about each item, see p 12-4 12-1 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-2 2012 Corporations Volume/Solutions Manual Question/ Problem 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 *47 *48 49 50 51 52 53 54 55 Status: Present Edition Q/P in Prior Edition Shareholder salaries, distributions Distribution: appreciated property AMT flow-through Distribution and stock basis Modified New New New 29 AAA, AEP: Distribution OAA Calculating AAA Property distribution AAA bypass election Loss carryover Loss carryover election Loan basis Loan basis Loan basis Alternative minimum tax New New New Unchanged Unchanged New New Unchanged Unchanged Unchanged Unchanged 38 39 40 41 Loss allocation Loss allocation Loss allocation New New Unchanged 44 Stock basis Built-in gains tax Passive investment income tax Family S corporation and reallocation of operating income Liquidation of S corporation Section 1244 stock Reducing salary to owner Built-in gain Stock basis and NOL Unchanged New New Unchanged Learning Objective LO 5, LO 6, 7, LO 6, 11 LO 6, 8, 9, 11 LO LO LO LO 6, 7, LO 6, 7, LO 8, LO 8, LO LO LO LO 5, 6, 11 LO 6, LO 6, LO 5, 6, 8, LO 5, 6, LO 10 LO 10 LO 5, 6, 11 LO 11 LO 6, 10 LO 11 LO 10 LO 1, 6, 8, 9, 11 Topic 36 37 45 50 Unchanged New Unchanged Updated New 51 53 54 *The solution to this problem is available on a transparency master Instructor: For difficulty, timing, and assessment information about each item, see p 12-4 Tax Return Problem Topic Computing ordinary income, Schedule K-1 items adjustments (Form 1120S) Computing ordinary income, Schedule K-1 items adjustments (Form 1120S) Status Present Edition Q/P in Prior Edition New New © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com S Corporations Research Problem Topic 2% shareholder Locating S corporation rulings Second class of stock Sale of S corporation Internet activity Internet activity Internet activity Internet activity 12-3 Status Present Edition Unchanged New New Unchanged Unchanged Unchanged New New Q/P in Prior Edition © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-4 2012 Corporations Volume/Solutions Manual Question/ Problem Est’d completion time Difficulty Assessment Information AICPA* AACSB* Core Comp Core Comp 10 11 12 13 Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Medium Medium 5 5 5 5 5 15 10 FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting FN-Reporting 14 15 16 17 Medium Easy Medium Medium 10 10 10 18 Medium 10 19 20 Easy Medium 10 10 21 Medium 10 22 Easy 23 Easy 24 Easy 10 25 Easy 10 26 Easy 10 27 Medium 10 28 Medium 10 29 Medium 10 30 Medium 10 FN-Reporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Communication | Analytic Analytic Communication | Analytic Analytic | Reflective Thinking Communication | Analytic Analytic Analytic Analytic | Reflective Thinking Communication | Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com S Corporations Question/ Problem Difficulty Est’d completion time 31 Medium 10 32 Medium 15 33 Medium 10 34 Medium 10 35 Medium 10 36 Medium 10 37 Medium 10 38 Medium 10 39 Medium 10 40 Easy 41 Easy 42 Easy 43 Medium 10 44 Medium 10 45 Medium 10 46 Medium 10 47 Easy 10 48 49 50 Medium Easy Easy 10 10 51 Medium 10 52 Medium 10 53 54 55 Medium Easy Medium 10 10 12-5 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement FN-Measurement | FNReporting Analytic Communication | Analytic Communication | Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Communication | Analytic Analytic Communication | Analytic Analytic Analytic Analytic Analytic Communication | Analytic Analytic Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-6 2012 Corporations Volume/Solutions Manual CHECK FIGURES 24.a 24.b 25.a 25.b 26.a 26.b 26.c 27 28.a 28.b 29.a 29.b 30 31 32 33 34 $84,020 $21,005 $26,160 $6,000 $74,800 $24,933 $3,000 AAA, ($7,000); stock basis, $1,000; AEP, $2,000 Thomas $123,287.85; Estate $376,712.87; Ralph $500,000 Ralph $500,000; Thomas $200,000; Estate $300,000 Tobias $90,000 ordinary income (salary); Goblins $90,000 deduction Tobias $90,000 ordinary income (dividend); Goblins no deduction Capital gain, $80,000; David’s stock basis, $50,000 Epstein recognizes one-third of each item No ACE