Area 5

Question 1

How are intercompany transaction taxed?

Answer 1

The intercompany gain(loss) is realized and put into a suspense account until the related company sales the property to a third party. Once sold to a third party, both companies recognize their share of the gain(loss).

Question 2

How are Net Operating Losses by C Corps Treated?

Answer 2

Prior to TCJA, Corporations had the option to carry back the NOL 2 years or forward 20 years. As Per TCJA, losses arising for tax years beginning after December 31, 2017, no NOL carryback is allowed, but a carry forward is allowed indefinitely.

Additionally, under the prior law, a 100% deduction of the NOL was allowed.

However, as per TCJA, the deduction for NOL is limited to the lesser of:

The aggregate of net operating loss carryovers to such year, plus the net operating loss carryback to such year, or
80% of taxable income computed without regard to deduction allowable.

Question 3

What is the charity deduction limitation for C Corps?

Answer 3

A corporation’s deduction for charitable contributions generally is limited to 10% of taxable income without regard to

(1) the deduction for charitable contributions
(2) the dividends-received deduction
(3) any capital loss carryback to that year

Question 4

What is the Dividends Received Deduction?

Answer 4

Dividend Received Deduction (DRD) is a special deduction available to certain corporations on the amount of dividend income received. The amount of deduction varies with the % of ownership in the investee and is calculated on the lower of actual dividends received or taxable income (updated for TCJA):

<20% interest – 50% deduction
20% to 80% - 65% deduction
>80% interest - 100% deduction via consolidation.

The 50% deduction is calculated on the lower of taxable income or the actual dividends received.

Question 5

What is the Accumulated Earnings Tax?

Answer 5

Accumulated earnings tax (AET) is a form of penalty tax that is imposed by the IRS on non-personal holding companies which unreasonably accumulate excessive (retained) earnings without distributing as dividends to shareholders. AET can be eliminated/reduced if: Actual dividends are paid during the tax year or within 3 1/2 months after the tax year (i.e. due date of tax return) Accumulated earnings which have “reasonable” needs as demonstrated by a specific , definite and feasible plan for use.

Question 6

What is Built In Gain?

Answer 6

Under TCJA, S Corporations that were previously C corporations are subject to a built-in-gains tax @ 21% if they sell or distribute assets within 10 years of the election of S-Corp. status (Note: The recognition period has been reduced to 5 years starting from 2011). The tax is imposed on the unrealized gain calculated as the difference between the FMV of asset and its basis at the time of S-election.

Question 7

How is basis calculated in an S Corp?

Answer 7

An S corporation shareholder’s initial basis in the S corporation’s stock is increased by the share­holder’s pro rata share of non-separately stated income, separately stated income, and depletion in excess of basis in the property as well as reduced by the shareholder’s pro rata share of losses, separately stated deduc­tion items, distributions not reported as income by the shareholder, and nondeductible expenses of the corpor­ation.

Question 8

How do Property Distributions affect a Partner’s Basis in a Partnership?

Answer 8

In general, under §732(a)(1) a partner’s basis in property distributed to her or him by the partnership as a nonliquidating distribution is the same basis that the partnership had in the property. However, §732(a)(2) limits the partner’s basis in the distributed property to her or his adjusted basis in the partnership reduced by any money distributed in the same transaction.

In short, the basis is in the property is the lower of the basis in the partnership or the basis in the land. If the Basis in the property exceeds the basis in the partnership. Reduce the partner’s basis in the property by the difference from the basis in the partnership and the partnership’s basis in the property.

Question 9

How is a Partner’s initial basis treated in acquiring a percentage of ownership in the partnership when rendering services? When acquiring a percentage by giving cash or property?

Answer 9

When a partner renders services to a partnership in exchange for an interest in the partnership, the partner reports ordinary income equal to the Fair Market Value (FMV) of the partnership interest being granted.

Generally an exchange of partnership interest for cash or property is a tax-free transaction. A partner’s basis in partnership is increased for cash or adjusted basis of property contributed. FMV of property is ignored in determining the partner’s basis.

Question 10

How to calculate gain on sale of share of partnership.

Answer 10

Calculate actual amount realized. (Cash received + Share of Liabilities given up)

Calculate Basis- Add Income + Share of Liability - Distributions

Subtract Basis from amount realized to get gain on sale of share.

Question 11

Distributions from partnership - Property

Answer 11

When a partnership distributes property. The partner gets carryover basis from the partnership.

A non-liquidating distribution by a partnership to its partners is not taxable and it has the effect of reducing the basis that the Partner holds in the Partnership. The partner’s basis in the partnership is reduced by the tax basis of the asset and fair market value of the asset is ignored. Only if the basis of distributed assets is more than the partner’s basis in the partnership would the gain be recognized.

Question 12

Personal Holding Company PHC

Answer 12

If at any time during the last half of the tax year, more than 50% of the value of the outstanding stock of a corporation is owned directly or indirectly by five or fewer individuals, and at least 60% of the corporation’s adjusted ordinary gross income consists of certain passive income, the corporation is a personal holding company.

Question 13

S Corp

Compute Earnings for members that acquired stock in the middle of the year.

Answer 13

Share holder earnings in an S Corp are computed on a per share per day basis.

Earning x Days of stock held/Days of the year x percent of stock owned

Question 14

Partnerships

How do liabilites affect basis?

Answer 14

Increase/decrease in liabilities at the end of the year increases/decreases the partner’s basis.

