S-Corp, APIC, and dissolution

[Brad Imsdahl]

IRS Pub 542, page 3 says:

"Paid-in capital. Contributions to the capital of
a corporation, whether or not by shareholders,
are paid-in capital. These contributions are not
taxable to the corporation.

The basis of property contributed to capital
by a person other than a shareholder is zero."

Obviously there are occasions where tax free contributions to capital by nonshareholders are allowed. Otherwise the IRS Pub would not say what it says.

[OldJack]

First Brad, your page number is wrong your quote came from page 5 of the publication.

Second, you really should take a continuing education course in accounting. It would help you with these things.

Third, Well... there you go again taking a little clip out of context to the subject being discussed in the publication. The capital contribution they are referring to is for property being contributed and how the basis of the property is determined.

The term you quoted that they used in the pub, "Paid-In Capital", is not talking about the "Paid-In Capital Account", rather the broad term that it is Capital that has been paid into the corporation as you have also used the same term in your book for the same broad meaning (see TTB quote below).

And yes, when property is contributed it is in exchange for stock with certain requirements or it is a taxable transaction [IRC§351(a)](see quote below). edit: correction the taxable amount is to the shareholder and not the corporation. Its not likely the shareholder is going to make a contribution that is taxable to him.

Note the pub quote comment "The basis of property contributed to capital by a person other than a shareholder is zero." That means no entry in Paid-In Capital Account for the contribution unless you like recording zero's.

The publication 542 goes further to say "If a corporation receives a cash contribution from a person other than a shareholder, the corporation must reduce the basis of any property...... Again, this is not an entry to an equity account especially the "Additional Paid-In Capital" account. The entry to record this contribution would be to debit cash and credit the property asset account to reduce basis as required.

Basis. The corporation’s basis of property contributed to
capital by a shareholder is the same as the basis the
shareholder had in the property, increased by any gain the
shareholder recognized on the exchange. However, the
increase for the gain recognized may be limited. For more
information, see Basis of property transferred, earlier, and
section 362 of the Internal Revenue Code.

The basis of property contributed to capital by a person
other than a shareholder is zero.

If a corporation receives a cash contribution from a
person other than a shareholder, the corporation must
reduce the basis of any property acquired with the contribution
during the 12-month period beginning on the day it
received the contribution by the amount of the contribution.
If the amount contributed is more than the cost of the
property acquired, then reduce, but not below zero, the
basis of the other properties held by the corporation on the
last day of the 12-month period in the following order.

I also refer you to your own generic statement "Paid-In Capital" in TTB, page 18-5 that is not talking about the Additional Paid-In Capital Account.

stock. Ownership in a corporation is represented by shares of stock. Cash or property transferred to a corporation in exchange for stock is call "paid-in-capital".

The code that makes a contribution taxable unless the contribution is in exchange for stock of the corporation [IRC§351].

Sec. 351. Transfer to corporation controlled by transferor

-STATUTE-
(a) General rule
No gain or loss shall be recognized if property is transferred to
a corporation by one or more persons solely in exchange for stock
in such corporation and immediately after the exchange such person
or persons are in control (as defined in section 368(c)) of the
corporation.

[Brad Imsdahl]

First Brad, your page number is wrong your quote came from page 5 of the publication.

The November 2004 version of Pub 542 has it on page 3, not page 5.

Second, you really should take a continuing education course in accounting. It would help you with these things.

Why would I do that when I got you to educate me on matters?

Third, Well... there you go again taking a little clip out of context to the subject being discussed in the publication. The capital contribution they are referring to is for property being contributed and how the basis of the property is determined.

I understand the basis issue. We are not talking about basis. We are talking about the balance sheet. I disagree with your method of keeping books.

The publication also refers to the basis of property contributed in exchange for stock and that it is a tax free exchange under Section 351.

For example, if I have a carpet cleaning machine worth $1,000 with a basis of $200, and I contribute it to the corporation in exchange for stock in a Section 351 transaction, the corporation’s basis in the carpet cleaning machine is $200, and my stock basis is $200.

However, for accounting purposes, you debit fixed assets $1,000 and paid-in-capital $1,000. The difference between depreciation for tax purposes and depreciation for book purposes is reconciled on Schedule M-1.

The same is true for contributions to capital of money or property by non-shareholders. Under Section 362(c) (and according to Pub 542), if the city of Becker were to contribute land worth $1 million to your corporation so that you will locate there, the contribution is tax free. The city of Becker gets no stock. You have no taxable income. You record the transaction by debiting fixed assets (land) $1 million, and credit additional paid-in-capital $1 million. For tax purposes your corporation has zero basis in the contribution. The same is true for cash contributed. No tax because the basis of all other assets are reduced by the cash contributed. However, you still keep the value of the asset on the books the same, by debiting cash and crediting paid-in-capital.