Ending stock basis, $0 Suspended loss, $50,000 AAA, ($60,000); AEP, $110,000 $56,400 35 36 37 40 41 42 44 45 46 47 48 49 52 53 54 55 Ending AAA, $801,280 Each shareholder has $200,000 dividend income, $250,000 ending basis Each shareholder has $300,000 dividend income $11,000 return of capital; $4,000 capital gain None $2,000 capital gain; $2,000 ordinary income Scott, $28,932 Ann, $31,068; Becky, $41,300 $19,200 operating loss; $4,800 capital loss Andre $6,500; Crum $16,500; Barbara $22,500 $206,500 $11,200 $84,250 loss, $50,000 ordinary deduction $3,060 saved $45,000 built-in gain; $25,000 pass-through $6,020 loss deductible © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com S Corporations 12-7 DISCUSSION QUESTIONS a No b No c No d Yes e No pp 12-2 and 12-4 Distributions to S shareholders are tax-free only to the extent that the distributed earnings were previously taxed p 12-2 In general, there is no corporate tax imposed on an S corporation As Example explains, with earnings of $300,000, an S corporation generates an extra $26,700 of after-tax earnings Further, Example illustrates the advantage of a flow through of NOLs by S corporations pp 12-3, 12-4, and Examples and If shareholders have high marginal rates relative to C corporation rates, it may be desirable to avoid S corporation status Although C corporation earnings can be subject to double taxation, good tax planning mitigates this result (e.g., when the owners take profits out as salary) Likewise, profits of the corporation may be taken out by the shareholders as capital gain income through stock redemptions, liquidations, or sales of stock paid to others Alternatively, C corporation profits may be paid out as dividends, subject to a 15% maximum tax rate Any distribution of profits or sale of stock can be deferred to a later year, thereby reducing the present value of shareholder taxes Finally, potential shareholder-level tax on corporate profits can be eliminated by a step-up in the basis of the stock upon the shareholder’s death pp 12-3 and 12-4 C corporation NOL carryovers cannot be used in an S year Even worse, S corporation years reduce the 20-year carryover period (These carryover NOLs can be used to reduce built-in gains.) pp 12-4 and 12-27 Charitable contributions are not subject to the 10% limitation at the corporate level (They flow through as a Schedule K item.) S corporations cannot take advantage of the special provisions for contributions of inventory and scientific equipment pp 12-4, 12-11, and Figure 12.1 An entity must meet these requirements to elect S corporation status: • Is a domestic corporation (incorporated and organized in the United States) • Is an eligible corporation • Issues only one class of stock • Is limited to a theoretical maximum of 100 shareholders • Has only individuals, estates, and certain trusts and exempt organizations as shareholders • Has no nonresident alien shareholders © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-8 2012 Corporations Volume/Solutions Manual pp 12-4 and 12-5 a Yes b No c No d No e No f No g No p 12-5 Characteristics of straight debt are: • The debtor is subject to a written, unconditional promise to pay on demand or on a specified date a sum certain in money • The interest rate and payment date are not contingent on corporate profits, management discretion, or similar factors • The debt is not convertible into stock • The debt is held by a creditor who is an individual (other than a nonresident alien), an estate, or a qualified trust • Straight debt can be held by creditors actively and regularly engaged in the business of lending money p 12-5 10 a No b No c No pp 12-5, 12-6, 12-30, and 12-31 11 a No b No c No d Yes e Yes © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com S Corporations 12 f Most IRAs may not be an S shareholder g Yes p 12-7 12-9 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 May 19, 2011 Bob Roman 8411 Huron Boulevard West Chester, PA 19382 Dear Mr Roman: A qualified Subchapter S subsidiary (QSSS) should be helpful in your situation The advent of QSSSs has enhanced your ability to insulate different projects from the liabilities of other projects and, at the same