Reg 5 - Flow Through Entity Taxation and Multi-jurisdictional Tax Issues

Question 1

What are requirements to qualify as an S Corp?

Answer 1

1. Qualified domestic corporation
2. Eligible shareholders (individuals, estates, certain trusts, retirement plans, 501c3
3. Shareholder limit (100 maximum, family members count as one shareholder)
4. One class of stock (differences in common stock voting rights allowed)

partnerships are not eligible to be a S corp. an LLC with more than 1 owner is CANNOT be treated as S corp

Question 2

Relating to a S Corp, what is Accumulated adjustments account (AAA) and Other Adjustments Account (OAA)?

Answer 2

Accumulated adjustments account (AAA) is the accumulated earnings and profits of the S Corp. It is increased by ordinary business income and separately stated income and gains. AAA is decreased by ordinary business losses, separately stated losses and deductions, nondeductible expenses (other than tax exempt income), and distributions.
capital contributions does not impact AAA

Other adjustments account (OAA) is increased by tax exempt income and decreased by nondeductible expenses related to tax exempt income

Question 3

Relating to partnerships, how are nonliquidating distributions treated for the following:

1. Cash
2. Property

Answer 3

1. Cash distributions (nonliquidating) are nontaxable to the extent of the partner’s basis, if the cash distribution is in excess of basis, then it will be taxable income
2. Property distributions (nonliquidating) are NEVER taxable income to the partner

Question 4

A partner in a RE partnership had a basis of $5K at the beg of year and $10K at end of year. The partner’s at risk amount was $8K. The partner’s K-1 listed $12K as his share of partnership loss. What amount can the partner deduct on his tax return?

Answer 4

The partner would be able to deduct $8K, the at risk amount. This results in a $2K suspended loss.

The flow through of the loss is first limited to the partner’s basis of $10K, then is further limited by the at risk amount of $8K,

Question 5

Relating to a complete liquidation for a partnership, what would be the partners basis in the property distributed?

Answer 5

it would be the partner’s basis in the partnership, minus cash distributions (it would not be the FMV of the property)

Question 6

Relating to a complete liquidation for a partnership, when would gain be recognized on a property distribution?

Answer 6

a partner would recognized a gain only to the extent that the money received exceeds the partner’s basis. if no money is received then no gain is recognized

Question 7

What percentage of shareholders need to approve an S Corp revocation statement ?

Answer 7

the S Corp is revoked on the date when over 50% of the shareholders elect to revoke.

Question 8

What percentage of shareholders need to approve an S Corp election status?

Answer 8

100% of the shareholders or it will be invalid

Question 9

Greg’s basis in Massi Partnership was $70 at the time he received a non-liquidating distribution of partnership capital assets. These capital assets had an adjusted basis of $65 and FMV of $83. What is Greg’s recognized gain or loss on the distribution?

Answer 9

0. No gain or loss. The FMV of the property is not relevant. Greg’s basis will be $5 after the distribution.

Question 10

how can a corporation claim foreign income taxes?

Answer 10

either as a deduction or credit, at the option of the company

Question 11

Greg’s stock basis in his S Corp stock at end of Y1 is $30K. Greg also loaned the S Corp $10K from his checking account in Y1. In Y2, the S Corp incurred an ordinary business loss and Greg’s share was $75K. In Y3, the S Corp had business income and Greg’s share was $50K. What is the ordinary income or loss flowed through to Greg for Y2 and Y3? what is the tax basis for both years?

Answer 11

Y2 - Greg has flow through $40K loss of the $75K. This is limited due to the $40K tax basis ($30K stock basis and $10K debt basis). The additional $35K loss is suspended and carried forward. The tax basis in now $0.

Y3 - Greg has $50K in ordinary income flowed through. The income first reinstates the debt basis to $10K, then the remaining $40K increase her stock basis. The suspended loss of $35K can now be flowed through for deduction for Greg and the tax basis is now $5K ($40K - $35K)

Question 12

Rachel, a single taxpayer, created an LLC, which she elected to be taxed as a partnership. Rachel has contributed $20K cash at inception. Rachel was allocated $5K recourse debt that she had to personally guarantee and $8K of nonrecourse debt. In Y1, her share of ordinary business loss was $35K. She is actively involved in the business. What is her tax basis, at risk amount, and what loss can she deduct on her personal income tax return?

