R5: Flow-Through Entity Taxation and Multi-Jurisdictional Tax Issues
Foreign Base Company Income
"bad income" that includes passive income and active income tied to a related party. A US shareholder of a CFC generating this "bad income" is taxed on a current basis (no deferral and no DRD) with respect to the shareholder's pro rata share of income.
Blue Corp., a CFC with no prior US property investments, makes a $1 million loan to its US parent in the second quarter of Year 1. The loan remains outstanding at the end of Year 1. Determine Blue Corp.'s increase in earnings invested in US property in Year 1.
$0 = first quarter balance $1,000,000 = second quarter balance $1,000,000 = third quarter balance $1,000,000 = fourth quarter balance 3 quarters / 4 quarters = 75% 75% * $1,000,000 = $750,000 Each taxpayer would be taxed CURRENTLY on their pro rata share of of Blue Corp.'s increased investment in US property during the tax year.
Becker and Peter admit Tim to their partnership as a one-third partner. Tim contributes a building that is worth $500,000 but has a basis of $100,000. There is a mortgage on the building of $225,000, assumed by the partnership. Determine any gain Tim might recognize and his basis in the partnership.
$100,000 rollover cost basis - $150,000 liabilities assumed by others (2/3) = ($50,000) "net basis" $50,000 --> boot recognized by Tim on transfer Tim's basis in the partnership is netted at $0
Kristi sold her interest in KJT Partnership to a new partner, John, for $15,000 cash. John agreed to assume her $5,000 share in partnership liabilities. Determine the amount realized on the sale of Kristi's partnership interest.
$15,000 cash + $5,000 debt assumed by new partner = $20,000 amount realized on the sale Gain or loss will be determined by comparing the $20,000 to the basis of Kristi's share in the partnership.
The adjusted basis of Vance's partnership interest in Lex Associates was $180,000 immediately before receiving the following distribution in complete liquidation of Lex: Cash: basis = $100,000, FMV = $100,000 Real estate: basis = $70,000, FMV = $96,000 What is Vance's basis in the real estate?
$180,000 Partnership interest - $100,000 cash received = $80,000 remaining basis Real estate basis = $80,000. Partners have to ZERO OUT TO GET OUT, so adjust their basis in property to bring their basis in partnership down to zero.
Ray contributes property with a FMV of $20,000 and an adjusted basis to Ray of $10,000 in exchange for stock in Falcon Corporation, an existing S corporation. Immediately after the transfer, Ray owns 20% of Falcon's stock. Determine Ray's realized gain or loss on the exchange and his basis in the S corporation stock.
$20,000 FMV - $10,000 adjusted basis = $10,000 gain realized Ray did not have 80% or more ownership in Falcon after the exchange, so he had to recognize the gain on the transaction. Ray will have a basis in stock of $20,000 ($10,000 carryover basis + $10,000 gain recognized) Falcon's basis in the property received is also $20,000
Gearty's basis in his partnership was $229,000. He received a liquidating distribution consisting of the following assets: Cash: basis = $4,000, FMV = $4,000 Inventory: basis = $10,000, FMV = $15,000 Land-Lot A: basis = $200,000, FMV = $150,000 Land-Lot B: basis = $100,000, FMV = $300,000 Total basis = $314,000 Determine Gearty's basis in the property distributed and his basis in his partnership interest immediately after distribution.
$229,000 basis in partnership interest - $314,000 total basis = ($85,000) excess basis in assets --> write down needed ($85,000) excess basis in assets + $50,000 decrease basis of lot A to FMV = ($35,000) remaining to be written down **allocate remaining basis in partnership interest to Lot A and Lot B based on relative bases in assets after the $50,000 adjustment Lot A: 200K - 50K = 150K /250K = 60% * 35K remaining Lot B: 100K / 250K = 40% * 35K remaining ($35,000) remaining basis + $21,000 Lot A 60% + $14,000 Lot B 40% = $0 basis in partnership interest after liquidation
On December 31 of the current year, after receipt of his share of partnership income, Clark sold his interest in a limited partnership for $30,000 cash and relief of all partnership liabilities. On that date, the adjusted basis of Clark's partnership interest was $40,000, consisting of his capital account of $15,000 and his share of partnership liabilities of $25,000. The partnership has no unrealized receivables or substantially appreciated inventory. What is Clark's gain or loss on the sale of his partnership interest?
$30,000 Purchase price + $25,000 relief of debt = $55,000 Amount realized - $40,000 Clark's basis in partnership interest = $15,000 Capital Gain
XYZ, Corp., a calendar year S corporation, makes a liquidating distribution of a building with a FMV of $100,000 and a basis to XYZ of $60,000 to its sole shareholder W. XYZ also had ordinary business income for the year of $10,000. W has a basis in XYZ stock of $30,000 at the beginning of the year. Determine the tax consequences of the liquidating distribution of the building ($100,000 - $60,000 basis), which flows through the shareholder W.
$30,000 beginning basis + $10,000 ordinary business income + $40,000 XYZ gain on distributing building = $80,000 W's adjusted basis $100,000 FMV building - $80,000 adjusted basis = $20,000 W's gain on distribution
Olinto's basis in his partnership interest was $30,000. He received a nonliquidating operating distribution consisting of the following assets: Cash: basis = $24,000, FMV = $24,000 Inventory: basis = $5,000, FMV = $6,000 Land: basis = $9,000, FMV = $12,000 Determine Olinto's basis in the property distributed and his basis in the partnership interest immediately after distribution.