time, reduced the tax costs previously associated with such liability insulation Create a QSSS and make the § 1031 exchange, and the parent S corporation does not have the potential liability exposure Thus, by using a QSSS, your parent corporation avoids any potential environmental liabilities QSSSs are treated as disregarded entities They have a separate legal existence for liability purposes, but exist only as a division of the parent S corporation for tax purposes Sincerely, Michael Barbosa, CPA Partner p 12-5 13 The two shareholders will have difficulty making the S election effective for 2011 • For the election to be effective as of January 1, 2011, the previous shareholder also must consent to the election Under § 1362(b)(2)(B)(ii), where any shareholder who owns stock at the beginning of the tax year for which the election is effective, but not on the date of the election, does not consent to the election, the election is effective as of the next taxable year • Effective if the previous shareholder does consent, this previous shareholder is not a qualified shareholder (i.e., a nonresident alien) Thus, the S election is effective for 2012 (but not for 2011) pp 12-7 and 12-9 14 TAX FILE MEMORANDUM Date: September 8, 2011 From: Ryne Vorhies © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-10 2012 Corporations Volume/Solutions Manual Re: Involuntary termination of two-person S corporation—Caleb Samford, shareholder I told Mr Samford over the phone that, after an election has been terminated, five years must pass before a new election can be made Theoretically, Mr Samford must wait until the year 2015 before a new election is available Section 1362(f) does allow the IRS to make exceptions to this rule and permit an earlier election in two situations • There is a more-than-50% change in ownership after the first year for which the termination is applicable • The event causing the termination was not reasonably within the control of the S corporation or its majority shareholders Thus, Mr Samford might have a chance of an early election Reg § 1.1372-5(a) and Rev Rul 78-274, 1978-2 C.B 220 p 12-11 15 a Yes; corporate rules apply b No; dividends flow through to shareholders c No d No e No; flows through to shareholders p 12-12 16 a + OAA d + OAA g – AAA b – AAA e – OAA h – AAA c + AAA f – AAA i – AAA pp 12-17, 12-18, and Example 26 17 Collett should consider the following factors • A bypass election is available to the S corporation With the consent of all of its shareholders, an S corporation may elect to have a distribution treated as made from AEP rather than from AAA The distribution will be taxable to the shareholder, but any AEP is eliminated pp 12-16, 12-17, 12-32, and Examples 25 and 46 • Absent the bypass election, no adjustments are made to AEP during S years except for distributions taxed as dividends and adjustments from redemptions, liquidations, and reorganizations pp 12-16, 12-17, and 12-32 • Even without AEP, the S corporation should maintain an AAA This figure is needed during the post-termination transition period of approximately one year A cash distribution can reduce AAA during this postelection termination period p 12-19 and Example 27 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com S Corporations 12-11 The AAA bypass election may be used in the final year of an S election to avoid the accumulated earnings tax or personal holding company tax p 12-32 and Example 46 18 TAX FILE MEMORANDUM Date: November 1, 2011 To: Scott Roberts Re: Differences between AAA and stock basis of an S corporation Stock basis typically opens at a positive amount, and AAA starts out with a zero balance • AAA is a corporate account, and stock basis is calculated at the shareholder level • AAA can have a negative balance, but stock basis cannot go below zero • AAA is not adjusted for tax-exempt income or related expenses or for Federal taxes attributable to a C corporation tax year Stock basis is adjusted for these items pp 12-15 to 12-17, 12-20 to 12-22, and Exhibit 12.1 19 a – d + g – j + m + b + e – h – k + n – c – f + i – l – o – pp 12-20 and 12-21 20 Pertinent tax issues include the following • Can the shareholder prove the