Answer 12

Rachel’s tax basis is $33K. ($20K contribution + $5K recourse debt + $8K nonrecourse debt)

Rachel’s at risk amount is $25K ($20K contribution + $5K recourse debt)

Rachel can deduct $25K of loss in her tax return for year 1:

Following the 4 business loss limitations

1. Tax basis is $33K, so loss is limited to $33K
2. Then at risk amount is $25K, so loss is limited to $25K
3. Then PAL limit, since this isnt a passive activity for Rachel she is not subjected to PAL limitation.
4. Business loss limitation - Rachel’s combined business loss is $25K which is below the $270K max for the year.

Question 13

Rachel, a single taxpayer, created an LLC, which she elected to be taxed as a partnership. Rachel has contributed $100K cash at inception. Rachel was allocated $20K recourse debt that she had to personally guarantee and $30K of nonrecourse debt. In Y1, her share of ordinary business loss was $50K. She is NOT actively involved in the business. What is her tax basis, at risk amount, and what loss can she deduct on her personal income tax return?

Answer 13

Rachel’s tax basis is $150K. ($100K contribution + $20K recourse debt + $30K nonrecourse debt)

Rachel’s at risk amount is $120K ($100K contribution + $20K recourse debt)

Rachel cannot deduct any of the loss in her tax return for year 1:

Following the 4 business loss limitations

1. Tax basis is $150K, so loss is $50K (ordinary business loss)
2. Then at risk amount is $120K, so loss is $50K (ordinary business loss)
3. Then PAL limit, since this is passive activity and Rachel has no other passive income she is not able to deduct any of the $50K.
4. Business loss limitation - do not need to do analysis as the loss is limited at the PAL step.

Question 14

For an S Corp, does tax exempt interest increase a company’s OAA and AAA?

Answer 14

Tax exempt interest will only increase an S Corp’s OAA

Question 15

For an S Corp, what is the treatment of fringe benefits (ie medical insurance) for shareholders?

Answer 15

Fringe benefits paid by an S Corp are deductible only for non-shareholder employees and 2% or less employee-shareholders

Question 16

If a shareholder loans the S Corp money, how does this loan impact the shareholder’s basis?

Answer 16

it will increase the shareholder’s basis by the loaned amount.

Question 17

An S Corp has income of $72K after the following deductions:

• IRC Section 179 election to expense depreciable property $15K
• Charitable contributions $11K
• Salary to owner who worked as CEO of the Corporation $84K

What is the amount of non-separately stated income shown on the S Corp’s income tax return?

Answer 17

$98K ($72K + $15K + $11K)

Section 179 expense is a separately stated item (flows to shareholder directly)

Question 18

If an S Corp distributes $30K and the shareholder tax basis is $25K, what is the tax treatment of the distribution?

Answer 18

$25K is considered a return of capital and reduces the basis to 0

$5K is considered a capital gain distribution. will be long term is the stock is held longer than 1 yr.

Question 19

Greg contributed artwork in exchange for a partnership interest. The artwork had an adjusted basis of $7K, had a FMV of $50K, and was subject to a loan of $5K. What is the partnership’s basis in the artwork?

Answer 19

The partnership’s basis would be $7K

Question 20

Doris and Lydia are equal partners in the capital and profits of a partnership. Lydia sold Misonix stock to the partnership for $4K, her basis was $9K. what is the treatment of this transaction for Lydia (realized and recognized).

Answer 20

Realized loss of $5K, and recognized loss of $3K

**if Lydia had owned more than 50% the loss would have been disallowed.

Question 21

Snail Corporation filed its 2021 Form 1120-S on February 20, 2023. Snail is a calendar-year taxpayer with 5 shareholders. What amount will Snail owe for failure to file on time?

Answer 21

Under Sec. 6699, a penalty is imposed on an S corporation for failure to file an S corporation return within 2 1/2 months of the end of the tax year. The penalty is imposed in the amount of the number of persons who were shareholders during any part of the year multiplied by $210 for each of up to 12 months (including a portion of one) that the return was late. As a calendar-year taxpayer, Snail’s 1120-S was due March 15, 2022. Counting whole and partial months, the return was 12 months late, making the penalty $12,600 (5 shareholders × $210 penalty × 12 months).

Question 22

Last year, Jim, one of two equal partners, contributed land with a basis to him of $15,000 and a fair market value of $10,000 to the partnership of which he was a member. His capital account was credited for $10,000. The land was later sold for $8,000. As a result of this sale, Jim must report on his personal income tax return

Answer 22

$6K loss

Generally, neither the partnership nor any partner recognizes gain or loss when property is contributed in exchange for a partnership interest. The partnership’s basis in the property is $15,000 (the contributing partner’s basis at the time of contribution). The sale of the property by the partnership resulted in a $7,000 loss ($8,000 proceeds less $15,000 AB). Precontribution loss must be allocated to the contributing partner. Jim must recognize all of the precontribution loss of $5,000 ($15,000 basis – $10,000 FMV contribution) plus his $1,000 share of postcontribution loss [($10,000 FMV of contribution – $8,000 sales price) × 1/2].