$30,000 original basis in interest - $24,000 cash distribution = $6,000 - $5,000 inventory basis = $1,000 - $9,000 land basis = $0 basis in partnership interest *STOP AT ZERO Partner's basis in assets distributed: Cash: $24,000 Inventory: $5,000 Land: $1,000
Olinto's basis in his partnership interest was $30,000. He received a nonliquidating operating distribution of $24,000 cash plus a parcel of land with a FMV of $12,000 and partnership basis of $9,000. Determine Olinto's basis in the land distributed and his basis in his partnership interest immediately after distribution.
$30,000 original basis in partnership - $24,000 cash distributed = $6,000 - $9,000 property distributed = $0 STOP AT ZERO **the basis in the partnership may not be reduced below zero--therefore, the land has a basis in the hands of the partner of $6,000, the remaining interest in his partnership
Gearty's basis in his partnership was $529,000. He received a liquidating distribution consisting of the following assets: Cash: basis = $4,000, FMV = $4,000 Inventory: basis = $10,000, FMV = $15,000 Land-Lot A: basis = $200,000, FMV = $150,000 Land-Lot B: basis = $100,000, FMV = $300,000 Total basis = $314,000 Determine Gearty's basis in the property distributed and his basis in his partnership interest immediately after distribution.
$529,000 basis in partnership prior to distribution - $314,000 total basis in assets = $215,000 excess basis in partnership $215,000 - $200,000 increase Lot B basis to FMV = $15,000 **allocate remaining basis in partnership between Lot A and Lot B based on their UPDATED allocations Lot A: $150,000 / $450,000 = 33% * $15,000 Lot B: $300,000 / $450,000 = 66% * $15,000 $15,000 - $5,000 Lot A allocation 33% - $10,000 Lot B allocation 66% = $0 basis in partnership interest after liquidation
Fern received $30,000 in cash and an automobile with and adjusted basis and FMV of $20,000 in a liquidating distribution of EF partnership. Fern's basis in the partnership interest was $60,000 before the distribution. What is Fern's basis in the automobile received in the liquidation?
$60,000 partnership interest - $30,000 cash received = $30,000 remaining basis in partnership Fern's basis in the automobile will be $30,000 to zero out of the partnership.
Built-In Gain tax
(21% tax) A distribution/sale of a corporation's assets may result in a corporate-level tax on any built-in gain. An unrealized built-in gain results when both of the following conditions are met: 1. A C Corporation elect S Corporation status, and 2. FMV > adjusted basis of asset on election date (appreciated property) **remember, C corp is key--it had to be a company that was originally a C corp AND asset must've been acquired when they were a C corp
Partnership Loss Limitations
(Same as S corporations) 1. Tax basis limitation 2. At-risk basis limitation 3. Passive activity loss (PAL) limitation 4. Excess business loss limitation
Hundley Corporation sells computers and is incorporated and resides in California. In addition to California, Hundley solicites sales in Oregon, Arizona, and Colorado. In provides installation services to its customers in Arizona, and it conducts employee training at a facility in Colorado. Determine with which states Hundley has nexus.
- California: state of incorporation and residence - Arizona: provides installation services to customers - Colorado: conducts employee training **Hundley is likely protected from nexus in Oregon because all they do in Oregon is solicite sales
2 types of partnership interest
1. Capital interest: a right to share in the net assets of the partnership when it liquidates 2. Profits interest: a right to share in the future profits and losses of the partnership
How can you liquidate partnership interest?
1. Complete withdrawal (liquidating distribution) 2. Sale of partnership interest 3. Retirement or death
2 Categories of Expatriated Entities
1. Continue to be treated as a US corporation if former US shareholders hold over 80%, or more of interest in foreign parent; OR 2. Denied certain tax attributes such as NOL and foreign tax credits to offset "inversion gain" if former shareholders hold at least 60% but less than 80% of interests in new foreign parents
Qualifications of an S Corporation
1. Must be a domestic corporation, independent of C corps 2. Shareholders must be individuals, cannot be nonresident aliens, cannot be a corporation or partnership 3. No more than 100 shareholders 4. There is only one class of stock (common stock)
Categories of Foreign Taxable Income
1. Passive category income 2. General category income 3. Foreign branch income 4. Global intangible low-taxed income
How can a taxpayer avoid penalties from IRS adjustments to "true taxable income"?
1. Section 482 Study Based on Allocated Pricing Methods 2. Section 482 Study NOT Based on Allocated Pricing Methods (what was likely to be fair) 3. Transactions Solely Between Foreign Corporations
Under what conditions will an S corporation status terminate?
1. Shareholders with over 50% ownership consent to revocation, 2. Corporation fails to meet any of the qualifications for S status, or 3. More than 25% of total gross receipts are from passive investment income over the past 3 years
What limits must an S corp shareholder satisfy to deduct a loss?
1. Tax basis limitation 2. At-risk basis limitation 3. Passive activity loss (PAL) limitation 4. Excess loss limitation
Transfer Pricing Issues
1. When a US taxpayer transfers, sells, purchases, or leases tangible or intangible property from an affiliate that either (a) is not subject to US tax, or (b) does not file a consolidated return with the US taxpayer 2. When a US taxpayer enters into loan agreements or service contracts with an affiliate that either (a) is not subject to US tax, or (b) does not file a consolidated return with the US taxpayer 3. When a US taxpayer shares costs with an affiliate that either (a) is not subject to US tax, or (b) does not file a consolidated return with the US taxpayer
Foreign-Derived Intangible Income Deduction
A US corporation can get a deduction for its foreign-derived intangible income (involving non US persons occurring outside the US) (aka Export income) - 37.5% deductions before 2026
Foreign-Source Dividend Payment treatment
A US corporation is allowed to exempt foreign-source dividend payments from US taxation by taking 100% dividends-received deduction against such income if it owns over 10% of the dividend-paying foreign corporation
Previously Taxed Income treatment
A US shareholder can exclude distributions of a CFC's earnings and profits that were previously-taxed income (PFC) to US shareholders as part of the Subpart F inclusion, GILTI inclusion, or an investment in US property.