year’s ending basis in the S corporation stock? • What is the basis of the shareholder’s stock? • What is the basis of loans that the shareholder has made to the S corporation? • In what order should the shareholder apply the year’s adjustments to the S corporation stock basis? • Is there more than one type of loss (e.g., capital, passive, § 1231, etc.) that passes through to the shareholder for the year? • Does the shareholder have at-risk amounts so that the pass-through passive loss can be deducted? • Does the shareholder have passive income amounts so that the pass-through passive loss can be deducted? pp 12-23 to 12-25 21 Texas, Inc should remain a C corporation for 2011 and possibly for the next few years The $110,000 NOL carryover could not be used if the S election were made (except for purposes © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-12 2012 Corporations Volume/Solutions Manual of the built-in gains tax) The projected income for 2011–2014 indicates that Texas can take advantage of this NOL if it remains a C corporation pp 12-4 and 12-30 22 If § 1244 stock is issued to an S corporation, the S corporation and its shareholders may not treat losses on such stock as ordinary losses However, an S corporation should issue § 1244 stock to its shareholders so they can obtain ordinary loss treatment p 12-30 23 The AAA bypass election allows an S corporation to pay out AEP before AAA, e.g., to simplify the books With no AEP, the S corporation uses the simple approach to distributions When AEP is present, a negative AAA may cause double taxation The AAA bypass election also may enable the S corporation to avoid the passive investment income penalty tax pp 12-17, 12-32, 12-34, and 12-36 PROBLEMS 24 a Net sales Depreciation recapture income Deduct: Cost of goods sold Administrative expenses Depreciation expense Nonseparately computed income b $140,020 14,000 $154,020 $42,000 15,000 13,000 (70,000) $ 84,020 $84,020 ÷ = $21,005 pp 12-12, 12-13, and Example 17 25 a Sales Depreciation recapture income Less: Cost of goods sold Administrative expenses Depreciation expense Nonseparately computed income b $100,400 20,000 $120,400 $40,000 5,000 10,000 (55,000) $ 65,400 × 40 $ 26,160 $15,000 × 40 = $6,000 LTCG to Neely pp 12-12, 12-13, and Example 17 26 a Book income Add: Long-term capital loss Deduct: Dividends Tax-exempt interest § 1231 gain Recovery of bad debts Subchapter S taxable income $90,000 6,000 $96,000 $9,000 2,200 6,000 4,000 (21,200) $74,800 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com S Corporations b $24,933 ($74,800 ÷ 3) c $9,000 ÷ = $3,000 12-13 pp 12-12, 12-13, and Example 17 27 Beginning balance LTCG Balance Distribution ($6,000) Balance Loss ($9,000) Ending balance AAA $2,000 2,000 $4,000 (4,000) $ –0– (9,000) ($9,000) Stock Basis $10,000 2,000 $12,000 (4,000) $ 8,000 (8,000) $ –0– ** AEP $6,000 –0– $6,000 (2,000)* $4,000 No effect $4,000 *Taxable dividend **$1,000 suspended loss, cannot have negative stock basis pp 12-15, 12-16, 12-20 to 12-25, Example 23, and Exhibit 12.1 28 29 a Absent a per-books election, the income is allocated by assigning an equal portion of the annual income of $1 million to each day (or $2,739.72 per day) and allocating the daily portion among the two shareholders Thomas is allocated 50% of the daily income for 90 days from January through April 1, or $124,657.72 ($2,739.73 ữ ì 91) Thomass estate would be allocated 50% of the income for the 274 days from April through December 31, or $375,342.28 ($500,000 – $124,657.72) Ralph would be allocated $500,000 for the full year b If the per-books election is made, the income of $400,000 from January through April is divided equally between Ralph and Thomas, so that each would be allocated $200,000 The income of $600,000 from April through December 31 is divided equally between Ralph and Thomas’s estate, or $300,000 to each pp 12-13, 12-14, and Example 21 a Tobias recognizes $90,000 of ordinary income The corporation has a $90,000 deduction which passes through to Tobias His stock basis is reduced to zero, and he has a $10,000 loss carryover pp 12-12, 12-15, 12-16, Figure 12.1, and Concept Summary 12.1 b Tobias recognizes $90,000 of