The balance sheet for bookkeeping purposes does not reflect the basis in assets. It reflects the fair market value of all assets at the time they were contributed or purchased by the corporation.

[OldJack]

You would never record the $1,000 fair-market-value in a corporate contribution. That would make the financial statements not GAAP as fair-market-value statements are not allowed as that was not your cost. I believe the only time FMV is used in a contribution is if it is lower than cost basis when converting property. Since that is unusual, I don't remember ever seeing it, I would have to check to see if it is even allowed then with a corporation.

You are still confused with partnership accounting where FMV can be recorded with the amount above basis as a non-depreciable asset and the asset has to be kept track of with the partner that made the contribution for later possible allocations.

And again the land you site would not be recorded on the books at $1,000,000 as that is the FMV, your cost is zero and historical accounting would not allow such an entry.

>>The balance sheet for bookkeeping purposes does not reflect the basis in assets. It reflects the fair market value of all assets at the time they were contributed or purchased by the corporation.<< Absolutely false, the financial statement represents historical cost which in most cases is the fair-market-value at the time of the transaction because it is the amount you purchase. But, after the date of purchase it makes the financial statements historical cost statements which is in accordance with GAAP (generally accepted account principles). Independent auditors only issue audits in accordance with GAAP, there is no such thing as an "audited statement" other than in accordance with GAAP.

Your theory is kind of like you think a gift should carryover and record basis as fair-market-value rather than the donors basis.

Nonsense, if FMV was allowed to be what is recorded, financial statements would never represent anything but fair-market-value as corporations would constantly be trading (tax-free exchanges) assets to receive step-up in the financial statements to attract investors. Can't you just imagine how the stock market would go crazy trying to figure out what corporations are worth when the balance sheet keeps increasing in value with little or no earnings? Get real.

As to your statement "Why would I do that when I got you to educate me on matters?". Well, you have to remember that I am getting older and tired of your insisting you are right when you are wrong. This thread is an example of it turning into a textbook and becoming entirely too long when it is only remotely on the original subject. Why don't you make me a $$ offer to tutor you.

[Brad Imsdahl]

I'm not going to argue accounting with you. Read TTB page 25-3 under the heading Book to Tax Adjustments. That's my story, and I'm sticking to it.

[OldJack]

Read TTB page 25-3 under the heading Book to Tax Adjustments. That's my story, and I'm sticking to it.

So what is your point? Of course there are difference in book and tax requiring adjustments in 1120S, page 4, Sch-M, and that is what TTB page 25-3 thru 25-5 is talking about.

Your sticking story accuracy in our case is only a figment of your imagination.

Again, you just will not read even your own writing as to what it is talking about. First the tab is "Other Business Topics", not tab 18 or 19, Corporations. You can't just extract something from its subject and make it into anything you want it to be.

The first transaction listed in the page 25-4 chart says "Assets other than cash contributed to the business in exchange for an ownership interest", the next column "Per Book" says "Record as if the asset was sold to the business at FMV", the next column says it is a tax-free transfer.

Note that it say to the "business" and not to the corporation. That can be true if the business was not a corporation as this note was not meant to be for a corporation or this would have been covered under your tab 18 & 19. Also note that it says for an ownership interest and not for capital stock issued.

Recording the FMV is usually only in partnership accounting (the business) where it is desirable to have the capital accounts equal 50-50 partners since one partner contributed cash and the other partner contributed his personal §179 backhoe worth an equal amount of cash. That is about the only time accountants record at FMV and then the asset is usually carried on the books as an asset with 2 entries, one for the depreciable basis and the other as FMV that is not depreciated with both entries credited to the partners capital account. However, partnership rules require tracking of this as when the asset is disposed of a portion of the gain has to be allocated specifically to that partner. Its a complicated thing with elections of this and that. I don't do a lot of partnerships as most of my clients are corporations.

I think it appropriate to point out that everything one reads does not mean it is correct. Just like I am not always correct. But then, I run about the same average. You really should not think that everything stated in TTB can be applied to every situation or maybe I should say everything is even accurate in every situation. It would be nice if the tax law could always be applied equally to every situation and if so we would not have to have arguments over interpretations or a tax court.

Its too bad that this thread has gotten so long that no one but you and I will read it.

[Brad Imsdahl]

OK, lets say you and I form a 50/50 S corp.

I have a carpet cleaning machine worth $1,000. If we sold the machine today, we could get $1,000 cash.

You have $1,000 cash.

My basis in the carpet cleaning machine is $200.

Under a Section 351 transfer, I pay no tax on the transfer to the corporation in exchange for stock. The corporation pays no tax on the receipt of the machine in exchange for giving me stock.

For book purposes, I would record the transaction as follows:

Debit cash $1,000
Debit depreciable assets $1,000
Credit Capital Stock $2,000

There would need to be two sets of depreciation schedules. One to record depreciation for book purposes at $1,000, another to record depreciation for tax purposes at $200.

