TAX 4011 Final Exam

Sales Tax Nexus

-Physical presence of: 1. Sales personnel (or other employees) within the state 2. Independent agents acting on behalf of the taxpayer 3. Real or personal property within the state -after Wayfair, state can impose sales tax responsibility if it meets criteria of: (1) a safe harbour excluding business that have less than $100,000 in sales or 200 sales transactions, (2) no retroactive tax collection, (3) single, state-level admin of sales taxes, (4) simplified tax rate structure, (5) uniform definition and rules, (6) state provides software and immunity for businesses that rely on software

Organizational Expenditures, Start-up Costs, and Syndication Costs

-Syndication costs - not deductible -Org and start-up costs - can be amortized

Disproportionate distributions

-can be both liquidating and operating -not reflecting a partner's proportionate share

S-Corp Tax Basis Limitation

-cannot deduct losses in excess of their stock basis -excess loss carried over until sufficient basis created -create debt basis by loaning money directly to the corporation -losses are created first by tax basis in their shares and then in their bases in any direct loans made to their S corps -losses cannot exceed debt basis. -in subsequent years, debt basis will increase first, then stock bases

Post-Termination Transition Period Loss Limitation

-carryover losses are not deductible after s-termination date -Section 1366d3 allows them to treat any suspended losses existing at the S termination date as occurring on the last day of the Post-termination transition period (PTTP begins on day of corp's last taxable year as an S corp and begins on the later day of (a) 1 year after S corp date or (b) due date of filing last year as an s corp)

partner's outside basis when the partnership assumes debt of the partner secured by property the partner contributes to the partnership

-contributing partner must treat her debt relief as a deemed cash distribution from the partnership that reduces her outside basis -if nonrecourse debt -> the amount of debt in excess of the basis of the contributed property is allocated solely to the contributing partner, and remaining debt allocated to all partners according to profit-sharing ratios

Voluntary termination of S-corp Status

-corp can make a voluntary revocation if shareholders of more than 50% of stock agree

S-Corp Self-Employment Income

-even when shareholder actively works for the business, S corp shareholder's allocated income is not classified as self-employment income -shareholders that work for the business can also receive a salary

Involuntary termination of S-corp Status

-failure to meet requirements - automatically terminated on day it fails to meet requirements -excess passive investment income - if an S corp has E&P from a previous C corp year, its election is terminated if the S corp has passive investment income in excess of 25% of gross receipts for three consecutive years (doesn't apply if never operated as c corp)

partner's initial tax basis if partnernship has debt

-first, each partner must include her share of the partnership's debt in calculating the tax basis in her partnership interest -then, it depends on whether its recourse or nonrecourse debt

order of adjustment

-first, increases -then, distributions -then, nondeductible expenses -then, by deductible expenses and losses to extent that any basis remains (basis adjustments that decrease basis can never put basis below zero)

S-Corp Fringe benefits

-for shareholders that own 2% or less of the entity: tax deduction for qualifying fringe benefits and benefits are non taxable to all employees (like a C Corp) -for shareholders that own more than 2% of the entity: tax deduction, but qualifying fringe benefits are taxable to employee-shareholders with 2%+ ownership (like a partnership)

Seller Issues

-gain or loss is calculated by the difference between the amount realized and outside basis in the partnership -any debt relief increases the amount the partner realizes from the sale under general tax principles -most gain/loss are are capital, but will be ordinary if any gain/loss is attributable to hot assets

Self-Employment Tax liabilities for individual partners

-general partners: report guaranteed payments for services provided and their share of ordinary business income as self-employment income -limited partners: their share of income is not subject to self-employment tax but guaranteed payments are

accounting method - partnership may not use cash method if

-has C corporation partners unless their average annual gross income does not exceed $26 million for the past three years

Excess Net Passive Income Tax

-if an s corp previously operated as a c corp and has accumulated E&P at the end of the year from a prior c corp year, it may be subject to excess net passive income tax -excess net passive income=net passive investment income x [(passive investment income-25%gross receipts)/passive investment income] -tax is 21%

