Ccorp, Bulldozer and the deceased

[Harvey Lucas]

Client owns Ccorp 100%, lives in a community property state, has cancer and will die in a few months (in 2006). He is survived by his spouse who will inherit the Ccorp stock at stepped up FMV basis.

2005 1120 is done, all taxes are paid.

There will be little or no income/expense in the corp for 2006.

The only assett in the corp is one piece of section 1245 depreciable equipment that was bought a few years ago, we will call it a Bulldozer, 7 year property, macrs, bonus deprciation, etc.

Rounding off the numbers to keep it simple...the Bulldozer original cost was 350,000....depeciation claimed thru 12-31-05 was 270,000, depreciation for 2006 if held 1/2 year will be 10,000.....350,000 cost, less 280,000 depreciation means basis is 70,000.

The equipment was used very little and is still in like new condition...the client says that it could be sold for approx 275,000. (He got a great price on it at purchase, paid about 50,000 under market)

When my client dies, the spouse will inherit the stock, her basis in the stock will be 275,000, i.e. the value of the only remaining assett in the corp, however, I'm at a loss for how to advise her to proceed. Seems like she will get no benefit for this stepped up basis?

If the corp sells the bulldozer for 275,000....with a basis of 70,000, there will be a corp gain of 205,000....since the entire amount of the gain is from depreciation, the gain will be ordinary income and taxed as regular corporation income and will generate a huge tax bill.

I guess one solution is to sell the stock of the corp and not the bulldozer, however, I think it is unlikely that a buyer will want to buy the stock of an unknown corp since he will not know what hidden liabilities lie therein?

She could liquidate the corp, but my understanding is that in doing so it is treated as if the assett were sold for FMV and the tax result is the same.

Any idea's?...Am I missing something?


Thank You

HarveyLucas

[OldJack]

It appears you have your facts and analysis accurate. However, you did not mention if the C-corp had liabilities, retain earnings, or losses (capital or NOL) that could change the value of things.

Has the taxpayers considered keeping the C-corp and simply leasing the equipment to someone?

[Harvey Lucas]

Keeping it Simple

I was trying not to confuse the illustration too much...there is actually 100,000 cash in the Corp as of 12-31-05.

The Corp owes the client 50,000 on a note, plus interest for a couple of years.
There is retained earnings of approx 50,000.

Plan is to pay the note and interest to widow, principal will be tax free, interest taxable.
The balance of Corp cash can be paid to her as a dividend and as such taxed at lower tax rate on 1040.

The problem we are left with is the bulldozer...the widow won't have much use for it after the husband is gone.

The leasing thing is an option, except that in the state where they are, the leasing of equipment is subject to sales tax. I guess that cost can be passed along to the buyer/lessee....but big problem there is turning over such an expensive piece of equipment without adequate money from the buyer/lesse...if things went sideways the equipment could be rendered worthless.

Of course the widow just wants to be done with it, does not want to bother with all the complictaed details of tax minimizing efforts.

Of course it is not a bad problem to have, ie, we have a $275,000 assett that can be converted to cash, no debt, that is great...the corp paying tax on the sale just comes with the territory, the widow gets the cash that is left...Presumeably, after the dozer is sold, we would have the corp redeem 99% of the widow's corp stock, in exchange for the net proceeds from the sale after paying the corp income tax thereon....The stock redemption will be tax free to widow because of the stepped up basis rules.

My goal of course is to not end up looking stupid and/or negligent by overlooking some clever or not so clever manuever to avoid all this tax. And of course I want to provide my client the best service possible and not pay a bunch of tax if it can somehow be avoided.

As I see it, if the dozer is to be sold, there are not to many options:

1. Have the corp sell it, pay corp income tax on the sale, distribute the proceeds tax free to the widow in a tax free stock redemption.

or

2. Find a willing buyer who is confident that there are no hidden problems or liabilities regarding the corp...the buyer buys the stock of the corp from the widow at a lower price than the $275,000 FMV of the dozer recognizing the fact that the buyer will get little to no deprection on his purchase...the stock sale is tax free to the widow, (possibly even a loss).

3. Any others?

Thank You

HarveyLucas

[OldJack]

<<redeem 99% of the widow's corp stock, in exchange for the net proceeds from the sale after paying the corp income tax thereon....The stock redemption will be tax free to widow because of the stepped up basis rules.>>

The widow owns 100% of the stock outstanding before the redemption and 100% of the stock outstanding after redemption. That is not the sale of stock with capital gains.. that is a taxable dividend with the widow still owning her 1% of stock (now 100%) at the same tax basis. See code §302(a).

There is a 80% test [code §302(b)(2)(C)] and a 50% test [code §302(b)(2)(B)] formula if she was actually selling to another owner by way of redemption but that is not your case.

The only way to get the sale proceeds out as a sale of stock on the 1040 is to do a complete liquidation of the C-corp. Of course right now dividends are taxed at a max of 15% the same as gain on sale of stock.

[veritas]

Old Jack

I don't work with C Corps very much. When they repealed the general utilities doctrine we converted nearly every corporation we had to an S Corp.

