Ch 12 S Corp Basis Overview 221 Ch 12 S Corp Basis Overview Basis from Stock and Loans 2014 Rules for Loan Basis Operation how basis is used and restored Accounting for Capital Accounts

S Corp Basis Overview 221 Stock basis- used first Then Debt Basis The must be separately accounted for. How basis gets restored is based on if there is an overall “net increase” or not. Basis calculation is required with the return when a loss is deducted. The Shareholder has the responsibility for determining basis.

E. Order of Basis Adjustments 173 225 E. Order of Basis Adjustments Basis + Income Items - Distributions - Non deductibles - Loss Items

F. Elective Ordering Rule (Reg. 1.1367-1(g) 173 225 F. Elective Ordering Rule (Reg. 1.1367-1(g) Basis + Income Items - Distributions - Non deductibles - Loss Items Would you like to change?

F. Electing Ordering Rule Example 226 F. Electing Ordering Rule Example

F. Electing Ordering Rule Example 226 F. Electing Ordering Rule Example

F. Electing Ordering Rule Example NIM F. Electing Ordering Rule Example Without the Election- Year 2 Sus. Loss Current Year Allow Carryforward Nondeductible $3,500 Deductible $4,500 $14,000 $18,500 Total $17,500

F. Electing Ordering Rule Example NIM F. Electing Ordering Rule Example With the Election- Year 2 Sus. Loss Current Year Allow Carryforward Nondeductible $1,000 $3,500 $4,500 Deductible $14,000 $18,500 Total $17,500 $23,000

F. Electing Ordering Rule Example NIM F. Electing Ordering Rule Example With the Election- Year 3 Gain of $5,000 Sus. Loss Current Year Allow Carryforward Nondeductible $4,500 $3,500 $8,000 Deductible $18,500 $5,000 $13,500 Total $23,000 $21,500

F. Electing Ordering Rule Example NIM F. Electing Ordering Rule Example With the Election- Year 3 Gain of $20,000 Sus. Loss Current Year Allow Carryforward Nondeductible $4,500 $3,500 $1,500 $6,500 Deductible $18,500 $0 Total $23,000 $17,500

Not Enough Basis? Comment Contribute cash to corp. Contribute property Buy shares Make loans to the corporation

233 Debt Basis Final Regulations use Bona Fide debt standard rather than “actual economic outlay. Guarantees are still based on the “actual economic outlay” standard.

Old Standard 233 S1 Corp S2 Corp Cash -0- Cash $100 K Loss 100 K Income $100 K Client Basis In S1 $0 Basis in S2- $100K

Old Standard 233 S1 Corp S2 Corp Cash -0- Cash $100 K Loss 100 K Income $100 K Client Basis In S1 $0 Basis in S2- $100K

Old Standard 233 S1 Corp S2 Corp Cash -0- Cash $100 K Loss 100 K Income $100 K Client Basis In S1 $0 Basis in S2- $100K

Old Standard 233 S1 Corp S2 Corp Cash -0- Cash $100 K Loss 100 K Income $100 K Client Basis In S1 $0 Basis in S2- $100K

Old Standard 233 S1 Corp S2 Corp Cash -0- Cash $100 K Loss 100 K Income $100 K Client Basis In S1 $0 Basis in S2- $100K

Old Standard 233 S1 Corp S2 Corp Cash -0- Cash $100 K Loss 100 K Income $100 K Client Basis In S1 $0 Basis in S2- $100K

Old Standard 233 S1 Corp S2 Corp Cash -0- Cash $100 K Loss 100 K Income $100 K Client Basis In S1 $0 Basis in S2- $100K

New Standard – Bona Fide Debt 233 New Standard – Bona Fide Debt S1 Corp Cash -0- Loss 100 K S2 Corp Cash $100 K Income $100 K YES Client Basis In S1 $0 Basis in S2- $100K

Bona Fide Debt Standard 233 Bona Fide Debt Standard The following work Example 1- Bona Fide Loan from Shareholder Example 2- Guarantees remain unchanged Example 3- Back to Back Loans Example 4- Loan through distributions.