Adjustments to partnership interests

-increase for actual and deemed cash contributions to partnership -income for partner's share of ordinary income and separately stated income/gain items -increase for partner's share of tax exempt income -decrease for actual and deemed cash distributions during the year -decrease for partners share of nondeductible expenses -decrease for partner's share of disallowed business interest expense -decrease for partner's share of ordinary loss and separately stated expense/loss items

s corp shareholders make the following adjustments to their stock basis annually, in the order listed:

-increase for any contributions to the S corp during the year -increase for shareholder's share of ordinary business income and separately stated income/gain items -decrease for distributions during the year -decrease for shareholder's share of nondeductible expenses -decrease for shareholder's share of ordinary business loss and separately stated expense/loss items *cannot deduct debt *basis cannot be reduced below zero

Required Year-Ends (must use one of three year ends)

-majority interest taxable year: the taxable year of one or more partners who together own more than 50% of the capital and profit interest in partnership -principal partners test: the required taxable year is the taxable year the principle partners all have in common -least aggregate deferral: the tax year of the partners that provides the partner group as a whole with the smallest amount of aggregate tax deferral

Income and Loss Allocations

-must allocate profits and losses pro rata, based on the number of outstanding shares each shareholder owns on each day of the tax year -usually allocated on last day of the year, unless a shareholder sells her shares during the year

S Corp Reelections

-must wait until the beginning of the fifth tax year after the tax year it terminated the election -IRS may consent to earlier if (1) corp is now owned by 50% shareholders who weren't owners at time of termination, (2) if termination was not reasonably within control of corps or shareholders with a substantial interest in the corp and was not part of a planned termination by the corp or shareholders

Buyer and Partnership Issues

-new buyer steps in the shoes of the seller's inside basis

Tax Elections

-new partnerships determine their accounting periods and make tax elections, including the election of overall accounting method, the election to expense a portion of org and start-up costs, and the election to expense tangible personal property (partnership usually responsible for making elections)

S-Corp Accounting Methods and Periods

-no limit to using cash method (unless inventory is primary income, so it would use accrual for gross profits/hybrid for everything else) -s-corps must use calendar year-end unless they have a business purpose for an alternative year end or a natural business year-end

Contribution of Services - profits interest

-no liquidation value, only right to future profits -not immediately taxed

Operating Distributions for Money Only

-no tax needs to be recognized, only outside basis in partnership interest is reduced -partner reduces her outside basis to zero and recognizes a gain to the extent the amount of money distributed is greater than her outside basis

Excess Business Loss Limitation

-noncorporate taxpayers cannot deduct excess business loss -applies to losses deductible under the other three limitations -2019 thresholds - $510,000 for MFJ & $225,000 for all others

S-Corp Qualification Requirements

-only us citizens, residents, estates, certain trusts, and tax-exempt orgs can be shareholders (no corp or partnership) -no more than 100 shareholders -be a domestic corporation -not be a specifically identified ineligible corporation -have only one class of stock (identical liquidation and distribution rights, diff voting rights are permissible)

Contribution of Services - capital interests

-partners who receive unrestricted capital interests in exchange for services have the right to receive a share of the partnership' capital if it liquidates -partners receiving capital interests for services must treat the amount they would receive if the partnership were to liquidate (liquidation value) as ordinary income -capital interest = ordinary income recognized -partnership either deducts or capitalizes value of capitalized interest

Gain or Loss Recognition in Liquidating Distributions

-recognize a gain when terminating partner receives more money in the distribution than her outside basis -recognize a loss if (1) the distribution is only cash and hot assets and (2) the partner's outside basis is greater than the sum of the inside bases of the distributed assets

LIFO recapture tax

-requires c corp to include the LIFO recapture amount in its gross income in the last year it operates as a C Corporation -equals excess of inventory basis computed using the FIFO method over the inventory basis computed using the LIFO method at the end of corp's last tax year as a C corp

S-Corp Initial Basis

-shareholder's basis in stock received in the exchange equals the tax basis of property transferred. less any liabilities assumed by the corp on property contributed -increased by gain recognized, reduced by FMV of any prop received other than stock -if shareholder purchases stock from another shareholder, basis is purchase price