dividend income, with no deduction pass-through, and has an $80,000 remaining stock basis AEP is reduced to zero pp 12-15, 12-16, and Concept Summary 12.1 30 A capital gain of $80,000 ($240,000 – $160,000) is reported at the corporate level and each shareholder includes a flow through of $20,000 ($80,000 ÷ 4) David’s stock basis drops to $50,000 ($270,000 – 240,000 + 20,000) pp 12-13, 12-19 to 12-21, and Concept Summary 12.2 31 Pam Epstein recognizes one-third of each of the three preferences or adjustment items, as follows Mining exploration costs, $22,000 ($66,000 ữ 3) Excess depletion, $32,000 ($96,000 ữ 3) â 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-14 2012 Corporations Volume/Solutions Manual • Certified pollution control, $12,000 ($36,000 ÷ 3) An S corporation does not generate an ACE adjustment, so none of the $102,000 flows through to Epstein Bear in mind that the 26/28% individual AMT rates are higher than the corresponding 20% corporate AMT rate Furthermore, an S corporation may not take advantage of the small corporation AMT exemption pp 12-13 and 12-35 32 TAX FILE MEMORANDUM Date: October 3, 2011 Re: S corporation losses and distributions S corporation tax law now provides that distributions are treated as reductions of stock basis before considering any losses Thus, Storm Nelson, the sole shareholder, should treat the loss and distribution as follows Nelson’s beginning stock basis Less: Current year distributions Basis before loss Less: Partial loss Ending stock basis $200,000 (140,000) $ 60,000 (60,000) $ –0– Suspended loss $ 50,000 pp 12-20 to 12-24 and Example 36 33 There will be a $60,000 negative balance in AAA, and AEP remains at $110,000 Beginning balance, 1-1-12 Less: Distributions Less: Loss Ending Balance AAA $200,000 (140,000) (120,000) ($ 60,000) AEP $110,000 (–0–) (–0–) $110,000 Here AAA is adjusted first for the distributions and then for the loss However, the negative balance must be restored to a positive balance before the shareholders may receive any distributions that will not be taxed as dividend income pp 12-15, 12-16, and Exhibit 12.1 34 $56,400 ($3,900 + $5,300 + $50,000 – $2,800) pp 12-17, 12-18, and Example 26 35 a Beginning AAA Add: Sales income Dividend income Interest income $715,000 $206,000 17,000 3,000 $226,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com S Corporations Less: Real estate loss Charitable contributions § 179 expense Administrative expenses $ 5,000 22,000 2,500 41,000 Less distributions Ending AAA 12-15 (70,500) 155,500 $870,500 (69,220) $801,280 pp 12-15, 12-16, Example 26, and Exhibit 12.1 36 On the distribution of the securities, there is a recognized gain of $200,000 to Money, Inc ($1 million – $800,000), which increases AAA by $200,000 This $200,000 of gain flows through to the two shareholders ($100,000 each), and each shareholder increases his or her stock basis by $100,000 The $100,000 operating income increases the corporate AAA by $100,000 The operating income flows through to the two shareholders ($50,000 each) and increases each shareholder’s stock basis by $50,000 Thus, before the distribution of securities, AAA is $600,000 ($300,000 + $100,000 + $200,000) The $1 million distribution is treated as coming first from AAA, to the extent of $600,000, and then from AEP, to the extent of $400,000 AAA is reduced to zero ($600,000 – $600,000), and AEP is reduced to $200,000 ($600,000 – $400,000) Before the distribution, each shareholder’s basis is $550,000 ($400,000 + $100,000 + $50,000) Basis then is reduced by the nontaxable portion of the distribution (i.e., $300,000 from AAA) to $250,000 each Each shareholder has $200,000 of dividend income resulting from the distribution pp 12-13, 12-15, 12-16, 12-19 to 12-21, Exhibit 12.1, Concept Summaries 12.1, 12.2, and § 1367(a)(2)(A) 37 Most of the results are the same as in item 36, except that AEP is reduced to zero Each shareholder receives a $300,000 taxable distribution and a $200,000 tax-free distribution from AAA The AAA is $200,000 at the end of the year ($600,000 – $400,000), and each shareholder’s basis is $350,000 (550,000 – $200,000) pp 12-13, 12-15, 12-16, 12-19 to 12-21, Exhibit 12.1, and Concept