Substantial Presence Test
A foreign individual is considered a resident of the US if he or she is substantially present in the US for: 1. at least 31 days of the current year, AND 2. at least 183 days during a 3 year period
Tax Basis Limitation
A loss can only be flowed through to an S corporation shareholder's income tax return to the extent of the shareholder's tax basis (basically, stock basis) A loss in excess of the tax basis is suspended until basis is reinstated.
Global Intangible Low-Taxed Income Tax (GILTI)
A minimum tax imposed on certain low-taxed income that is intended to reduce the incentive to relocate CFCs to low-tax jurisdictions Inclusion: The US shareholder's share of CFC's net income reduced by the excess of CFC's property basis over net interest expense
Territorial Tax System
A nation only taxes its citizens and residents on income earned inside its borders. Income earned outside the borders is not subject to tax
When does a partnership terminate?
A partnership terminates when: - Operations cease, or - There are fewer than two partners
Foreign Subsidiary definition
A separate legal entity, incorporated under the laws of the foreign host country - profits are taxed by the host country - not taxed in the US until earnings are "brought back"
Partner A, a 20% partner, sells her entire partnership interest to Partner B on March 31 of the current year. The partnership reported $80,000 in income for the entire tax year. Determine A's and B's share of partnership income for the year.
A: (90 days/365 days) * $80,000 * 20% = $3,945 B: (275 days/365 days) * $80,000 * 20% = $12,055
Accumulated Adjustments Account (AAA)
Accumulated earnings and profits during the year a corporation is an S corporation Increases AAA: - Ordinary business income - Separately stated income items Decreases AAA: - Ordinary business losses - Separately stated losses/deductions - Nondeductible expenses - Distributions
Mark-to-Market Tax calculation
All property of the "covered expatriate" is treated as sold on the date of expatriation with any gain taken into account - $737K deduction allowed
Participation Exemption
Allows foreign taxpayers to exempt foreign income from taxation
Tax on Passive Investment Income
An S corporation is subject to income tax at the corporate tax rate (21%) on the lesser of net income or excess passive investment income if the following 2 tests are met: 1. An S corp has accumulated C corp E&P, and 2. Passive investment income exceeds 25% of total gross receipts
Why is Transfer Pricing used?
An affiliated group of businesses operating in several countries and conducting sales between affiliates could have a pricing structure that understates income in certain countries (countries with higher tax brackets), resulting in some countries receiving less income tax
Passive Foreign Investment Company
An entity is considered a PFIC if it meets ONE of the following: 1. 75% or more of the foreign corporation's gross income is passive, or 2. At least 50% of the foreign corporation's assets are foreign assets
Property Contribution to S Corporation treatment
An initial contribution in formation of an S Corporation is nontaxable if: - its a contribution of property (not services--taxable) - solely in exchange for stock (no boot), and - after transfer stockholder(s) immediately has 80%+ ownership
Foreign Branch definition
An unincorporated foreign entity that is viewed as an extension of a domestic corporation - not a separate legal entity--profits are treated as being earned directly by the domestic corporation - BUT earnings are usually taxed in the foreign entity as well - Foreign tax credit/deduction is allowed
Controlled Taxpayer definition
Any one of two or more taxpayers owned or controlled directly or indirectly by the same interest --usually, a subsidiary
Uncontrolled Transaction definition
Any transaction between two or more taxpayers that are not members of the same group of controlled taxpayers --between company and customer
Controlled Transaction definition
Any transaction or transfer between two or more members of the same group of controlled taxpayers --between parent and sub or between sub and sub
Ball and Baig are equal partners in the firm of Games Associates. On January 1 of the current year, each partner's basis in their Games partnership interest was $50,000. During the year, Games borrowed $80,000, for which Ball and Baig are personally liable. Games sustained an ordinary business loss of $30,000 for the current year. What is each partner's basis of interest in Games at the end of the current year?
Basis: $50,000 beginning basis + $40,000 ($80,000 liability / 2 partners) - $15,000 ($30,000 business loss / 2 partners) = $75,000 basis
Subpart F income
Because deferrals create opportunities to shift income to lower tax jurisdictions to avoid US taxes, Subpart F curbs this behavior. Subpart F rules include the following: - A controlled foreign corporation (CFC) is a foreign corporation with over 50% US shareholder ownership - US shareholder is a US person owning at least 10% of foreign corporation stock - limit only applies to CFCs
Baker is a partner in BDT with a basis in his partnership interest of $60,000. BDT made a liquidating distribution of land with an adjusted basis of $75,000 and FMV of $40,000 to Baker. What amount of gain or loss should Baker report?
Because he received land (not cash) in liquidation, there is no gain or loss recognized here. You just have to zero out your partnership interest with distribution received (Zero out to get out).
On January 1, Year 1, Becker and Conviser formed a partnership with each contributing the following property: Becker: basis = $30,000, FMV = $30,000 Conviser: basis = $6,000, FMV = $30,000 The partners have agreed to share profits and losses equally. During Year 1, each partner withdrew $3,000; and for the year end December 31, Year 1, the partnership's ordinary business loss was $8,000. Determine how much of the ordinary business loss each partner can flow through to their individual tax return in Year 1.
