Excess distribution

[Gretel]

I am still working on this tax return and am just thinking out loud. This is a first year tax return with depreciation choices, meaning that I can eliminate excess distributions (no basis) and have some income or I have a small loss (non-deductible) and excess distributions, or anything in between.

The taxable income for this taxpayer is in the 15% tax bracket (and will stay in that bracket even if more income from the S-Corp needs to be reported). Effectively this should mean that my client does not pay tax (0% capital gain taxes in his case) on his excess distributions.

Is this correct? Am I missing something?

[Gretel]

Last night a question came up with this: If there are several distributions throughout the year, are they all deemed to be taken out on the last day of the year for purposes of holding period on Schedule D?

[DaveinTexas]

My thought is

The sales price on your D would be the date of distribution so if this is a first year S Corp, all distributions would be STCG taxed as ordinary income.

I like your thought of taking less accelerated depreciation because if there is limited basis the loss won't do much good anyway. Many times it makes more sense not to accelerate the depreciation in the first year so there will be a greater amount of depreciation to deduct in the second (hopefully more profitable) year.

I wonder, how did he/she keep the company going with no basis to take the loss? I'm just thinking out loud but most first year companies can't obtain credit so normally the shareholders have to infuse their own cash into the Corp (adding basis). Or, they make a loan to the Corp (also adding basis) and instead of buying equipment maybe they contributed property/equipment to the Corp (adding basis). Any of these situations occur?

Try to get some sleep now!

[Maribeth]

I am still working on this tax return and am just thinking out loud. This is a first year tax return with depreciation choices, meaning that I can eliminate excess distributions (no basis) and have some income or I have a small loss (non-deductible) and excess distributions, or anything in between.

The taxable income for this taxpayer is in the 15% tax bracket (and will stay in that bracket even if more income from the S-Corp needs to be reported). Effectively this should mean that my client does not pay tax (0% capital gain taxes in his case) on his excess distributions.

Is this correct? Am I missing something?

Rule of thumb: do not take any "unusual" deductions if the taxpayer does not need them, i.e. do not take bonus depreciation if the taxpayer is already okay with just taking regular depreciation. (now, make sure you look at NOL c/b when you are going through this process but with your posting it looks like that NOL's might not be relevant).

Run your scenarios with the different options: bonus depreciation, no bonus depreciation, any other elections that are available. THEN meet with your client, explain the options, talk with them about their expectations for next year, and then let THEM make the decision as to which way to go. Of course, document this in your workpapers.

I never like to "waste" a deduction in the current year that might have a better tax benefit in a future year.

Regarding your question about holding period for your excess distributions: by definition, they are considered long term. One line item on Schedule D is sufficient.

Maribeth

[Gretel]

Thank you so much, Maribeth and Davein.

Maribeth, I agree with you 100% and already did what you suggested. Most of the depr/amort comes from the purchase of the biz, and to possibly not have excess distributions again for 2012 they are all on S/L. Goodwill alone is almost $500,000. Even with everything on S/L there will be excess distributions. I found really conflicting information for the holding period, and since the shareholder didn't even pay in the much too low $1,000, in a way there don't even own the stocks. That concerns me. They just made a promise to their corporation, and this is recorded on the books as such. I refuse to send in a tax return with no amount for stocks.

Do you by any chance have a reference for long-term treatment?

Davein, here is some more food for your curious mind: You are right, no bank would give him loans. His father got the loan for 80% of the purchase price, the previous owner financed the remainder. In addition, later in the year, he got a LOC and a truck loan. The checking account always shows a negative, and sometimes he mails the checks 2 months later. Most of these things will be remedied by the end of this year. I am not sure if I will be the one who will be doing this year's tax return, he actually thought a friend of his could do this.

By the way, what would you guys charge for this tax return, revenues are well over 1 Million, about 10 employees. Besides some messes he is a nice guy. Don't include any bookkeeping clean up in your quote.

[geekgirldany]

On long term treatment of the excess distributions for 2012, you could put it down as loan to shareholder and clear that out account out in 2013. Of course add interest to that. But the capital gain rates are going to rise for 2013 so that option may be out.