Summaries 12.1 and 12.2 38 Under the general rule of Reg § 1.1367-1(f), the normal basis adjustment can result in the disappearance of $1,000 of the nondeductible, noncapital losses Hence, Wheat’s 2010 stock basis of $5,000 is reduced to zero by the $6,000 nondeductible, noncapital losses, since losses cannot drop stock basis below zero Although the 2010 $10,000 ordinary loss carries over to 2011 to help offset the 2011 taxable income of $12,000, none of the unused nondeductible, noncapital losses (e.g., $1,000) carries over p 12-21 39 Under the Reg § 1.1367-1(g) election, the $10,000 ordinary loss reduces Wheat’s stock basis to zero, allowing Wheat to deduct $5,000 of the $10,000 The other unused $5,000 ordinary loss carries over to 2011 Likewise, the $6,000 of nondeductible loss in 2010 is treated as incurred in 2011 (and thereby deductible) against the 2011 taxable income of $12,000 p 12-21 40 Section 1367(b)(2)(B) indicates that only the ‘‘net increase” is applied to restore any reduction in loan basis Here there is no net increase ($11,000 – $15,000) Since stock basis © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-16 2012 Corporations Volume/Solutions Manual has been increased by $11,000, there is $11,000 tax-free income and a $4,000 capital gain p 12-21 and Example 32 41 None, since the loan basis is back to the original $10,000 p 12-21 and Example 31 42 Here the loan basis is only back to $8,000, so Jeff has a $2,000 capital gain ($10,000 – $8,000) with a corporate note If no corporate note exists, Jeff reports $2,000 ordinary income pp 12-21 and 12-22 43 Section 56(b)(1)(A)(i) denies a deduction for the $400,000 of investment expenses for purposes of the alternative minimum tax, even though net taxable income seemingly is zero ($400,000 – $400,000) Thus, $400,000 of investment income flows through to the shareholder If an S corporation makes cash distributions to the shareholder to help pay any AMT, these distributions in turn create additional alternative minimum tax liability p 12-35 and Figure 12.1 44 Scott: $28,932 ($120,000 × 50% × 176/365) pp 12-13, 12-22, and 12-23 45 Ann: $31,068 ($120,000 × 50 × 189/365) Becky: $60,000 ($120,000 × 50), but limited to $41,300 pp 12-13, 12-22, and 12-23 46 TAX FILE MEMORANDUM Date: December 1, 2011 RE: Flow-through of Losses If a shareholder’s basis is insufficient to allow the full use of the flow-through losses and there is more than one type of loss, the amount of each deductible flow-through loss is determined on a pro rata basis Ms Freiberg’s share of the operating loss is $24,000 ($80,000 × 30%) and of the capital loss is $6,000 ($20,000 × 30%), for a total share of losses of $30,000 Since her basis in the stock is $24,000, only $24,000 is deductible Thus, $19,200 of the operating loss [($24,000/$30,000) × $24,000] and $4,800 of the capital loss [($6,000/$30,000) × $24,000] can be deducted currently by Ms Freiberg The unused losses ($4,800 operating loss; $1,200 capital loss) are carried forward to future years pp 12-12, 12-13, 12-20 to 12-23, and Figure 12.1 47 Beginning basis STCG Distribution Nondeductible fees and penalties Net tax operating loss LTCL Ending stock basis Andre $12,000 12,500 (5,000) (1,000) (10,000) (2,000) $ 6,500 Crum $22,000 12,500 (5,000) (1,000) (10,000) (2,000) $16,500 Barbara $28,000 12,500 (5,000) (1,000) (10,000) (2,000) $22,500 pp 12-13, 12-20, 12-21, and Example 31 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com S Corporations 48 12-17 $206,500 The net unrealized built-in gain on the conversion date is $685,000 ($105,000 – $10,000 + $700,000 – $110,000), the maximum amount subject to the §1374 tax The recognized built-in gains and loss are: Accounts receivable collected Accounts payable Gain on the land (limited to the built-in gain) Total $105,000 (110,000) 700,000 $695,000 Taxable income is $590,000 and the built-in gains tax is assessed on the smaller amount ($590,000 × 35% = $206,500) However, there is a carryforward of the net built-in gains amount that escapes taxation due to the taxable income limitation, to be taxed in subsequent years when taxable income is sufficient Therefore, $95,000 is carried into 2012 and treated as a