Becker (can flow through the entire $4,000 loss): $30,000 original basis - $3,000 distributions to each partner = $27,000 - $4,000 ordinary business loss to each partner = $23,000 adjusted basis Conviser (must carryforward some of the loss): $6,000 original basis - $3,000 distributions to each partner = $3,000 - $4,000 ordinary business loss to each partner = ($3,000) **LIMIT ON LOSS TO TAX BASIS $1,000 of Conviser's loss will be carried forward until their tax basis is reinstated.
Sale of Partnership Interest Gain/Loss Calculation
Beginning capital account + share of partnership income/loss leading up to sale = Capital account at sale date + Share of partnership liabilities = Adjusted basis in partnership interest - Amount realized (cash, relief of debt, FMV property) = Capital gain or loss on sale
Forming an LLC
Business owner files articles of organization with the state where the LLC originated--similar to the formation of a corporation - similar protection from liabilities as corporations, but no double tax - LLC cannot become a public company - can be single member
Partner's Basis in Partnership Interest (Outside Basis)
Cash contributed + Property contributed + Services contributed (FMV, if capital interest) + Partner's share of partnership liabilities - Liabilities transferred to the OTHER partners = Partner's initial basis in partnership
Cathleen is a US citizen who has lived in the United States her entire life. She is the founder of Cupcakes, Inc., a US company. Her stock in the company is worth $7 million and her basis in the stock is $250,000. In 2020, Cathleen renounces her citizenship and moves to Bermuda. Assume that the gain exclusion for 2020 is $737,000. Determine Cathleen's US tax consequences of this action.
Cathleen qualifies as a "covered expatriate" because her net worth exceeds $2 million. She will be treated as if she sold her stock at FMV the day before her expatriation. Cathleen's long-term capita gain is: $7,000,000 FMV company - $250,000 basis in stock - $737,000 exclusion = $6,013,000 LTCG
Worldwide Tax System
Citizens and residents are generally subject to tax on their worldwide income (regardless of where you earn it)
How does liquidating an S corporation impact the corporation and the shareholder?
Corporation: Recognizes a gain or loss on the distribution of property as if the property were sold at FMV Shareholders: Distributions from the corporation are treated as payments in exchange for stock (amount realized - stock basis - liabilities previously assumed = shareholder's gain or loss)
Company ABC (a US company) is a 12% owner in a foreign corporation, D, whose primary source of income is investments (80% of gross income). The other shareholders of D include six US persons owning 10% (60% total) and a foreign person who owns 28%. Determine the tax treatment of ABC's investment in D.
D qualifies as both a CFC (owned 72% by US persons) and a PFIC (80% of gross income). Because Subpart F supersedes PFIC rules, D will be treated as a CFC and ABC's income from D will be subject to Subpart F rules, resulting in immediate income recognition of D's Subpart F income.
Recourse debt in a partnership
Debt for which a partner is personally liable - General partners are usually held personally liable for recourse debts if it is not satisfied by the partnership - Limited partners are usually not held personally responsible unless they put a personal guarantee on the loan
What is the purpose of Sourcing Rules?
Determine whether income and deductions are generated from sources within or outside the United States. Help to provide limits on what is subject to taxation in the US
What is the tax treatment on distributions to S corp shareholders?
Distributions: to extent of AAA: non taxable, reduces stock basis to extent of C corp E&P: taxed as dividend, does NOT reduce basis to extent of stock basis: non taxable, reduces stock basis In excess of stock basis: taxed as LTCG
CFC Untaxed Earnings
Divided into 2 groups: 1. Cash/cash equivalents taxed at 15.5% (not reinvested) 2. All other earnings, taxed at 8% (reinvested)
Earnings Invested in US Property treatment
Each US shareholder must include in income their pro rata share of: 1. Subpart F income, and 2. Earnings invested in US property To prevent US taxpayers from repatriating income in loan form or other tax free manners, these rules were instated. "US Property" includes tangible property located in the US, stock of domestic corporations, obligations to US persons
Federal Limitations on a State's Right to Impose Income Tax
Federal law prohibits states from imposing a net income tax on a person's net income derived from interstate commerce occurring within the state's borders--only if the following are met: - Only business activities is solicitation of sales, - Orders are sent outside the state for approval, and - If the orders are accepted, they are filled for delivery outside the state ex: sending employees to a different state for training
GILTI tax deduction
For 2018 - 2025, the deduction amount is 50% of GILTI and the taxpayer can take a foreign tax credit of up to 80% of foreign taxes deemed paid
LIFO recapture tax
For C corps that then elect to be S corps, C corp must compute the excess inventory using the FIFO system over the excess inventory using the LIFO system.
S Corporation - Fringe Benefits treatment
Fringe benefits for employees owning less than 2% of the corporation is deductible for the S corporation in arriving at ordinary business income. Fringe benefits for employees owning more than 2% of the corporation is NOT deductible unless included in employee's W-2 income
Hughes Corp (a US corporation) owns 15% of EKM Corp. (a CFC). EKM's net income for Year 1 is $1,500,000 and the adjusted basis of its tangible property at the end of each quarter was $1,000,000 (first quarter), $1,250,000 (second quarter), $1,225,000 (third quarter), and $1,150,000 (fourth quarter). Determine Hughes Corp.'s GILTI inclusion and deduction.