Bona Fide Debt Standard 235 Bona Fide Debt Standard B. The James Maguire, et us vs. Comm- TC Memo 2012-160 Lead to the 2014 debt regulations. Taxpayers owned a finance company and an auto dealership. Finance company earned a profit while the auto dealership operated at a loss.

Bona Fide Debt Standard 235 Bona Fide Debt Standard B. The James Maguire, et us vs. Comm- TC Memo 2012-160 Taxpayers had basis in the finance company but no basis in the auto dealership. Taxpayers took a distribution of AR from finance company- at FMV Contributed the AR to the auto dealership.

Bona Fide Debt Standard 235 Bona Fide Debt Standard B. The James Maguire, et us vs. Comm- TC Memo 2012-160 IRS disallowed the loses Court sided with the taxpayer Note: QSub or used of LLC sub could have fixed this also.

Bona Fide Debt Standard 235 Bona Fide Debt Standard C. Hargis, TC Memo 2016-232 In 2009 and 2010 Taxpayer was the co-borrower on loans Arkansas state law holds co-borrowers as directly liable for the loans. All indebtedness and payments ran directly through the company. Including loans from related party LLCs.

Bona Fide Debt Standard 235 Bona Fide Debt Standard C. Hargis, TC Memo 2016-232 Court held that none of the loans increased basis. 4. Court cited lack of evidence in with regard to the LLC loans to the company.

The lender intended to make a loan to the taxpayer, however the loan documents indicated the taxpayer’s S Corp is the borrower. The taxpayer used the loan for basis to deduct losses. In the case the Court sided with: The taxpayer- thanks to the testimony of Bank’s lending officer. With IRS, because the Court found there was insufficient evidence to find the loan was made to taxpayer. Answer: B- The Court sided with IRS. Page 236. D.

Bona Fide Debt Standard 236 Bona Fide Debt Standard D. Tinsley, TC Summary Op 2017-9 In 2006, the corporation took out loans with the shareholders as the guarantor. Four years later the corporation was liquidated. Taxpayers took loss. The year after the liquidation, the loan was renewed.

Bona Fide Debt Standard 236 Bona Fide Debt Standard D. Tinsley, TC Summary Op 2017-9 Both the bank and the taxpayers intended the loan to be to the “taxpayers”. However the loan documents were still in the name of the defunct corporation. Finding: Court found there was insufficient evidence to find the loan was from Tinsley.

Bona Fide Debt Standard 236 Bona Fide Debt Standard E. Phillips, TC Memo 2017-61 Question: Was a judgement against the taxpayer an economic outlay. Phillips was a real estate developer who had fallen on hard times. All notes were forced to a judgement Phillips never made any payments on the judgement.

Bona Fide Debt Standard 236 Bona Fide Debt Standard E. Phillips, TC Memo 2017-61 Taxpayer’s argued that the judgements were “deemed capital” contributions. Court agreed with the IRS. Memo: it seems that this is more along the lines of a guarantee and even under the new regs. would not provide basis.

Deducting Losses Against Debt 237 Deducting Losses Against Debt Once Stock basis is reduced to “Zero” Loan basis is used. Example Gary on this page.

Example: Deducting Losses Against Debt 237 Example: Deducting Losses Against Debt K-1 Items Total Non-separately stated loss $ -41,000 Long-term capital gain $ 5,000 IRC 1231 loss $ -6,000

Example: Deducting Losses Against Debt 237 Example: Deducting Losses Against Debt Stock Basis Total Stock basis, beginning $ 25,000 Add income items- gain $ 5,000 Basis before loss $ 30,000 Total losses $47,000 $ -30,000 Stock basis ending $ -0- Total Loss is comprised of Non-separately stated loss $41,000 and 1231 loss of $6,000.

Example: Deducting Losses Against Debt 237 Example: Deducting Losses Against Debt Debt Basis Total Debt basis beginning $ 50,000 Remaining loss $ -17,000 Debt basis ending $ 33,000

238-239 Restoration of Basis C. If a ‘net increase” debt basis gets restored first, up to the outstanding amount as of the beginning of the year. D. Net increase- income items exceed loss, deduction and distributions . (pg. 239). E. Capital contributions are not counted. F. Otherwise the activity starts with stock basis until it hits “Zero”.