Commonly Separately Stated Items

-short term capital gains/losses -long term capital gains/losses -section 1231 gains and losses -dividends -interest income -charitable contributions -tax-exempt income -net rental real estate income -investment interest expense -section 179 deduction -foreign taxes -Section 199A qualified business income, allocated wages, & unadjusted basis of qualified property

S-Corp Annual Basis Adjustment

-stock basis must be adjusted every year (like a partnership)

Sales subject to sales tax

-tangible personal property -restaurant meals -rental cars -hotel room rentals -some services -purchases of inventory for resale are exempt

S-Corp Excess Business Loss Limitation

-threshold for MFJ is $510,000 and for others is $255,000

What states impose sales tax?

45 states and D.C. *states that don't: Alaska, Delaware, Montana, New Hampshire, and Oregon

Use Tax

A sales tax that is collectible by the seller where the purchaser is domiciled in a different state.

Built-In Gains Tax

Built in gains tax triggered when: 1) A C-corp elects S corp status 2) The FMV of the corporate assets exceeds the adjusted basis of corporate assets on the election date

Nondomiciliary Businesses

Businesses not domiciled or headquartered in a state; These are subject to tax only where they have nexus

Operating Distributions that include property other than money

First, partner allocates the outside basis to any money received and then to the other property as a carryover basis. The remainder is the partner's outside basis after the dsitribution

Self-Employment Tax liabilities for LLC members

LLC members that have personal liability for debts of the LLC by reason of being a member, have authority to contract on behalf of the LLC, or who participate in more than 500 hours of LLC's trade or business should be classified as general partners for self-employment tax rules

Determining gain with hot assets

(1) calculate total gain/loss (2) calculate partner's share of gain/loss (3) subtract (1)-(2)

Scenario 2 steps

(1) determine outside basis net of any debt relief, then allocate that mount to money and hot assets equal to partnership's basis in these assets, and does the same for other distributed property (2) allocate the remaining outside basis to the other distributed property that has unrealized appreciation to the extent of that appreciation (ex- asset with $500 basis and FMV of $700 would be allocated $200) (3) partner allocates any remaining basis to all other property in proportion to the relative FMV of the other property (basis allocation = remaining basis x FMV asset/ sum of FMV distributed other prop)

Scenario 5: Other property included in distributions

(1) first, aprtner determines outside basis net of any debt relieft and then allocates that amount to any money, inventory, and unrealized receivables equal to partnership's basis in these assets and to distributed property (2) partner then allocates the required decrease to the property that has unrealized depreciation to the extent of that depreciation to eliminate inherent losses (3) any remaining decrease - basis reduction=required decrease x asset/sum of all assets

Income and Loss Baskets

(1) passive activity income or loss - tp not a material participant (2) portfolio income - investments (3) active business income - income from sources that taxpayer is materially involved in *passive losses cannot offset basket 2 or 3

Partnership losses are deductible if they clear four separate hurdles

(1) tax basis (2) at-risk amount (3) passive activity (4) excess business loss limitation

Loss Limitations of an S-corp

(1) tax basis, (2) at-risk amount, & (3) passive activity

Passive Activity Loss Limitation

- As in partnerships, the passive activity loss rules limit the ability of S corporation shareholders to deduct losses unless they are involved in actively managing the business -applied after tax basis and at-risk limitation

S- Corp Operating Distributions with No C Corp E & P:

- Distributions are tax-free to the extent of shareholder's basis - Excess distribution is capital gain

S- Corp Operating Distributions with C Corp E & P:

- Distributions come from (1) AAA account, (2) E & P, and then (3) any remaining shareholder stock basis - Distributions from AAA are nontaxable to extent of shareholder's basis; any excess is capital gain - Distributions from E & P are taxed as dividends - Distributions from shareholder basis are nontaxable to extent of basis; any excess is capital gain *AAA is cum income/loss for period that corp has been an S corp

S-Corp Liquidating Distributions

- S corporation rules follow C corporation rules - S corporations generally recognize gain or loss on each asset they distribute in liquidation - These gains and losses are allocated to the S corporation shareholders, increasing or decreasing their stock basis - In general, shareholders recognize gain on the distribution if the value of the property exceeds their stock basis; they recognize loss if their stock basis exceeds the value of the property

