Advanced Tax Strategies for S Corporations

American Recovery and Reinvestment Act of 2009 1-1 American Recovery and Reinvestment Act of 2009 Extended carryback period for NOLs arising from small businesses Built-in gain tax not imposed on the 8th, 9th or 10th year of recognition period COD income may be deferred to 2014 and taxed over 5 years Private Activity Bond interest not subject to AMT

2008 Tax Extenders and AMT Relief Act 1-2 2008 Tax Extenders and AMT Relief Act Tax preparers may use the substantial authority standard in non-tax-shelters R&D credit extended to 2008 and 2009 Incremental credit repealed after 2008 Rules under Rev. Rul. 2008-16 for charitable contributions extended to 2008 and 2009

The Small Business and Work Opportunity Tax Act of 2007 1-3 The Small Business and Work Opportunity Tax Act of 2007 Bank S corporations Change to reserve method Bank director shares Accumulated earnings & profits ESBT Sale of QSub stock More-likely-than-not standard

The American Jobs Creation Act of 2004 1-4 The American Jobs Creation Act of 2004 Increase in number of shareholders Limit increased to 100 Family treated as 1 shareholder Inadvertent termination relief IRA as an S corporation bank shareholder ESBT beneficiary defined

The American Jobs Creation Act of 2004 – Losses 1-5 The American Jobs Creation Act of 2004 – Losses Transfer of suspended loss to spouse Passive activity losses and at risk amounts for QSSTs

The American Jobs Creation Act of 2004 – QSub 1-6 The American Jobs Creation Act of 2004 – QSub Inadvertent invalid election relief QSub information returns No longer on the no ruling list

3 – Basis in S Corporation Stock Understand the rules relating to the adjustment of basis in stock by S corporation shareholder Understand how losses are limited by basis

Computation of Basis Original basis + Additional capital contribution 3-1 Computation of Basis Original basis + Additional capital contribution + Share of separately stated income items + Share of nonseparately stated income and gains + Share of tax exempt income + Excess of deduction for depletion over the basis of the property subject to depletion - Distributions - Share of nondeductible, non-capital expenses - Share of nonseparately stated ordinary loss - Share of separately stated deductions/losses - Shareholder’s deduction for depletion Shareholder’s stock basis not below zero

Adjustments to Basis Basis is adjusted in the following order 3-2 Adjustments to Basis Basis is adjusted in the following order All positive items Distributions Nondeductible, noncapital expenses Other deductions Basis is generally computed at year-end Basis is adjusted per share

Basis of Indebtedness Must be direct shareholder debt 3-3 Basis of Indebtedness Must be direct shareholder debt Personal guarantees do not increase basis Stock basis is decreased by losses first, then basis in debt Basis in debt is restored before basis in stock

3-4 Economic Outlay Shareholder acquires basis in debt only if they experience an actual economic outlay Issue becomes a problem with Loans from related entities Back-to-back loans

Limitation of Deduction of Losses 3-5 Limitation of Deduction of Losses Amount of losses that can be deducted limited to the sum of the shareholder’s basis in stock and direct loans Losses limited by Section 1336(d) are carried over indefinitely Losses carried over only with respect to that shareholder Losses are then limited by at-risk basis and passive activity rules

4 – Distributions Be able to apply the rules for cash distributions Be aware of the rules for property distributions Understand the ordering of distributions

4-1 Distributions Distributions are payments to shareholders that are based on stock ownership No effect on corporate income Whether or not taxable to the shareholder depends on if the S corporation has AE&P

Cash Distributions Made by S Corporation without E&P 4-2 Cash Distributions Made by S Corporation without E&P Tax-free return of stock basis Distribution reported when received Gain only if amount received exceeds basis Distribution reduces basis in stock

Cash Distributions Made by S Corporation with AE&P 4-3 Cash Distributions Made by S Corporation with AE&P Distributions come out of the following accounts in the order shown Accumulated Adjustments Account (AAA) Previously Taxed Income (PTI) Accumulated Earnings & Profit (AE&P) Other Adjustments Account (OAA) Election allowed under Section 1368(d) to take distribution out of AE&P first

Tax Effect of Distributions 4-4 Tax Effect of Distributions AAA, PTI, and OAA – Nontaxable to the extent of basis; Gain in excess of basis AE&P – Taxable Dividend; No effect on basis

4-5 AAA Balance starts at zero the 1st day of the 1st taxable year after 1982 Increased by Nonseparately stated income; Separately stated items of income and gain; Excess depletion (other than oil and gas); and Decreased by Nonseparately stated loss; Separately stated items of loss or deduction; Nondeductible or noncapital expenses; Cost depletion

Differences between AAA and Basis 4-6 Differences between AAA and Basis The AAA increases and decreases by the same items as basis does each year, except Tax-exempt income increases basis, but does not increase the AAA Expenses relating to tax-exempt income reduce basis, but do not decrease the AAA Federal taxes relating to a C corporation year reduce basis, but do not decrease the AAA The order that increases and decreases is applied to basis and AAA differs Losses and deductions (but not distributions) can reduce the AAA below zero. Basis can never have a negative balance

Property Distributions 4-7 Property Distributions Amount Distributed = FMV of property S corporation must recognize income (but not loss) as if the property had been sold Sale could be subject to BIG tax

Post-termination Transition Period (PTTP) 4-8 Post-termination Transition Period (PTTP) Cash distributions during PTTP applied against basis to the extent of AAA PTTP begins on the day after the last day as S corporation and ends the later of (1) one year after termination, (2) the due date (including extended date) of final S return or (3)120 days after a final determination (e.g., court decision) that S election was terminated