238-239 Restoration of Basis Warning: To track debt basis properly you must include the “opening debt balance” in the software.

Example: Deducting Losses Against Debt 239 Example: Deducting Losses Against Debt K-1 Items Total Non-separately stated Income $ 41,000 Long-term capital gain $ 5,000 IRC 1231 loss $ -6,000 Non-dividend distribution $-30,000 Do we have a net increase?

Example: Deducting Losses Against Debt 239 Example: Deducting Losses Against Debt K-1 Items Total Non-separately stated Income $ 41,000 Long-term capital gain $ 5,000 IRC 1231 loss $ -6,000 Non-dividend distribution $-30,000 Do we have a net increase? Yes not increase of $10,000.

Example: Restoration of Basis 239 Example: Restoration of Basis The Rule: if you have a net increase then you restore debt basis first up to its outstanding balance as of the beginning of the year. Outstanding balance as of beginning of year is $50,000. Basis in the loan is $33,000. The entire $10,000 is applied against debt basis.

Example: Deducting Losses Against Debt 205 Example: Deducting Losses Against Debt Debt Basis Total Debt basis beginning $ 33,000 Remaining loss $ 10,000 Debt basis ending $ 43,000

Example: Restoration of Basis 239 Example: Restoration of Basis F. When netting results in a negative number, debt basis is not increased by pass through items.

Example: Deducting Losses Against Debt 239 Example: Deducting Losses Against Debt K-1 Items Total Non-separately stated Income. $ 41,000 Long-term capital gain $ 5,000 IRC 1231 loss $ -0- Non-dividend distribution $-46,000 Do we have a net increase?

Example: Deducting Losses Against Debt 239 Example: Deducting Losses Against Debt K-1 Items Total Non-separately stated loss $ 41,000 Long-term capital gain $ 5,000 IRC 1231 loss $ -6,000 Non-dividend distribution $-46,000 Do we have a net increase? No, no increase “Zero”

Example: Deducting Losses Against Debt 240 Example: Deducting Losses Against Debt Stock Debt Beginning Basis $ -0- $ 33,000 Income Items $ 46,000 $ -0- Balance before dist. Distribution $-46,000 Balance before loss $ 33,000 IRC 1231 Loss $ -6,000 Basis End of Year $ 27,000

What if there are multiple debts? 241-242 What if there are multiple debts? If there are multiple debts and a net increase the increase is applied in the following manner. H. Debt that was repaid gets increased first up to the amount of repayment or the net increase. I. Anything remaining is applied based on the debts % of the total basis.

188 243 Q. Open Account Debt Our Client , Inc. 10 K

Q. Open Account Debt 188 Our Client , Inc. 243 188 Q. Open Account Debt Our Client , Inc. 5 K 10 K We can do this as long as the aggregate amount of debt outstanding at end of year does not exceed $25,000. Note on page 208- item 5- if the debt exceeded $25,000 on 8/20/08. You are stuck with this also.

243 Q. Open Account Debt Our Client , Inc. 25 K 10 K

VIII. Repayment of Reduced-Basis Debt 243 VIII. Repayment of Reduced-Basis Debt IRS is big on this issue. You repay reduced basis debt- you have a taxable gain. See example on page 245

XI. S Corp Capital Accounts 247 XI. S Corp Capital Accounts AAA- Accumulated Adjustments Account E&P- C Corp earnings- page 249. PIT- Previously Taxed income pre-1983- page 250. OA- Other Adjustments Account.- tax exempt and federal taxes paid - 250

251 XV. Distributions Example on Page 251

Who would like to recognize a “qualified dividend” to create an ordinary loss?

253 Who would like to recognize a “qualified dividend” to create an ordinary loss? Strategy for an S Corp that was a former C Corp. or merged with a C Corp and has earnings an profits.

B.Make an election to by-pass AAA 253 Who would like to recognize a “qualified dividend” to create an ordinary loss? B.Make an election to by-pass AAA C. Elect to make a ‘deemed” dividend. Retained Earnings –Debt Contributed Capital- Credit Shareholder pay “dividend rate”