I tend to disagree with Maribeth on discussing with the client on what to do. They are always going to pick less taxes this year. A majority of them (well my clients) don't understand and tell me to do what is best for them. I've tried explaining several times the different options with using bonus depr/Sec 179 versus not using it and its effect on excess distributions. They don't get it and just want to pay lower tax.

On what to charge, I already charge $600 for S-Corps. I would add another $150 to that.

Did your client but stock in the corporation? You said his father got a loan for 80% of purchase price. What was purchased? Stock or assets?

Dany

[DaveinTexas]

I do want to highlight the fact

That the fact that the S scorp is in it's first year, I still believe the distributions in excess of basis would all be short term gains on the Sch D.

From IRS instructions, "A non-dividend distribution in excess of stock basis is taxed as a capital gain on the shareholder's personal return. Stock held for longer than one year is a long-term capital gain (LTCG)."

Key words are in the last sentence. Even if distributions are considered to adjust basis at year end, the fact remains that the shareholder could not have held the stock for over a year in a first year S Corp return year. What has been mentioned by others is to have the client treat the excess distributions as a loan to shareholder (create a promissory note and charge interest). The downside there is the client will have to repay the loan but at least the client wouldn't be taxed on the loan at ordinary income rates; just a thought.

Also, the fee I would charge for this return would be at least $700.

[Gretel]

On long term treatment of the excess distributions for 2012, you could put it down as loan to shareholder and clear that out account out in 2013. Of course add interest to that. But the capital gain rates are going to rise for 2013 so that option may be out.

I tend to disagree with Maribeth on discussing with the client on what to do. They are always going to pick less taxes this year. A majority of them (well my clients) don't understand and tell me to do what is best for them. I've tried explaining several times the different options with using bonus depr/Sec 179 versus not using it and its effect on excess distributions. They don't get it and just want to pay lower tax.

On what to charge, I already charge $600 for S-Corps. I would add another $150 to that.

Did your client but stock in the corporation? You said his father got a loan for 80% of purchase price. What was purchased? Stock or assets?

Dany

Thanks, Dany. The assets were purchased, dad put his home on the line.

I agree with you also. I discuss with my clients but not in technical detail, it's too much for me already, and I don't expect them "to get it". I also emphasize what I think is best, looking at the whole picture and they tend to agree unless they really, really need cash asap. I only leave a decision totally up to them if they have to take a risk and a position is not black and white.

[Gretel]

That the fact that the S scorp is in it's first year, I still believe the distributions in excess of basis would all be short term gains on the Sch D.

From IRS instructions, "A non-dividend distribution in excess of stock basis is taxed as a capital gain on the shareholder's personal return. Stock held for longer than one year is a long-term capital gain (LTCG)."

Key words are in the last sentence. Even if distributions are considered to adjust basis at year end, the fact remains that the shareholder could not have held the stock for over a year in a first year S Corp return year. What has been mentioned by others is to have the client treat the excess distributions as a loan to shareholder (create a promissory note and charge interest). The downside there is the client will have to repay the loan but at least the client wouldn't be taxed on the loan at ordinary income rates; just a thought.

Also, the fee I would charge for this return would be at least $700.

Thanks again, Davein. I read the instructions but was not (and am still not) clear in my special situation. Besides of him not having paid in for the stocks there is another caveat. The official starting date (incorporated with the State) was in the beginning of December the year before. The assets of the business were purchased on 1/3/11, so there were no business transactions to be reported in 2010.

I am going to charge this client $1,150 (including looking at the production deduction, late filing of 2553 and asset acquisition statement). The CPA who did the tax return for the previous owner (not dealing with production deduction and form 2553) charged $1,400.

[erchess]

Fees

When I charged by the form my "entity" returns other than no activity returns started at $600 for the base form and other forms ranged from about $25 to 100 for the ones i ever had occasion to do. Now I charge a straight hourly fee of $150 an hour and still entity returns have a surcharge of $250. These figures will go up for next season.