The partnership’s liabilities increased by the $20,000 by year-end. The individual is a 50% partner and liable for his/her share of liabilities. The individual’s share of the increase in liabilities is $10,000. This increases his/her basis since he/she is personally liable (i.e. recourse debt).

Question 15

Partnership

How is property treated in a liquidating and non-liquidating distribuiton?

Answer 15

Liquidating-
Partner’s current basis less cash received = Adjusted basis
The partner’s basis in the land is the partner’s adjusted basis.
Exception- If the partner’s adjusted basis is at or below 0, then the partner’s basis in the land is the carryover basis from the partnership.

Non-Liquidating
Partner’s Basis is the carryover from the partnership

Question 16

Partnership

Property Contributions and sale of that property.

Answer 16

If a partner contributes land with a FV higher than their basis in the land, the basis carries over to the partnership and there is a built-in gain. The built-in gain is not recognized until the partnership sells the property. The entire portion of the built-in gain is attributable to the partner that transferred the property. The remaining gain is spread evenly throughout the entire partnership.

According to Sec 704(c) of the IRC, when gain is realized on the sale of a built-in-gain property, the built-in-gain must be allocated solely to the contributor of property. Built-in gain is computed as the difference between the FMV and basis at time of contribution of property. The remaining gain is allocated among all partners in proportion to their interest or partnership agreement. When the land contributed by Acre was sold for $160,000, the total gain realized was $100,000 ($Selling price $160,000 - Cost basis $60,000). The built-in-gain portion of $40,000 (FMV $100,000 - Basis $60,000) must be allocated 100% to Acre. The remaining gain of $60,000 is shared equally as per the partnership agreement.

Question 17

Basis in Inherited Property

Answer 17

FMV of property on death of the individual. Or Six Months After.

Carryover Basis Not Allowed

Question 18

S Corp vs Partnership vs LLC Basis

Answer 18

LLCs can choose to be taxed as an S Corp or a Partnership

Income flows through for both entities

Liabilities outstanding at the end of the year only applies to Partnerships - NOT S Corps

Question 19

Which costs can be capitalized and amortized in the formation of a corporation?

Answer 19

Section 248(b) defines organization costs as costs incident to the creation of the corporation and chargeable to a capital account. Reg. §1.248-1(b)(2) includes costs of drafting the corporate charter as costs eligible for amortization. 
 AKA LEGAL FEES

Reg. §1.248-1(b)(3) includes professional fees, printing costs, and commissions incurred in the issuing or selling of stock as costs that are not eligible for amortization as organization costs. These costs are treated as a reduction of the corporation’s capital.

Question 20

When can a business recognize an expense when conducting business with an individual?

Answer 20

The business can recognize the expense when the individual recognizes the income.

If the individual is cash basis and the business only pays half of the expense accrued, then the business can only take half of the expense because the individual will only recognize the amount received.

Question 21

Types of Trusts

Answer 21

Grantor trust (revocable trust), which allows the grantor to retain control or ownership interest in the trust. Therefore, the trust is ignored for trust tax reporting purposes and the Grantor is required to report all income on individual tax return, Form 1040.

Simple trust is one where all income of the trust is distributed to the beneficiary during the year. It files Form 1041 which reports income passed on to the beneficiaries who pay taxes on them.

Complex trust is one where not all income earned by trust is passed on to beneficiaries. Some income is retained in the Corpus. It files Form 1041, which pays taxes on income retained in the Corpus and reports the remaining income that is allocated to the beneficiaries who pay taxes on the same.

Pre-Need Funeral trust is set up to meet the funeral expenses upon death.

Question 22

To Revoke S Corp Status

Answer 22

At least 51% of all shareholders must approve

To become a S Corp, 100% must approve.

Question 23

Guaranteed Payments in a Partnership

Answer 23

A partner does not receive salary or wages in a partnership. The payments are classified as guaranteed payments.

The Guaranteed payments are treated as wages and are deductible by the business. They also DO NOT affect individual partnership basis except by reducing net income before guaranteed payments.

Question 24

Accumulated Adjustments Account

Answer 24

Beginning Adjustments to Ending Adjustments

I.E.

$100,000 beginning accumulated adjustment account balance + $440,000 ordinary business income − $24,000 separately stated taxable income and deductible expense items − $2,000 nondeductible expense − $30,000 shareholder distributions = $484,000

Question 25

Sale of items with a partnership

Answer 25

If the partner owns a majority of the partnership, the gain on sale is ordinary.

While a partner may engage in a transaction with her partnership in a capacity other than as a member of such partnership [§707(a)], if the partner owns, directly or indirectly, more than 50% of the capital or profits interests in such partnership, then the gain upon the sale or exchange of property between them which, in the hands of the transferee, is not a capital asset as defined in §1221, shall be considered as ordinary income [§707(b)].

Question 26

What are Hot Assets?

Answer 26

Generally, the gain on sale of partnership interest is a capital gain, since it is sale of an investment asset. However, of the total gain, ordinary income must be recognized to the extent of partner’s share of inventory and receivables in the partnership. The remaining is capital gain. This is because had the partner not sold his interest, these “hot assets”, it would have yielded regular business income, which would have been treated as ordinary income by the partner.

Hot Assets are the partner’s share of ordinary income assets of the partnership that they use to differentiate the portion of the gain on sale of the partnership to ordinary income or capital gains.