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Discussion:C-corp electing S-Corp status as of 1/1/14

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Discussion Forum Index --> Advanced Tax Questions --> C-corp electing S-Corp status as of 1/1/14


Discussion Forum Index --> Tax Questions --> C-corp electing S-Corp status as of 1/1/14

Brian99j (talk|edits) said:

27 February 2014
What, if anything, would be of concern for an accrual basis C-corp with 12 shareholders converting to S-corp status as of the beginning of this year with the following:

245K in retained earnings 900K in inventory (will be marked up 100% for sale) no appreciation of real property or any other investments

Shareholders will be able to distribute profit as of 1/1/14 and their stock basis prior to dipping in to C-corp retained earnings, correct? And theoretically if shareholders did end up taking distributions from C-corp (pre-2014) retained earnings those would be distributions in excess of basis so taxed as long-term capital gains, correct?

Thanks.

Terry Oraha (talk|edits) said:

27 February 2014
And theoretically if shareholders did end up taking distributions from C-corp (pre-2014) retained earnings those would be distributions in excess of basis so taxed as long-term capital gains, correct?

NO. those have a high probability of being dividends. Determine E&P.

900K in inventory (will be marked up 100% for sale)

Not even sure what that means.

What, if anything, would be of concern for an accrual basis C-corp

Built-in gains tax. What about BIG accruals?

no appreciation of real property or any other investments

Don't let this be based on your valuation of property. Is there an appraisal?

Brian99j (talk|edits) said:

27 February 2014
I'll look into E&P issue. As far as I know it's just normal RE from operations. I meant the inventory will be sold for 1.8 million, 100% markup from cost of 900K. I need to look at accruals, AP and business loans I believe are the liabilities. I meant the corp doesn't own any real estate or other investments.

Common Stock is 300K.

Thanks for your response.

Terry Oraha (talk|edits) said:

27 February 2014
E&P is often very close to RE. You actually don't adjust retained earnings to get to E&P. You take accumulated taxable income and determine the necessary adjustments to get to E&P. I would review the company to see if any major adjustments exist. If not then RE can be a close guesstimate.

Now for BIG inventory fmv is determined as a hypothetical bulk sale, not retail.

Brian99j (talk|edits) said:

27 February 2014
Assets are Cash of 603K, A/R of 250K and Inventory of 910K - Liabilities are A/P of 690K, Commission payable of 48K and customer deposits of 208K.

Does that change anything? I don't think there is a built-in-gains issue here.

Would distributions made, let's say on day one after the conversion, be considered C-corp dividends? In other words, assuming R/E = E&P, is the E&P first to be distributed in the form of dividends? It sounds like that is the case per your response above. Thanks.

Terry Oraha (talk|edits) said:

27 February 2014
It sounds like that is the case per your response above - not really see 1368(c).


1368(c) says that if you exceed AAA then you start distributing E&P then after E&P then you go back to the general rule, which is making distributions in excess of basis.

Brian99j (talk|edits) said:

27 February 2014
That's how I understood it works. Is their any rule on length of time, 5 years maybe, after which the E&P dividend treatment doesn't apply, and they would be considered distributions in excess of basis?

What if an individual sold stock after conversion to S-corp? Can that trigger built-in-gains tax attributable to goodwill?

Laketahoecpa (talk|edits) said:

27 February 2014
I'm not sure if this was made clear but you can make a distribution January 1 and as long as S corp has positive AAA account at end of year (greater than distributions made) then you're okay. Per ยง1368(c), if the distributions during the taxable year exceed the amount in the accumulated adjustments account at the close of the taxable year, then you will dip into E&P and have dividend treatment.

No length of time on E&P dividend treatment. You'll be okay if you don't distribute more than S corp AAA.

You stated you don't think there is built-in gains issue. But I believe Terry pointed out that you've got built-in gains with your inventory.

Terry Oraha (talk|edits) said:

27 February 2014
There very well might not be a BIG issue with

Assets are Cash of 603K, A/R of 250K and Inventory of 910K

A/R is on the accrual, so nothing big there... Inventory is generally expected to be more than replacement cost and less than retail, somewhere in between, slow-moving inventory can have fluctuations the faster moving inventory is more likely to not have BIG or BIL. See Rev. Proc. 2003-51 guidance on fmv of bulk sale of inventory.


You may have no BiG afterall. However, what about shareholder comp not paid before year end that too is something I would consider. The rest of your AP and accruals if they were booked and deducted on the final C corp return they're done and we can forget about them. I would have some kind of Analysis to show the BIG or lack thereof for future reference. Appraisals are always the best, but may not apply here.

Doug M (talk|edits) said:

27 February 2014
As a starting point, you need to determine the FMV and tax basis of every asset, as well as the FMV of the liabilities.

Brian, don't take this wrong. If this is your first step into the BIG tax world, and this is a decent size client, and you might want to solicit some help on this one. This can be a tax trap for the unwary. Managing the BIG carryover, etc.

You may have no BiG afterall.

I have seen no discussion about equipment, goodwill, etc.

you've got built-in gains with your inventory.

I would argue strongly that you don't.

Terry Oraha (talk|edits) said:

27 February 2014
oh Doug brings a good point - Intangibles?

Doug M (talk|edits) said:

27 February 2014
You can also accrue a payable to the shareholders that will reduce your BIG that can be paid in 2014. Somebody out there knows the cite on this quirk. It might be nightsnorkeler.

Brian99j (talk|edits) said:

3 March 2014
Could there be an issue of an owner later sells their S-corp stock? Isn't their a 10 year rule? How is the shareholder's gain treated by the corp in this case?

Terry Oraha (talk|edits) said:

3 March 2014
Could there be an issue of an owner later sells their S-corp stock? - No

Isn't their a 10 year rule? How is the shareholder's gain treated by the corp in this case?

10 year built-in-gain recognition period applies to corporate assets, not stock.

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