Question 23

For the year ended December 31, 2021, the partnership of Murray and Parker had book income of
$100,000, which included the following:

Long-term capital gain $ 7,000
Section 1231 loss $(3,000)
Dividends $200
Interest paid to partners for use of capital $12,000

The partners share profits and losses equally. What amount of partnership income (excluding all partnership items that must be reported separately) should each partner report in his individual income tax return for 2021?

Answer 23

$47,900

A partnership’s ordinary income is the portion of taxable income not required to be stated separately. The interest paid to partners is a guaranteed payment, which results in an ordinary deduction. Book income may be adjusted to ordinary income by excluding all items of income and adding back all deduction and loss items, which must be separately stated. The partnership’s ordinary income is

Book income $100,000

Add back: Section 1231 loss 3,000
Subtract: Long-term capital gain (7,000)
Dividends (200)
=
Partnership ordinary income $ 95,800

Because the partners share profits and losses equally, each partner’s share of partnership income is $47,900 ($95,800 × 50%).

Question 24

The CSU partnership distributed to each partner cash of $4,000, inventory with a basis of $4,000 and a fair market value (FMV) of $6,000, and land with an adjusted basis of $5,000 and a FMV of $3,000 in a liquidating distribution. Partner Chang had an outside basis in Chang’s partnership interest of $12,000. In the second year after receiving the liquidating distribution, Chang sold the inventory for $5,000 and the land for $3,000. What income must Chang report upon the sale of these assets?

Answer 24

$1,000 ordinary gain and $1,000 capital loss.

Chang begins with $12,000 of AB. Cash is distributed first and Chang’s AB is reduced to $8,000. Next, the $4,000 of inventory reduces Chang’s overall AB to $4,000. Since there is only $4,000 AB remaining, Chang is only able to take a $4,000 basis in the land. He cannot go negative in basis for a non-cash distribution. The sale of the inventory was completed within 5 years of the distribution; therefore, the $1,000 gain ($5,000 sale price – $4,000 AB) is an ordinary gain (not capital gain). The sale of the land results in a $1,000 capital loss ($3,000 sale price – $4,000 AB).

Question 25

An S corp status will terminate if it has too much passive income. What is the rule for this?

Answer 25

if an S Corp has passive income greater than 25% for 3 consecutive years it will terminate its status

Question 26

Is the built in gains tax applicable to Sole proprietorships that have changed to S Corp?

Answer 26

no it is not, only applicable to previous C Corps

Question 27

Relating to a shareholder in an S Corp, what is the impact of a shareholder’s basis when guaranteeing corporate debt vs making a direct loan to the S Corp?

Answer 27

a guarantee for debt does not increase/create a debt basis for the shareholder.

When a shareholder directly loans $ to S Corp, this increases the shareholders basis

Question 28

What is the difference between an S Corp and Partnership when distributing appreciated property to shareholder (nonliquidating)?

Answer 28

S Corp cannot distribute appreciated property to shareholder without recognizing a gain.

Partnership can distribution is generally tax free

Question 29

is a section 1231 gain/loss a separately stated or ordinary income item for a partnership and S Corp?

Answer 29

it is a separately stated item for both.

Question 30

During the current year, Mr. and Mrs. X made joint gifts to their son of the following items:

• A painting with an adjusted basis of $16,000 and a fair market value of $45,000.
• Stock with an adjusted basis of $27,000 and a fair market value of $30,000.
• An auto with an adjusted basis of $16,000 and a fair market value of $18,000.
• An interest-free loan of $8,000 for a boat (for the son’s personal use) on January 1 of the current year, which was repaid by their son on December 31 of the current year. Assume the applicable federal rate was 11% per annum.

-What is the gross amount of gifts includible in Mr. and Mrs. X’s gift tax return?

Answer 30

$93,000

The amount of a gift made in property is the fair market value of the property on the date of the gift [Sec. 2512(a)]. The auto, painting, and stock have a combined fair market value of $93,000.
In general, an interest-free loan results in deemed transfers of interest between the borrower and lender. When the two parties are related, the lender is deemed to have made a gift of the interest amount to the borrower [Sec. 7872(a)(1)]. However, Sec. 7872(c)(2) excludes gift loans between individuals from this provision if the aggregate outstanding principal does not exceed $10,000. Accordingly, the $8,000 interest-free loan does not result in a gift.

