Related Parties - Cash Basis & Accrual Basiis

[JohnH]

Corp A is an S-Corp reporting on the accrual basis. The sole Corp A shareholder forms Corp B with a family member, which is also an S Corp with each owning 50% of Corp B. Corp B elects to report on the cash basis. During 2016, Corp B incurs 12K in expenses and issues only one invoice of $6K to Corp A, which Corp A pays in Feb 2017.

Seems to me the $6K expense cannot be accrued on Corp A's 2016 return, rather deducting when it is paid in 2017, and the income is reported on Corp B's 2017 return. Also, the $12K in expenses incurred by Corp B in 2016 must be capitalized. Anyone have other thoughts?

[Roland Slugg]

John, I read your post three times and couldn't make sense of it. Did you get your "Corp As" and "Corp Bs" mixed up along the way? I thought the references to invoices, expenses, etc. was also confusing. Would you consider a complete re-write?

[Burke]

It made sense to me.....but why can't the $6K be accrued on S-Corp A's return? S-Corp B would report the income on its return in year received and deduct expenses (if they are not start-up expenses) in year paid. But bigger question is, why is all this going on? Seems like a tax avoidance scheme on the face of it. And then there is that relationship thing......

[kathyc2]

Corp A is an S-Corp reporting on the accrual basis. The sole Corp A shareholder forms Corp B with a family member, which is also an S Corp with each owning 50% of Corp B. Corp B elects to report on the cash basis. During 2016, Corp B incurs 12K in expenses and issues only one invoice of $6K to Corp A, which Corp A pays in Feb 2017.

Seems to me the $6K expense cannot be accrued on Corp A's 2016 return, rather deducting when it is paid in 2017, and the income is reported on Corp B's 2017 return. Also, the $12K in expenses incurred by Corp B in 2016 must be capitalized. Anyone have other thoughts?

See if I'm following: B invoices A in 2016. Invoice is paid in 2017.

B (cash basis) will not recognize revenue until paid in 2017.
A (accrual) will enter invoice on books in 2016. However, due to 267(a)(2) an M1 adjustment will need to be made deferring the expense until 2017.

[JohnH]

I did have Corp B in a place I should have said Corp A. I corrected it - sorry for the confusion.

It isn't a tax avoidance scheme - all is on the up and up. The owner's adult son is developing a product with unique characteristics and some proprietary aspects. The father wants to firewall that business from Corp A. (Corp B is expected to even eventually be selling to competitors of Corp A). Dad wants the son to have significant ownership of the future profits if the venture takes off as expected, but he isn't interested in giving up ownership of any of Corp A.

I just thought the related party rules forced both companies to handle the invoice on a cash basis.

[JohnH]

OK, thanks.
I hadn't thought about an M1 adjustment.
I was simply going to ignore the invoice on A's accrued expenses at 12/31/16, picking it up as an expense in 2017.
But the M1 adjustment is cleaner and easier to follow.

[Roland Slugg]

I just thought the related party rules forced both companies to handle the invoice on a cash basis.

They do, but only if the accrual versus the actual payment cross taxable years.

If the accrual basis corp is the one with the expense, and the cash basis corp is the one with the income, the accrual basis corp can't deduct the expense until the year when the cash basis corp reports the income. Code §267(a)(2)

I saw no tax avoidance issues in the description whatsoever ... just two companies, with different ownerships (albeit related parties), doing business with each other.