If the Corp sold the bulldozer and paid the tax, then liquidated all the cash in exchange for the stock would that not eliminate any tax at the individual level since there would be no gain or loss due to stepped up basis? I'm thinking there would be no dividends taxed at the reduced rate.

[OldJack]

If 10 years has passed since you elected S-corp then there would be no BIG tax (built-in-gain) on the 1120S. As you know, the day you elected from C-corp to S-corp you established the FMV of all assets on that date as though you had sold them and thereby determined the gain called BIG.

If you sell any of those assets before the 10 years (unrecorded acct/rec, equip, etc) you have C-corp (double tax) tax reported as BIG tax on the 1120S with the actual gain passing to the shareholders on their 1120S-k1 for personal 1040 tax. Therefore the old double tax as the S-corp paid a tax and the 1040 paid a tax of the sale of the asset.

If 10 years have passed, the sale of the bulldozer would be reported on the 1120S-4797 and flow through as a capital or ordinary gain on the 1120S-k1 for tax on the 1040. The gain would have increased the AAA account for future tax-free distributions and increased the shareholders tax basis in his stock for liquidation.

The step-up in basis may or may not have any substantial tax effect on liquidation of an S-corp as tax basis is adjusted each year with S-corp income and losses and cash distributions. You would really need to know all the numbers to determine if the step-up changes much.

Does this make any sense?

[veritas]

Yes

It makes sense. When we converted there was a 3 tax year window.

My question wasn't about scorps it was on liquidating the ccorp. I saw comments on distributing the cash as dividends. My point was if the corp was entirely liquidated there would be no taxable dividends?

[OldJack]

I guess I misunderstood. I was talking about your corp and if you elected S-corp there is no longer be a C-corp to liquidate as it is a S-corp to liquidate.

Were you talking about the original bulldozer post C-corp liquidating? True..In that post case if they do a 100% liquidation it would be a sale/redemption/liquidation in exchange for stock (capital gains) and not taxable dividends (ordinary income, max 15% rate). However, the sale of the bulldozer still creates taxable income for tax at the C-corp level before the cash is available for liquidation to compare to stepped-up stock basis for gain.

[veritas]

Thanks Oldjack

Here is a quote from Harvey

"The balance of Corp cash can be paid to her as a dividend and as such taxed at lower tax rate on 1040."

So Harvey if you distribute this cash as a liquidating dividend there should be no tax.

[Harvey Lucas]

A little of both.

Thanks Jack, Thanks Veritas.

I had modified the facts a bit from the original post.

The Ccorp has approx $100,000 cash as of 12-31-05, plus a bulldozer that is mostly depreciated out.

The corp owes the client $50,000 on a promisorry note, plus interest for a couple of years.

After my client passes, The plan will now be:

1, Corp will payback the $50,000 note to the widow, plus $8000 interest is $58,000. The principal is tax free to the widow, the interest is taxable to widow on her 2006 1040.

2. There is now $42,000 cash left..plus a bulldozer.

3. The widows basis in the Ccorp stock is $42,000 (cash left after payment of the $58,000) plus the FMV of the bulldozer $275,000 less the corp income tax payable from the dozer sale, approx $60,800 equals widow basis of $256,200.

4. The corp will sell the dozer for $275,000, basis is $70,000, gain is $205,000, gain is all ordinary income because of depreciation.

5. 2006 1120 will show $205,000 ordinary gain from dozer sale, less $8000 interest expense, 1120 income tax will be $60,800.

6. Net cash from sale of dozer is $275,000 less $60,800 tax equals $214,200.

7. Cash in the corp is the $42,000 (left over from the original $100,000) plus the dozer net proceeds of $214,200 equal total cash of $256,200.

8. Corp liquidates before 12-31-06, the corp distributes the $256,200 cash to the widow in a liquidating distribution. The widows basis is $256,200.

9. The Corp issues a 1099 indicating a liqidating distibution of $256,200.

10. The widow reports on her 2006 1040 schedule D, $256,200 received, Cost is $256,200, gain is zero.

Does this pretty much sum it all up?

Thank you both so much for your input and feedback.

HarveyLucas

[OldJack]

As I understand... on the date of death spouse gets a step-up in basis to the FMV of the C-corp. At date of death FMV would appear to be $100,000 cash less 50,000 debt, less 8,000 interest payable, plus Bulldozer value of $275,000 equals $317,000 stock tax basis.

Taxable income = $205,000 gain -8,000 interest expense =$197,000. Tax = $60,080.

Liquidate = $100,000+275,000 - 50,000 - 8,000 - 60,080 = $256,920

The 1040 liquidation proceeds is $256,920 verses cost basis $317,000 for a long-term capital loss of $60,080 on 1040 Sch-D.

[Harvey Lucas]

I agree, thank you.

After I posted I thought the same thing...basis should be $317,000...should not have to be reduced by the corp income tax that would be due "if" a sale occurred.

Thank you so much for your feedback Jack.

It is very comforting to have a forum like this to bounce things around.

Happy fathers day to you....as for me, it is Saturday Night and I am heading to the dance hall for a little country 2-step

HarveyLucas