GILTI income: $1,500,000 Net income - $115,625 (10% * ([$1M + $1.25M + $1.225M + $1.15M]/4)) avg basis = $1,384,375 Because Hughes is a 15% shareholder, it will include: $1,384,375 GILTI income * 15% ownership = $207,656 included Hughes Corp. is eligible for a 50% deduction because it is a corporate shareholder. Deduction amount is: $207,656 * 50% deduction = $103,828 deducted
When is gain/loss recognized on a liquidating distribution?
Gain: The partner only recognizes a gain to the extent that money received exceeds the partner's basis in partnership interest. Loss: The partner only recognizes a loss if the cash or hot assets (ONLY) received are less than the partner's basis i partnership interest.
Taxation of Noncitizens and Nonresidents
Generally requires a connection or "nexus" to the country. Income must be "effectively connected" to the country.
S Corporation Tax Year
Generally, December 31 is the required year end, unless there is a valid purpose established for a different taxable year. Form 1120S is due March 31 of the following year.
Transactions between partner and partnership treatment
Generally, if a partner enters into a transaction with their partnership, it is treated as if it is with an unrelated party. However, there are few exceptions: - Related party losses are not deductible (WRaP) - Related party gains for a controlling partner are ordinary income
Annual Taxation on S Corporations
Generally, the corporation is not taxed--all earnings are passed through to the shareholders and paid at the individual level There are a few exceptions: 1. LIFO recapture tax 2. Built-In Gains tax 3. Tax on Passive Investment income
Sale of Partnership Interest
Generally, the partner has a capital gain or loss when selling off their partnership interest because partnership interest is a capital asset to the partner. The only exception is when HOT ASSETS are sold. Those gains are treated as ordinary because they are expected to produce future ordinary income.
A taxpayer receives a 20 percent partnership capital interest in exchange for services provided. On the day he is admitted to the partnership, the partnership's assets have a basis of $20,000 and a liquidation value of $80,000. Determine the amount of income, gain, or loss recognized by the taxpayer.
He will recognize ordinary income of $16,000 20% * $80,000 liquidation = $16,000
Arm's Length Standard
IRS adjustments to arrive at "true taxable income"--assure that reported prices that one affiliate charges to another affiliate yield results consistent with the results that would've been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances.
Foreign Tax Credit Limitation
If a US taxpayer earns income in a foreign jurisdiction with a higher tax rate, no residual taxes will be paid to the US government, but the foreign tax credit will be limited to the US taxes attributable to foreign income
Partnerships: cash distribution treatment
If a partner receives a cash distribution that is greater than the partner's basis in their interest, the partner recognizes a capital gain for the excess
Property Distribution treatment
If basis in partnership interest > basis in property dist: - the partner's basis in the interest is reduced by the adjusted basis of the property If basis in partnership interest < basis in property dist: - the partner's basis in the property distributed is reduced and equals the remaining basis in the partnership interest. The partnership interest is reduced to zero
Electing S Corporation Status
If the S Corporation election is made before March 15, it is establish retroactively for January of that year. If it is after March 15 filing, it starts January 1 of the following year. After the election is in effect, consent of new shareholders is not required.
Holding Periods of property contributed to partnership
If: - property contributed is a capital asset (cap gains/losses, Sec 1231), the partner's holding period in ownership interest includes the holding period of the property contributed - property contributed is an ordinary income asset (like inventory), the partner's holding period in ownership interest is the day the asset is contributed
Mark-to-Market Regime for Individuals
Imposed on "covered expatriates" who renounce their US citizenship and satisfy one of the following 3 tests: 1. Tax Liability test: average tax liability over the past 5 years exceeds $171K 2. Net worth of $2 million or more, or 3. Compliance test: individual failed to comply with US tax obligations for 5 preceding tax years
Base Erosion and Anti-Abuse Tax (BEAT)
Imposes a minimum tax on large US corporations (average gross receipts of at least $500M for the last 3 years) with a significant amount of deductible payments to foreign affiliates because it reduces the US tax base. You have to add back a lot of deductions taken (like DRD, any CFC deductions) 10% BEAT tax will begin to apply when payments to foreign affiliates exceed taxable income by more than 10%--applies to the extent that it exceeds regular tax liability
Shareholder basis in S corporation stock
Initial basis (contributions) + income items (including tax free items) + additional contributions - distributions to shareholders - losses/deduction items = Ending basis
Can US persons defer foreign source income from US taxation?
It can be deferred only until the income is repatriated in the United States
What is the treatment for liquidating an LLC?
It is treated the same as either a corporation or partnership, depending on whichever the LLC chose initially to be taxed as.
Separately Stated Items
Items stated on a separate schedule before being reported on the final 1040 Rental real estate income: Schedule E Interest/Dividend income: Schedule B Royalties: Schedule E Capital gains/losses, 1231: Schedule D Charitable contributions: Schedule A
In Year 1, Jeff contributes the following items to KNC partnership in exchange for one-third partnership interest: - $10,000 cash - building with FMV of $300,000 and adjusted basis to Jeff of $100,000. The building is subject to a liability of $90,000 - In Year 2, Jeff contributes another building with a FMV of $600,000 and and adjusted basis to Jeff of $300,000 - The partnership had $150,000 of net income for Year 2 Determine Jeff's initial outside basis in the partnership in Year 1, and his outside basis in his partnership interest at the end of Year 2. Also determine the partnership's inside basis and holding period in Jeff's contributed assets.