Tax Basis

Partners may not utilize partnership losses in excess of their investment or outside basis (excess can be carried forward, unless partners sell their interest)

Property Distributions

S corporation consequences: - recognizes gain on distribution of appreciated property (FMV) - does not recognize loss on distribution of property whose value has declined Shareholder consequences: - recognizes distributive share of the deemed gain and increase stock basis accordingly - the property distribution is the FMV of the property received - taxability of distribution is determined based on distribution rules discussed previously - basis is FMV of property

S-Corp Net Investment Income Tax

S-corp shareholders are subject to a 3.8% net investment income tax on their share of an S corps gross income from interest, dividends, annuities, royalties, rents, a trade or business that is a passive activity of a trade or business of trading financial instruments or commodities, and any net gain from disposing of property * also any gain from selling S-corp stock

Partner's Outside Basis is Greater than Inside Bases of Distributed Assets

Scenario 1: if distribution is only money and hot assets, partner recognizes a capital loss Scenario 2: partner must allocate all her outside basis to the distributed assets

Partner's Outside Basis is Less than Inside Bases of Distributed Assets

Scenario 3: if money only, recognize gain in amount received excess of basis Scenario 4: (for money and hot assets) first partner assigns her outside basis to the assets received in an amount equal to the assets' inside basis. the, partner allocates the required decrease to the assets with unrealized depreciation. finally, partner allocates any remaining required decrease to the distributed assets in proportion to their adjusted bases (basis allocation=required decrease x Asset/Sum of distributed assets) Scenario 5: other property included in distributions

Hot Assets

Unrealized receivables and substantially appreciated inventory under § 751. When hot assets are present, the sale of a partnership interest or the disproportionate distribution of the assets can cause ordinary income to be recognized. -unrealized receivables: A/R for cash-method payers only, & items that the partnership would treat as ordinary income if it sold the assets for its FMV -inventory: classic inventory, and any assets that aren't capital assets or 1231 assets (this includes assets used in business not held for 1+ year and A/R)Buy

special allocations

When a partnership splits up profits and losses in a way that does not correspond to the owners' percentage interest in the business. (For example, electing to split losses 90/10 while splitting gains 50/50). To be certain that a special allocation is legitimate, the IRS checks to see whether the allocation has what it calls "substantial economic effect." some are mandatory: if a partner contributes asset with built-in gains or losses, they must allocate the built-in gains or losses solely to the contributing partner

Nexus

a sufficient connection to justify state taxation

Net Investment Income Tax

an individual partner's share of gross income from interest, dividends, annuities, royalities, or rents is included in the partner's net investment income when calculating the net investment income tax

Distributions

as long as a cash distribution does not exceed a partner's outside basis before distributions, it reduces basis but is not taxed

S-Corp At-Risk Amount Limitation

can only deduct at-risk amount, which is sum of stock and debt basis, except for nonrecourse loans. -nonrecourse loans increase amount at-risk only by net FMV of property used as collateral for loan

Section 704(b) Capital Accounts

capital accounts reflect the fair market value rather than the tax basis of contributed assets

Partner's Holding Period in the Partnership Interest

capital asset, so holding period determines whether its a short-term or long-term capital gain

Post Termination Transition Period Distributions

cash distributions after an S election termination and during the PTTP are tax free to the extent they do not exceed the corp's AAA balance and shareholder basis in stock

recourse debt

debts that at least one partner has economic risk of loss - satisfy the debt with their own funds (allocated to partners that will be responsible for paying it) -limited partners may be allocated recourse debt if they forgo their legal protection by guaranteeing some or all fo the debt

Liquidating Distributions

distributing assets to terminate a partner's interest

Operating Distributions

distributions of the partnership

nonrecourse debt

don't provide creditors with the same amount of legal recourse against partners (debts are allocated to partners base don profit-sharing ratios) -LLC members are protected so normally treat debt as nonrecourse unless they guarantee a portion of the debt

partner's initial tax basis if partnership has no debt

equal to the tax basis of the property and cash she contributed

Guaranteed Payments

fixed amounts paid to partners regardless of wether the partnership shows a profit or loss (include in computing partnership's ordinary income but separately stated)

Allocating partners' share of income and loss

if they are not defined in the partnership agreement or do not have substantial economic effect, allocations to partners must be made in accordance with the partners interest in the partnership

Flow-through income

income is not taxed at the entity level, but instead flows through to the shareholders or the owners of the entity.