recognized built-in gain then pp 12-25 to 12-27 and Concept Summary 12.3 49 Lesser of taxable income or excess net passive income: $32,000 × 35% = $11,200 The alternative minimum tax does not apply to an S corporation pp 12-27 and 12-28 50 This family may be trying to avoid salaries to obtain employment tax savings Likewise, the absence of salaries to the parents shifts income to the daughter, who may be in a lower tax bracket Under § 1366(e) and Reg § 1.1373-1(a)(2), the IRS agent could require that reasonable compensation be paid to all three owners Additional payroll taxes also may be assessed In this case, however, the allocation of compensation to the daughter results in an increase in her earned income and a decrease in her unearned income (i.e., her pro rata share of S corporation ordinary income) This, in turn, results in a reduction in the kiddie tax, which applies only to unearned income, and consequently may reduce the overall income taxes paid by the family members However, the agent also would impose payroll taxes upon the salary amounts Bonnie Clyde Daughter No Salaries $60,000 60,000 60,000 With Salaries* $35,000 35,000 35,000 *$180,000 – $30,000 – $35,000 – $10,000 = $105,000 × 1/3 = $35,000 pp 12-13, 12-29, 12-32, 12-33, and Example 43 51 TAX FILE MEMORANDUM Date: June 15, 2011 From: Judy Hernandez Re: Friedman, Inc., liquidation I told Arnold Schwartz, CFO, over the phone that S corporations are subject to many of the same liquidation rules applicable to regular corporations For example, the distribution of the appreciated land and inventory is treated as if the property were sold to the shareholders in a taxable transaction The S corporation incurs no corporate tax (except for any § 1374 tax), but the gains flow through to the shareholders Any corporate gain increases the shareholders’ stock basis by like © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-18 2012 Corporations Volume/Solutions Manual amounts and reduces any gains realized by the shareholders when they receive the liquidation proceeds Typically, double tax is avoided, but special tax attributes disappear (i.e., AAA) With respect to the depreciated marketable securities, the S corporation can recognize the loss p 12-36 52 Ms Crochet recognizes a loss of $84,250 ($12,750 – $97,000), of which $50,000 is an ordinary § 1244 deduction, and $34,250 is a LTCL (subject to her $3,000 per year limitation) pp 12-30, 12-31, and Chapter 53 Opal and the corporation save $3,060 in FICA taxes ($20,000 × 153) However, an IRS agent may argue that a reasonable salary is not being paid and recharacterize the distribution as a salary pp 12-32, 12-33, and Footnote 68 54 Total gain is $70,000 ($120,000 – $50,000), and the net unrealized built-in gain as of January 2011 is $45,000 ($60,000 – $15,000) The net amount of gains and losses sets the upper limit on the tax base for the built-in gains tax Thus, $45,000 of the $70,000 is subject to the corporate built-in gains tax The other $25,000 of gain is subject to the S corporation pass-through rules and bypasses the corporate income tax pp 12-26 and 12-27 55 The 2010 C corporation NOL of $74,000 does not carry forward into the S corporation year (except for built-in gains purposes) Although Pete’s share of the 2011 NOL is $10,750 ($43,000 × 25), only $6,020 of the total loss is deductible by Pete in 2011, with a $4,730 carryover pp 12-4, 12-13, 12-20, 12-21, 12-23, 12-24, 12-33, and Example 47 The answers to the Research Problems and the Tax Return Problems are incorporated into the Instructor’s Guide with Lecture Notes to accompany the 2012 Annual Edition of SOUTH-WESTERN FEDERAL TAXATION: CORPORATIONS, PARTNERSHIPS, ESTATES & TRUSTS © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ... more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-10 2012 Corporations Volume/Solutions Manual Re: Involuntary termination of two-person S corporation Caleb...To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-2 2012 Corporations Volume/Solutions Manual Question/ Problem 29 30 31 32 33 34... or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-12 2012 Corporations Volume/Solutions Manual of the built-in gains tax) The projected