Jeff's initial outside basis in Year 1: $10,000 cash + $100,000 basis in property - $60,000 liabilities assumed by other partners (2/3) = $50,000 outside basis KNC's inside basis in the building Jeff contributed in Year 1: Greater of: - $100,000 NBV, or - $60,000 debt assumed by partnership $100,000 = KNC's inside basis Jeff's outside basis in Year 2: $50,000 basis from Year 1 + $300,000 adjusted basis in building + $50,000 Jeff's share of net income = $400,000 Jeff's adjusted outside basis for Year 2
First-Year Election as US Resident
Must meeting the following requirements: 1. Must be in the US for 31 consecutive days of the current year, 2. Must be in the US for 75 days of the current year, and 3. Meets substantial presence test for succeeding year
State Allocation and Apportionment of Federal Income
Nonbusiness income: income not relating to the primary business activities are typically allocated to the state in which the company resides Business income: apportioned using an apportionment factor between states
Reelecting S corp status
Once S corp status has been terminated, the corporation must wait five years before applying for S corp status again
Taxation of an LLC
One member: Taxed as a sole proprietorship or "disregarded entity" 2+ members: Taxed as a partnership unless specifically elects to be taxed as a corporation
Gray Corporation, an S corporation, had the following items of income and deduction for the year: Gross income $150,000 Cost of Goods Sold $70,000 Interest income $10,000 Section 1231 gain $5,000 Salary expense $40,000 Depreciation expense (MACRS) $10,000 Charitable contributions $5,000 Calculate Gray Corporation's ordinary business income and separately stated items for the year.
Ordinary business income: $150,000 gross income - $70,000 cost of goods sold - $40,000 salary expense - $10,000 depreciation expense = $30,000 ordinary business income Separately stated items: Interest income $10,000 - Schedule B Section 1231 gain $5,000 - Schedule D Charitable contributions $5,000 - Schedule A
Oscar purchased Bernie's 25% interest in Handly Partnership for $500,000. At the time of sale, Handly made a 754 election to adjust the basis of the partnership asset. Immediately before the sale, the inside basis of the partnership asset (a building) was $1,200,000 and the FMV was $2,000,000. Calculate the basis adjustment required under Section 743(b), and describe the consequences of a future sale of the assets.
Oscar's percent basis in partnership assets: $1,200,000 * 25% = $300,000 $500,000 Purchase price of partnership interest - $300,000 inside basis in partnership assets = $200,000 743(b) basis adjustment If the building is later sold for $2,000,000 FMV, a tax gain will be recognized in the amount of $600,000, the difference between $2,000,000 FMV and the $1,400,000 newly adjusted basis (with the $200,000 743(b) adjustment added to basis)
ABC Partnership has 3 equal partners. A and B are general partners, and C is a limited partner. In the current year, ABC Partnership borrowed $60,000 in qualified, nonrecourse financing debt, $30,000 in other nonrecourse financing debt, and $20,000 in recourse debt. Calculate the increase in each partner's tax basis in their partnership interest and their at-risk basis for the partnership debt.
Partner A (General Partner): $20,000 ($60,000 QFN debt * 1/3) + $10,000 ($30,000 nonrecourse debt * 1/3) + $10,000 ($20,000 recourse debt * 1/2) = $40,000 increase in tax basis $20,000 QFN debt + $10,000 nonrecourse debt = $30,000 increase in at-risk basis Partner B (General Partner): $20,000 ($60,000 QFN debt * 1/3) + $10,000 ($30,000 nonrecourse debt * 1/3) + $10,000 ($20,000 recourse debt * 1/2) = $40,000 increase in tax basis $20,000 QFN debt + $10,000 nonrecourse debt = $30,000 increase in at-risk basis Partner C (Limited Partner): $20,000 ($60,000 WFN debt * 1/3) + $10,000 ($30,000 nonrecourse * 1/3) = $30,000 increase in tax basis $20,000 QFN = increase in at-risk basis
Section 754 Election/743(b) adjustment
Partnership have this option when there is a transfer of a partnership interest by sale or exchange, OR upon retirement or death of a partner. Made when there is a DIFFERENCE in partner's share of partnership assets (inside basis) and partner's basis in their partnership interest (outside basis) For sale/exchange: there is a 743(b) adjustment that equals the difference between the outside and inside basis. The goal is to make the transferee have an inside basis in partnership assets EQUAL to his or her outside basis.
Liquidating partnership interest as a result of Retirement or Death
Payments for interest in partnership assets result in a capital gain or loss. If payments are measured by partnership income, they are treated as partnership income regardless of when they are paid. These payments are treated as ORDINARY income.
Calculating Apportionment Factor
Property or Rent expense in that state/Total rent expense + Payroll expense within that state / Total payroll expense + Sales from sources within the state / Total Sales **Sum is divided by 3 for an average--> income apportioned to that state
Guaranteed Payments
Reasonable compensation paid to a partner for services provided or use of capital without regard to the partner's income- or loss-sharing ratio - tax deduction to the partnership - taxable as ordinary income to the individual partner
How do partners/partnerships treat retirement payments?
Retirement payments NOT in liquidation as a partnership are treated as: - ordinary income to the recipient, and - deductions to the partnership
The Duffy Corp, an S corporation, is owned equally by three shareholders: Rick, Tim, and Peter. The corporation is on a calendar-year basis. On February 1, Year 5, Peter sold his one-third interest in Duffy Corp to George. For the year-end December 31, Year 5, the corporation had ordinary business income of $120,000 and no separately stated items. Calculate each shareholder's ordinary business income allocation for the year.
Rick: $120,000 / 3 = $40,000 Tim: $120,000 / 3 = $40,000 Peter: ($120,000 / 3) * 31/365 = $3,397 George: ($120,000 / 3) * 334/365 = $36,603
Partnerships: Organizational Expenditures and Start-up Costs
Same as corporations: each expense category immediately gets $5,000 minus any excess over $50,000. Any remainder after the $5,000 is amortized over 180 months
Where does a partner report their share of partnership operations?
