Section 351 Election required?

[equinecpa]

Facts: Client operated as a sole proprietorship prior to 12/31/08. Effective 01/01/09 established LLC and elected S-corp status.

I have two questions regarding transfer of assets:

1. IRS Section 351 applies when assets are exchanged for stock. In the case of an LLC there is no stock -so is there any election to make?

2. Client was taking actual expenses on a large vehicle. I doubt ownership has been transferred to the LLC - how should depreciation be claimed on this vehicle now? On the 1040 and then "lease" to corp to get the expense into the corporation?

[Bees Knees]

1) Section 351 is not an election. It automatically applies when those who transfer property to a corporation solely in exchange for stock immediately after the exchange control at least 80% of the voting power of all classes of stock. Since you have a sole owner electing to be taxed as an S corporation, that sole owner would own 100% of the voting power of all classes of stock (if there were stock issued), and thus there would be no tax on the exchange of property for stock in the new S corporation under Section 351.

2) If vehicle was not transferred to the corporation, the vehicle is owned by the individual, and as an employee of the S corporation, the individual could deduct vehicle expenses on Form 2106, subject to the 2% AGI limitation.

A better way to do it is to have the corporation reimburse the owner at the standard mileage rate under an accountable plan. The owner submits business mileage records to the corporation for reimbursement. The reimbursements are deductible by the corporation and tax free to the owner. The owner takes no deduction for actual expenses. This is allowed even if the owner was previously deducting actual expenses on the Schedule C prior to the election to be taxed as an S Corporation.

[equinecpa]

Oops I meant to say is this a section 351 exchange not election.

So a 351 exchange statement should be filed with the 1120S and 1040 then?

The vehicle is a large towing vehicle and not many miles put on it annually. The mileage doesn't come close to reimbursing for actual expenses of insurance, fuel and depreciation.

[Bees Knees]

When you elect to be taxed as a corporation for federal tax purposes, you are treated as a corporation for federal tax purposes, even if you are not officially a corporation with corporate stock issued under state law. Thus, I would attach a Section 351 exchange statement as if stock were issued even though in reality there is no stock, just to be safe.

As to the tow truck issue, you can also have an accountable plan that reimburses actual expenses. Thus, if the tow truck is not owned by the LLC (taxed as an S corporation), have the owner submit actual receipts to the LLC for reimbursement. The reimbursements are deductible by the LLC and tax free to the owner/employee.

The problem I have with trying to lease the truck to the business is IRS and court cases have re-classified these types of arrangements as wages when the rental is an integral part of the business. The wages are still deductible by the business entity, but become subject to payroll taxes to the one receiving the rent. Thus, I think you should either have the business own title to the truck, or reimburse all expenses under an accountable plan.