S-Corp Distribution

[techiegirl]

Customer is going from Sche C to S-Corp. Husband and wife
are both shareholders. He has taken distributions of $10,000
and wife has distributions of $5000. They contributed
property from the Sche C (transfer of assets) of around
$40,000.

Will the $15,000 in distributions be non-taxable because
they have a shareholder basis of $40,000? The net income
will be around $7,000 after depreciation.

Thank you.

 

[mpally]

Customer is going from Sche C to S-Corp. Husband and wife
are both shareholders. He has taken distributions of $10,000
and wife has distributions of $5000. They contributed
property from the Sche C (transfer of assets) of around
$40,000.

Will the $15,000 in distributions be non-taxable because
they have a shareholder basis of $40,000? The net income
will be around $7,000 after depreciation.

A few things. You say that the company is going from a Sch
C to a S. For the tax year in question, are they a Sch C or
a S? I will consider them to be a S. First, since the
company had a profit of $7,000, the first $7000 will be a
distribution (not taxable). The remaining $8000 will reduce
the shareholder's basis in the company and will not be
taxed. If the shareholder's distribute more than there
basis, then it is taxable. This could change if the Sch C
had earnings from previous years, but that could get very
involved.

 

[Thomas Healy]

Customer is going from Sche C to S-Corp. Husband and wife
are both shareholders. He has taken distributions of
$10,000 and wife has distributions of $5000. They
contributed property from the Sche C (transfer of assets)
of around $40,000.

Will the $15,000 in distributions be non-taxable because
they have a shareholder basis of $40,000? The net income
will be around $7,000 after depreciation.

Fortunately H & W are treated as one shareholder for tax
purposes. Otherwise these could be disproportionate
distributions, unless they were in proportion to the share
ownership of the two. And that could cause the S election to
fail.

 

[Shyster1040]

The basis they have in their stock will be determined, at
the start, by the basis they had in the assets they
transferred to the S-corp when they incorporated it, not by
the value of those assets. Contribution of assets by the
two sole shareholders in this case is a nonrecognition event
governed by section 351 - the corp takes the assets with a
carryover basis, and the shareholders take a transferred
basis in their shares.

Thus, whether or not the $15,000 in distributions will be
taxable will depend on the basis that they had in the
assets, which is now the basis of the stock, plus an
additional $7k of basis representing the $7,000 taxable
income that they have to take into their own tax returns.
Since you know that they have at least $7k of basis, they
will not have taxable gain on the distributions if the basis
that they had in the assets (which has now carried over to
the stock) was greater than $8,000.

 

[techiegirl]

Thank you all for your replies. They incorporated the
company on Jan 2004. So they were a S-Corp for the whole
year but going from a Sch C/Sole P. I've done some research
on the Section 351. I understand now that it is the "basis"
not the "FMV" that is carried to the S-Corp.

With that... I have an additional question. Is the carryover
basis reduced by any liabilites that are owed on the
equipment.... considering that these liabilities have also
been transferred to the S-Corp? If so this would
dramatically reduce the shareholder's basis.

If the distributions go over the shareholder's basis.... it
will be a taxable capital gain to the shareholders correct?
Thank you again for all your help

 

[Thomas Healy]

Thank you all for your replies. They incorporated the
company on Jan 2004. So they were a S-Corp for the whole
year but going from a Sch C/Sole P. I've done some research
on the Section 351. I understand now that it is the "basis"
not the "FMV" that is carried to the S-Corp.

With that... I have an additional question. Is the carryover
basis reduced by any liabilites that are owed on the
equipment.... considering that these liabilities have also
been transferred to the S-Corp? If so this would
dramatically reduce the shareholder's basis.

If the distributions go over the shareholder's basis.... it
will be a taxable capital gain to the shareholders correct?
Thank you again for all your help

Yes. The basis of the shares you receive is the basis of the assets reduced
by the basis of the liabilities assumed by the corporation. If some of the
assets were cash basis receivables, written off under Section 179, or fully
depreciated, it's possible that the liabilities even exceed the assets. That
results in an incorporation gain taxable in 2004, due to relief of
liabilities. The corporation would allocate the gain to the assets in
proportion to their relative fair market values.

 

[David Woods, EA, ChFC, CLU]

Thank you all for your replies. They incorporated the
company on Jan 2004. So they were a S-Corp for the whole
year but going from a Sch C/Sole P. I've done some research
on the Section 351. I understand now that it is the "basis"
not the "FMV" that is carried to the S-Corp.

With that... I have an additional question. Is the carryover
basis reduced by any liabilites that are owed on the
equipment.... considering that these liabilities have also
been transferred to the S-Corp? If so this would
dramatically reduce the shareholder's basis.

If the distributions go over the shareholder's basis.... it
will be a taxable capital gain to the shareholders correct?
Thank you again for all your help

Yes to both questions.

 

[Shyster1040]

In general the answer is yes, the basis of the stock will be
reduced by the amount of debt encumbering the assets
contributed to the corporation. See sec. 358(a) and (d).