PARTNERSHIP/S CORPORATION BASIS AND DISTRIBUTION ISSUES (PSBD) Edward K. Zollars, CPA (Arizona) [email protected] www.currentfederaltaxdevelopments.com www.currentfederaltaxdevelopments.com/idpsbd © Kaplan, Inc. 1 CURRENT DEVELOPMENTS - NEWS © Kaplan, Inc. 2 §199A S CORPORATION INSTRUCTIONS • Draft Form 1120-S Instructions, 10/16/19 – New QBI flowchart (p. 39) This Photo by Unknown Author is licensed under CC BY-SA © Kaplan, Inc. 3 © Kaplan, Inc. 4 §199A S CORPORATION INSTRUCTIONS • Draft Form 1120-S Instructions, 10/16/19 – Detailed §199A instructions for K- 1 on page 38 – 3 new statements to be attached to K-1s This Photo by Unknown Author is licensed under CC BY-SA © Kaplan, Inc. 5 © Kaplan, Inc. 6 © Kaplan, Inc. 7 © Kaplan, Inc. 8 §199A REVISIONS TO PASSTHROUGHS • Draft Schedule K-1, Form 1120S, 7/25/19 – Got rid of 5 codes for reporting §199A information – Now simply have code V, item 17 “other information” – Presumably will have to provide all details required by regulations Photo by Ross Findon on Unsplash – Likely to see similar changes on other 2019 K-1s © Kaplan, Inc. 9 §199A REVISIONS TO PASSTHROUGHS • Draft Form 1065, 1120-S and K-1s, 9/26/19 – Tax basis capital only on K-1 – More §704(c) information on K-1 – At risk and passive activity disclosures – Separate out 2 types of guaranteed payments Photo by Ross Findon on Unsplash © Kaplan, Inc. 10 © Kaplan, Inc. 11 © Kaplan, Inc. 12 © Kaplan, Inc. 13 © Kaplan, Inc. 14 §199A REVISIONS TO PASSTHROUGHS • Draft Form 1065, 1120-S and K-1s, 9/26/19 – Tax basis capital only on K-1 – More §704(c) information on K-1 – At risk and passive activity disclosures – Separate out 2 types of guaranteed payments Photo by Ross Findon on Unsplash © Kaplan, Inc. 15 © Kaplan, Inc. 16 © Kaplan, Inc. 17 © Kaplan, Inc. 18 © Kaplan, Inc. 19 *PARTNERSHIP TAX BASIS CAPITAL DISCLOSURE • Instructions to Form 1065, 2/4/19, Notice 2019-20 – IRS wants information on partners with negative tax basis capital – Indicates likely future income that should be recognized – Required disclosure on Schedule K-1 in those cases – Given to March 15, 2020 Photo by Marvin Esteve on Unsplash © Kaplan, Inc. 20 TEMPORARY REPRIEVE ON PARTNER CAPITAL • Notice 2019-20, 3/7/19 – Tax basis capital disclosure if it is negative at beginning or end of the year – Partnerships protested that they wouldn’t be able to timely provide information – No penalty if omitted from 2018 K-1s – But have to provide information by March 15, 2020 Photo by Veri Ivanova on Unsplash © Kaplan, Inc. 21 BASIS SCHEDULE QUESTION SCHEDULE E • Clarification on line 28, column (e), of Schedule E (Form 1040), IRS Website, 2/6/19 – Basis schedules have been required when S corporation shows loss – Now have check box on Schedule E for that situation Photo by Christa Dodoo on Unsplash © Kaplan, Inc. 22 © Kaplan, Inc. 23 BASIS SCHEDULE QUESTION SCHEDULE E • Clarification on line 28, column (e), of Schedule E (Form 1040), IRS Website, 2/6/19 – Basis schedules have been required when S corporation shows loss – Now have check box on Schedule E for that situation – IRS has also expanded list of situations where schedule must be included with the return Photo by Christa Dodoo on Unsplash © Kaplan, Inc. 24 FORMATION – S CORPORATIONS © Kaplan, Inc. 25 25 RULES FOR CORPORATE FORMATION • §351 Nonrecognition Rules and When They Apply • Interests in Property – Services, Intangibles, Other Issues • Transferor Requirement • Control Test • Step Transaction Doctrine • Controlled Groups © Kaplan, Inc. 26 26 SOLELY FOR STOCK AND BOOT • Definition of Stock • Boot and §351 • Transfers of Multiple Items of Property and Boot • Delayed Payments of Boot – Is it Boot or a Distribution? © Kaplan, Inc. 27 27 OTHER §351 ISSUES • Transfer of stock in a controlled corporation – §304 issue • Installment obligations and §351 transactions • Receipt for services and §83(b) issues (and S complications) • No actual exchange is required © Kaplan, Inc. 28 28 LIABILITIES AND §351 • General rule – liability not treated as boot • First exception – primary purpose is tax avoidance • Second exception – liabilities in excess of basis • Excluded liabilities • Allocation of gain © Kaplan, Inc. 29 29 LIABILITIES AND §351 • Assumption defined for §351 • Contingent liabilities • Character of gain • Effect of Liabilities on Basis – considered boot when determining basis © Kaplan, Inc. 30 30 STOCKHOLDER’S BASIS FOLLOWING §351 • Basis of stock received: – Add: basis of property transferred – Less: boot received (including liabilities assumed) – Add: gain recognized © Kaplan, Inc. 31 31 CORPORATION’S BASIS IN ASSETS • Basis of assets received by the corporation: – Add: adjusted basis of property received in hands of transferor – Add: gain recognized by the transferor on the exchange © Kaplan, Inc. 32 32 ADDITIONAL CORPORATE ISSUES • Nonrecognition by corporation on issuance of own stock for property • Recapture rules • Incorporation of a partnership – including LLC previously taxed as a partnership making an S election © Kaplan, Inc. 33 33 REPORTING – SIGNIFICANT SHAREHOLDERS • Name & EIN of transferee corporation • Date of the transfer • Aggregate FMV and basis of the transferred assets • Date and control number of any PLR received © Kaplan, Inc. 34 34 REPORTING – CORPORATION • Name and EIN/SSN of each significant transferor • Date(s) of the transfer(s) • Aggregate FMV and basis of transferred assets • Date and control number of any PLR received © Kaplan, Inc. 35 35 BASIC ISSUES • Number of shareholders • Eligible entity types as shareholders • Restrictions on foreign ownership • One class of stock • Ineligible corporations © Kaplan, Inc. 36 “100” SHAREHOLDERS One H W © Kaplan, Inc. 37 “100” SHAREHOLDERS Joe Son Daughter Son Daughter Son Daughter S D S D S D S D S D S D S D One Shareholder © Kaplan, Inc. 38 “100” SHAREHOLDERS • Held by others • Joint tenancy (count each) • Widow/er and estate of deceased = 1 • Restricted bank director stock = 0 © Kaplan, Inc. 39 ESTATES • Estate of Qualified Shareholder • Bankruptcy Estate • Life Estates if life tenant makes election (PLR 200404037) © Kaplan, Inc. 40 TRUSTS • Grantor trusts (complete ownership) • Testamentary trusts for 2 years • Voting trusts • Qualified Subchapter S Trust (QSST) • Electing Small Business Trust (ESBT) © Kaplan, Inc. 41 ONE CLASS OF STOCK • Only one class issued • Voting rights are ignored • Must have same rights to distributions and liquidation proceeds © Kaplan, Inc. 42 RESTRICTED STOCK • If no §83(b) election made, ignore shareholder until restrictions lapse • If make §83(b) election, then count these shares • Deferred compensation plan © Kaplan, Inc. 43 DISTRIBUTION/LIQUIDATION • Other agreements • Nonresident income taxes • ESOP Rules © Kaplan, Inc. 44 BUY/SELL AGREEMENTS • Death, disability, divorce or termination of employment agreements excluded • Other buy/sells – Not attempt to skirt 2nd class – Price near fair market value (GAAP exception) © Kaplan, Inc. 45 CALL OPTIONS • Prohibited features • Safe harbor rules © Kaplan, Inc. 46 LLCS • Check the box allows to be treated as corporation • Tests interests under same dual tests © Kaplan, Inc. 47 IS IT DEBT OR EQUITY? • Arrangement constitutes equity • Principal purpose to get around limitation on rights of stock • Straight debt rules © Kaplan, Inc. 48 STRAIGHT DEBT • §1361(c)(5) definition – Not contingent payments – No convertibility (direct or indirect) – Credit individual, estate, eligible trust, or commercial lender • Subordination is OK – but modifications are tested © Kaplan, Inc. 49 MAKING THE ELECTION & SELECTING A YEAR END © Kaplan, Inc. 50 WHO MAKES ELECTION? • Corporation elects • Shareholders consent © Kaplan, Inc. 51 WHEN ELECTION MADE Effective for Current Year First 2 1/2 Months or Following Year Last 9 1/2 Months Effective for Following Year © Kaplan, Inc. 52 EXISTING CORPORATION • Begins on first day of corporation’s year • Can create short year with change in fiscal year © Kaplan, Inc. 53 NEWLY-FORMED CORPORATIONS • First 2½ months of first taxable year • Note deemed incorporation if change LLC’s status to corporate with same 2½ month lookback © Kaplan, Inc. 54 START COUNTING... • First of the following: – First had shareholders, or – First had assets, or – Began doing business • Danger of electing too early © Kaplan, Inc. 55 ELECTION MADE • Form 2553 • No extensions allowed for election © Kaplan, Inc. 56 CONSENTS • Husband & wife if both have ownership interest (including community property) • Minors • Estates • Trusts © Kaplan, Inc. 57 INVALID ELECTIONS • IRS now has authority to waive effect • Requires user fee unless fall under automatic provisions of Revenue Procedures © Kaplan, Inc. 58 © Kaplan, Inc. 59 59 © Kaplan, Inc. 60 60 © Kaplan, Inc. 61 61 © Kaplan, Inc. 62 62 FORMATION – PARTNERSHIPS © Kaplan, Inc. 63 63 CONTRIBUTION OF PROPERTY • §721 recognition of gain or loss • Partners’ initial basis in interest – Add: cash contributed – Add: adjusted basis of property contributed – Add: gain recognized • Partnership gets carryover basis in property • Note contribution issue © Kaplan, Inc. 64 64 DEBT IN A PARTNERSHIP Contribution of cash §752(a) Distribution of cash §752(b) © Kaplan, Inc. 65 65 RECAPTURE PROVISIONS • Generally, no recapture triggered on contribution • Must carry over all attributes to new partnership © Kaplan, Inc. 66 66 PARTNER’S BASIS IN INTEREST – BEGINNING • Beginning if contribute to partnership: – Add: money contributed – Add: adjusted basis of other property – Add: gain recognized under §721(b) • If acquired