Question 31

Jimmy Johnson made several gifts during 2021. He gave his niece $10,000 as a graduation gift, he paid $15,000 college tuition for his nephew, and he gave his daughter $30,000 as a wedding gift. Jimmy is not married. What are the total taxable gifts to be reported?

Answer 31

$15,000

$30 - $15 = $15

Question 32

Joe is contemplating retirement and decided to simplify his financial situation by disposing of some assets. He had the following transactions during 2021:

1. Sold his business to his son for $100,000. The fair market value of the business at the time of the sale was $175,000.
2. Paid college tuition of $20,000 for his brother’s child.
3. Gave stock valued at $15,000 to his alma mater.
4. Paid $25,000 of the medical expenses of his sister who had no insurance.

What is the total amount of taxable gifts (before exclusion) that should be reported on his gift tax return for 2021?

Answer 32

$75K is reported as a taxable gift before exclusion

Question 33

In December 2021, Angela sold 20 shares of Neely Co. stock for $8,000. This was qualified small business stock that she had bought in August 2015. Her basis is $2,000. What is her taxable gain?

Answer 33

Under Sec. 1202(a), an individual may exclude from gross income 50% of any gain from the sale or exchange of qualified small business stock held for more than 5 years. The exclusion increased to 75% for purchases between February 17, 2009, and September 28, 2010, and 100% after that. Angela has met all of the requirements of Sec. 1202(a). Therefore, of the $6,000 ($8,000 – $2,000) gain, none of it (i.e., 100% exclusion) is taxable.

Question 34

Gwen owned a duplex and lived in one-half. The other half was rental property. The cost of the property was $80,000, of which $70,000 was allocated to the building and $10,000 to the land. During the current year, the property was condemned by the city. Up to that time, she had allowed/allowable depreciation of $23,000. The city paid Gwen $70,000. She bought another duplex for $85,000. Gwen lived in one-half, and the other half is a rental. What is the basis of the replacement property?

Answer 34

Gwen has two assets, one for rental and one for personal use. Each asset must be computed separately. The basis of the rental building before the sale was $17,000 ($40,000 purchase price – $23,000 depreciation taken). That portion of the building was sold for $35,000, leaving a gain of $18,000. The gain is deferred, leaving a basis for the replacement property of $24,500 ($42,500 – $18,000). The personal-use building has a $5,000 loss ($35,000 selling price – $40,000 basis). That loss is a nondeductible personal loss. The replacement portion has a basis of $42,500, the purchase price. The total basis is $67,000 ($24,500 rental portion + $42,500 personal-use portion).

Question 35

Nolan designed Timber Partnership’s new building. Nolan received an interest in the partnership for the services. Nolan’s normal billing for these services would be $80,000, and the fair market value of the partnership interest Nolan received is $120,000. What amount of income should Nolan report?

Answer 35

$120K

A partner who receives a partnership capital interest in exchange for services recognizes compensation income equal to the FMV of the partnership capital interest. Gross income must be reported when an interest received is subject to neither substantial risk of forfeiture nor restrictions on transfer. The income reported is ordinary.

Question 36

On September 1, 2021, Julie’s basis in her partnership interest was $75,000. In a distribution in liquidation of her entire interest on that date, she received properties A and B, neither of which were inventory or unrealized receivables. On September 1, 2021, property A had an adjusted basis to the partnership of $35,000 and a fair market value of $75,000. Property B had an adjusted basis to the partnership of $15,000 and a fair market value of $25,000. Based on this information, what was Julie’s basis in property A immediately after the distribution?

Answer 36

$55K

If a partner’s interest is liquidated solely through a distribution of partnership property other than money, no gain is recognized. If the partnership distributes property other than money, the partner’s basis in the partnership must be transferred to the distributed assets. When a liquidation occurs and the partner’s basis in the partnership exceeds the partnership’s basis in the distributed assets, the excess of the partner’s basis in the partnership must also be allocated among the distributed assets. Any basis increase required is allocated first to properties with unrealized appreciation in proportion to the respective amounts of unrealized appreciation inherent in each property (but only to the extent of each properties unrealized appreciation). Any remaining increase is then allocated in proportion to the properties’ fair market values. Property A is first assigned its basis of $35,000 and property B is assigned $15,000. Another $25,000 ($75,000 partnership basis minus $50,000 AB assigned to properties) must be allocated to the two properties. Property A is allocated $20,000 [$40,000 increase in FMV over $50,000 ($40,000 appreciation of A + $10,000 appreciation of B) total increase in FMV times $25,000]. Thus, property A is assigned a basis of $55,000 ($35,000 initial basis + $20,000 based on increase in FMVs).