Schedule K-1: each partner reports on their individual tax return their distributive share of ordinary business income or loss and each separately stated item for income, gain, loss, or deduction
Foreign Person with Business Income in US
Subject to US taxation on income connected to US trade or business. Foreign person with a US trade or business must file an 1120-F to report income earned by the US branch
Gearty is a shareholder in an S corporation. He contributed $12,000 in cash and land with a basis of $25,000 and a fair market value of $100,000. He also loaned the S corporation $15,000, which Gearty borrowed from another source on a nonrecourse basis. Gearty has $10,000 as his pro rata share of S corporation income that was not distributed. Calculate Gearty's tax basis and his at-risk basis.
Tax basis: $12,000 cash + $25,000 land + $15,000 loan + $10,000 income = $62,000 tax basis At-risk basis: $12,000 cash + $25,000 land + $10,000 income = $47,000 at-risk basis (no loan included)
Rachel, a single taxpayer, created a limited liability company which she elected to have taxed as a a partnership, to sell her handmade necklaces. Rachel had an initial cash contribution to the business of $20,000. Additionally, Rachel was allocated $5,000 of recourse debt that she had personally guaranteed and $8,000 of nonrecourse debt. In the first year of operation, Rachel was allocated $35,000 ordinary business loss from the LLC. Rachel has no other active or passive business activities. Calculate Rachel's tax basis and "at-risk" basis in the LLC. Calculate how much of the loss from the LLC she can deduct on her individual income tax return considering all four of the business loss limitations.
Tax basis: $20,000 cash contributions $5,000 personally guaranteed debt $8,000 nonrecourse debt = $33,000 tax basis At-risk basis: $20,000 cash contributions + $5,000 personally guaranteed debt = $25,000 at-risk basis Rachel can deduct a loss of $25,000, up to her at-risk basis limitation. The remaining $10,000 will be carried forward until basis is reinstated.
Foreign Person with Nonbusiness Income in US
Taxed on a gross basis at a 30% statutory withholding rate 2 types of holding regimes for nonbusiness income: 1. Fixed, Determinable, Annual, or Periodic Income (FDAP), or 2. Foreign Account Tax Compliance Act of 2010 (FATCA)
How does the IRS respond to Transfer Pricing?
The IRS has the authority to adjust income and deductions to prevent evasion of taxes or to clearly reflect income. The IRS can also impose penalties as a result of these adjustments.
Anti-deferral Rules
The US has two anti-deferral rules that result in the current taxation of foreign-source income: 1. Passive foreign investment company regime 2. Controlled foreign corporation rules/Subpart F
Lane Inc., an S corporation, pays single-coverage health insurance premiums of $4,800 per year and family coverage premiums of $7,200 per year. Mill is a 10% shareholder-employee in Lane. On Mill's behalf, Lane pays Mill's family coverage under the health insurance plan. What amount of insurance premium is includable in Mill's gross income?
The full $7,200. Because Mill owns over 2% of the company, none of the health insurance premiums are deductible.
Nexus definition
The minimum level of contact a taxpayer may have with a jurisdiction to be subject to its tax --typically caused by a company having property, payroll, or sales within that state
Partnership Formation
The partners contribute money, property, or services in return for their ownership interests. A new partner may also obtain an interest by making a contribution after the partnership is formed and already operating. Generally, no gain or loss is recognized on a contribution of property to a partnership in return for a partnership interest.
Who decides tax elections for partnerships?
The partnership as an organization--it does not trickle down to individual partners (accounting methods, tax years, etc.)
Partnership's Basis in Contributed Property (Inside Basis)
The partnership's basis is the contributor's basis, or carryover basis plus any gain recognized by contributing partner. Generally, the greater of: - NBV of property contributed, or - Debt assumed by the partnership
Competent Authority
The taxpayer can request that the IRS and other taxing officials ascertain the appropriate transfer price so that the taxpayer group is not taxed twice on the same income --get approval before the transaction is done
A taxpayer receives a 20 percent partnership profits interest in exchange for services provided. On the day he is admitted to the partnership, the partnership's assets have a basis of $20,000 and a liquidation value of $80,000. Determine the amount of income, gain, or loss recognized by the taxpayer.
The taxpayer will NOT have to recognize income at the time his services are exchanged for profits interest.
Uncontrolled Comparable definition
The uncontrolled transaction or uncontrolled taxpayer that is compared, under any applicable pricing methodology, with a controlled transaction or controlled taxpayer
What is the treatment for US shareholders of Passive Foreign Investment Companies?
They are subject to PFIC rules and PFIC undistributed earnings are subject to US taxation under one of the 3 methods: 1. Qualified election fund 2. Mark-to-market method 3. Excess distribution method
The New Elect Corporation was a C corporation until it elected S status on January 1, Year 2. New Elect had accumulated C corporation E&P of $20,000 at December 31, Year 1. For the period Year 2 to Year 8, New Elect had ordinary business income of $100,000 and had made shareholder distributions of $60,000. New Elect's AAA balance at December 31, Year 8 was $40,000 ($100,000 - $60,000). In Year 9, New Elect had ordinary business income of $50,000 and made distributions to shareholders of $120,000. Provide the tax results of the Year 9 distribution.