Commonly separated income items

interest income, guaranteed payments, net earnings from self-employment, tax-exempt income, net rental real estate income, investment interest expense, royalties, section 179 deduction

When a business sells tangible personal property that is included in the state's sales tax base

it must collect and remit the sales tax on a periodic basis if it has sales tax nexus in that stae

S-corp Passive Activity Loss Limitation

limit the ability of S corporation shareholders to deduct losses unless they are involved in actively managing the business

At-Risk Amount Limitation

limits the partners ability to use nonrecourse debt as a means of creating tax basis to use losses from tax shelter partnerships expressly designed to generate losses from their partners -limits losses to their amount "at-risk" -only exception is qualified nonrecourse financing -applied after tax basis limitation -excess can be carried forward

Deduction for Qualified Business Income

may deduct 20% of qualified business income allocated to them from the entity (income from a qualified trade or business)

Corporations

owners of entities that are taxed as corporations can elect to be treated as flow-through entities under the rules in Subchapter S, and referred to as S-corporations

outside basis

partners tax basis in her partnership interest

inside basis

partnership's basis in its assets

Contribution of Property to Partnerships - gain and loss recognition

partnerships/partners don't recognize gain or loss when they contribute property to partnerships (both in formation and after)

Profits Interest

right or obligation to receive a share of future profits or future losses

Short Tax Years

s corp election terminations frequently create an S corporation short tax year and a C corporation tax year, and allocate income between the two based on their days OR in the actual period it was earned

S-Corp Formations

same rules as forming a c-corp, Section 351 applies

Ways to dispose of a partnership interest

selling to a third party, selling to another partner, or transferring the interest back to the partnership

Special Basis Adjustment

tax rules allow partnerships to make an election to eliminate discrepancies between the inside and outside bases and to correct artificial income or loss at partnership level Situations that cause discrepancies: following sales of partnership interests, following distributions when a partner realizes a gain or loss

Partnership Interest

the bundle of economic rights granted to partners under the partnership agreement, including capital and partnership interest

To elect S-corp status effective as of the beginning of current tax year

the corp uses Form 2553, either in the prior tax year or on or before the 15th day of the third month of the current tax year

Limitation on Business Interest Expense

the deduction for business interest expense is limited to the sum of (1) business interest income and (2) 30% of the adjusted taxable income of the taxpayer for the taxable year. -any interest no disallowed is include in partnerships income(loss) -the disallowed expense is allocated to partners, reducing basis in their interest

recognizing gain when property secured by debt is contributed to the partnership

the partner recognizes gain only if the cash deemed to have been received from a partnership distribution exceeds the contributing partner's tax basis in her partnership interest prior to the deemed distributions

Basis in distributed property

the primary objective of the basis rules in liquidating distributions is to allocate the partner's outside basis in the partnership to the assets the partner receives i the liquidating distribution -allocation depends on: (1) the partnership's basis in the distributed assets relative to the partner's outside basis & (2) the type of property distributed - whether its money, hot assets, or other property

Capital Interest

the right to receive a share of the partnership net assets if the partnership is liquidated

Commercial Domicile

the state where a business is headquartered and directs its operations (not necessarily where company is incorporated) Must always collect sales tax and pay income tax in the state where domiciled

partnership equity

track the equity of their owners using capital account for each owner

Aggregate approach to parternships

treat partnerships simply as an aggregation of the partners' separate interests in the assets and liabilities of the partnership

Unincorporated business entities (general partnership, limited partnership, LLC)

treated as partnerships under Subchapter K of IRC unless they want to be taxed as corporations

Entity approach to partnerships

treating tax partnerships as entities separate from their interests

Adjustment in basis

unlike stock basis that is fixed, the basis in a partnership is dynamic aand must be generated based on income and loss, changes in debt, and distributions