To extent of S corp AAA: $90,000 nontaxable ($40,000 + $50,000) To extent of C corp E&P: $20,000 taxable as a dividend Excess $10,000: Nontaxable reduction in stock basis--any excess is taxed as a LTCG
Nonrecourse debt in a partnership
Typically secured by property. The creditor only has the right to take the secured property, not personal assets of the partners. - Nonrecourse debts are allocated to all partners based on their profit-sharing ratio
At-Risk Limitation
Typically the same as the shareholder's tax basis, except for any nonrecourse loans contributed to the corporation--those are subtracted out to arrive at the at-risk basis. Any excess loss is suspended until at-risk basis is reinstated. Any excess not reinstated can offset any gain when the shareholder sells their stock.
Holding Period Requirement on Foreign Dividend Payments
US Corporation must have held foreign corporation stock for at least 1 year of the last 2 years to qualify for the 100% deduction
Expatriated Entity definition
When a US company decides to reorganize its operations under a foreign parent to reduce its US tax obligations
How to form an S Corporation
When a corporation is formed, it is treated as a C Corporation be default. It is treated as an S corporation when valid election is filed on Form 2553
Built-In Gain/Loss on Contribution to Partnership
When a partner contributes property with a FMV higher or lower than its basis, a built-in gain or loss exists. When the property is subsequently sold, the built-in gain/loss must be allocated back to the contributing partner (along with his partnership share on gain/loss)
Capital Interest Acquired for Services Provided
When a partner provides services to a partnership in exchange for a capital interest, the compensation he receives for services provided is the liquidation value of the capital interest (the amount the contributing partner would receive if the partnership liquidated). The liquidation value of the capital interest is included in the taxpayer's ordinary income
Profits Interest Acquired for Services Provided
When a partner receives profits interest for services provided, the partner does NOT recognize any compensation as ordinary income--they're getting a PROMISE to uncertain profits, with no liquidation value
Partnerships: Distribution of Multiple Assets
When multiple assets are distributed to a partner and the partner's basis in the interest of the partnership is less than the basis of the assets, the partner's remaining basis in the partnership must be allocated between assets - basis is first assigned to cash, then "hot assets", then other property
Property Contributed to Partnership Subject to Excess Liability
When property is contributed that is subject to liability, the excess of the liabilities assumed BY THE OTHER PARTNERS (because you still get your own portion) over the contributed basis is treated taxable boot and is a gain to the partner
Transition Tax
While the US transfers from a worldwide tax system to more territorial, the transition requires all US shareholders to pay a one-time tax on the CFC's previously untaxed foreign earnings.
Foreign Account Tax Compliance Act of 2010 (FATCA)
Withholding tax on foreign entities for failure to provide information to US recipients - built to combat tax evasion tied to US persons investing in foreign entities - imposes 30% withholding taxes on foreign entities who do not provide info on US persons involved
In Year 1, Joan contributed property with an adjusted basis of $100,000 and a FMV of $150,000 to Morton Partnership in exchange for 20% partnership interest. In Year 3, Morton Partnership sold the property to an unrelated party for $180,000. Calculate the amount of gain recognized by Joan in Year 1 and in Year 3 related to the contributed property.
Year 1: No gain recognized--only when the property is subsequently sold Year 3: $180,000 sales price - $100,000 adjusted basis = $80,000 gain realized - $50,000 built-in gain = $30,000 gain allocated to partnership Joan's gain: $50,000 built-in gain + $6,000 ($30,000 * 20%) = $56,000 gain allocated to Joan
Anna's stock basis in her S corporation stock at the end of Year 1 is $30,000. Anna also loaned the S corporation $10,000 from her personal savings in Year 1. In Year 2, the S corporation incurred an ordinary business loss, and Anna's share of the loss was $75,000. The S corporation had ordinary business income in Year 3, and Anna's share was $50,000. There were no other changes in Anna's stock basis, and the corporation did not make on the loan from Anna in years 2 and 3. Calculate the amount of ordinary income or loss that is flowed through to Anna's individual income tax return each year and her basis in S corporation stock at the end of years 2 and 3.
Year 2: Tax basis AND at-risk basis: $40,000 ($30,000 + $10,000 recourse loan) Anna can flow through $40,000 of the $75,000 ordinary business loss she incurred. This reduces her basis in stock to $0. The remaining $35,000 will be suspended until her tax basis is reinstated. Year 3: Anna's ordinary income = $50,000 --> reinstates her debt basis of $10,000 and stock basis of $40,000. Anna's remaining $35,000 NOL can be offset by her stock basis of $40,000, reducing her basis to $5,000.
Does a partnership have to file a tax return?
Yes, they must file Form 1065. Although the partnership is not subject to income taxes (as it is flowed through to partners), this form is an informational document on the income and expenses and indicates the amount and type of each partner's share of ordinary business income
Advance Pricing Agreement Program
a binding contract between the IRS and the taxpayer by which the IRS agrees not to seek a transfer pricing adjustment for a covered transaction if the taxpayer files its return for a covered year consistent with the agreed transfer pricing method
S Corporations
a flow-through entity taxed in a manner similar to a partnership. All income, gains, losses, and deductions are passed through the corporation to the individual shareholders. The individual shareholders are taxed their portion of corporation earnings that year, regardless of if they have been distributed.
Which of the following payments to a foreign person is not subject to US withholding tax requirements? a. An interest payment from a savings account at a US bank b. A dividend payment from a US corporation c. A customer payment for the sale of inventory within the US d. A payment to a foreign financial institution that does not provide information about US persons
c. A customer payment for the sale of inventory within the US Payment to a foreign person NOT subject to US withholding
Fixed, Determinable, Annual, or Periodic Income (FDAP)
deals with the withholding of foreign persons' investment-type income - US person controlling such income to foreign person is responsible for withholding the appropriate amount of tax (30%)