The capital stock account on the balance sheet has to reflect the fact that you and I are equal shareholders. Since you agreed TTB, Tab 25 is correct, notice the two examples in the first column on page 25-5. Those are S corporation examples.

[OldJack]

No..no..no..NO!!!! Your book entry cannot be $1,000 for the machine and the equity account "Common Stock issued would not be $2,000.

Nothing you said is correct. I do not agree that TTB, Tab 25 is correct as it relates to what we are discussing in this case.

Denny's asset is contributed to the S-corp with the property asset account showing $2,000 and the accumulated depreciation account showing $951 (286+490+175) and the S-corp takes its $175 deduction for a final accumulated balance year-end of $1126. Some accountants would book only the net and not the prior accumulated amount, but I do not agree with that as it changes the depreciation per year.

I disagree with your broad statement in the next paragraph that implies that the booking entry is FMV, the same for a partnership and a corporation. Again, the fact that it is taxed as a S-corp does not mean it does its accounting the same as a partnership. An S-corp is a corporation and not a partnership.

A partnership balance sheet is nothing more than 2 sole proprietorships doing business together. A corporation is a separate and distinct entity. You must also realize that certain partnership rules applying to a S-corp for tax purposes but that does not make the entity a partnership for accounting.

A corporate balance sheet does not show shareholders are equal... the number of stock certificates in the hands of the shareholder make what is or is not equal. ANY numbers on the balance sheet of a corporation belongs equally to the shareholders on a per share basis... not equally according to how much they paid for their shares. You absolutely must get this straight in you head or you will never understand.

Maybe what is causing you problems is that you don't really understand why there is a difference between the book v. tax causing a required adjustment. The difference is normally due to the "number of years required" to be depreciated and normally has nothing to do with Cost v. FMV as FMV is not what is recorded on the books. GAAP life is usually longer than the tax law or MACRS life, thus the requirement of 2 depreciation schedules and an adjustment to reconcile the book basis balance sheet and book income with the tax basis income on the tax return.

[OldJack]

Your insistence that the corporation dollar amounts has to be equal in your example is overlooking the fact that they really are equal if the number of share issued are equal. As an example, if you liquidated the corporation each shareholder would be getting amounts that are equal as the cash is split equally and the sale of the machine is split equally giving both shareholders the same.

Of course the shareholders have different tax basis and gains on the liquidation which is fair that they do.

[Brad Imsdahl]

Yes, if I contribute property worth $1,000 and get 1,000 shares of stock in exchange with a par value of $1 per share, the corporate balance sheet should record $1,000 common stock in the capital account. Just like you get 1,000 shares of stock at a par value of $1 per share for your contribution of cash.

Basis in the property I contribute for tax purposes is irrelevant. Basis for book purposes has to be $1,000 because that is what I got. $1,000 worth of stock.

That is why you have an adjustment on Schedule M-1 for the difference between depreciation for tax purposes verses depreciation for book purposes. You keep trying to combine the two.

[OldJack]

it is interesting that you are the only CPA who has ever had a problem with the accounting theory behind the example.

And I would not have bothered to express my disagreement with your book had we not been having this discussion on this forum. Why would I care if your book was correct or not? I would simply ignore your book opinion and consider it as incorrect. I don't have time and its not my job to edit your book. Frankly, I would not look to your book for authority as to how to handle proper accounting and as such would not even be reading that paragraph. I consider your book as a tax book and not an accounting book.

[Brad Imsdahl]

Since when does tax basis have anything to do with GAAP?

If I contribute property worth $1,000 to a corporation in exchange for $1,000 worth of stock, where does GAAP require it to be recorded in the books under tax basis?

[OldJack]

Yes, if I contribute property worth $1,000 and get 1,000 shares of stock in exchange with a par value of $1 per share, the corporate balance sheet should record $1,000 common stock in the capital account. Just like you get 1,000 shares of stock at a par value of $1 per share for your contribution of cash.

I agree that if the corporation agrees to issue 1,000 shares of $1 par value stock for your machine that it would indeed record the asset with a cost value of $1,000 and the depreciable tax basis for such asset would also be $1,000. Thus, there would be no Sch-M adjustment for anything other than the difference in years calculating depreciation for GAAP and Tax. However, you must realize that the shareholder has not complied with §351 for a tax-free contribution in exchange for stock and would therefore have a taxable sale to report on his personal tax return.

[OldJack]

I'm sorry but this discussion has taken too much time and after all this is tax season. Therefore, I have to let you have whatever say you wish and end this thread.

[Brad Imsdahl]

I agree that if the corporation agrees to issue 1,000 shares of $1 par value stock for your machine that it would indeed record the asset with a cost value of $1,000 and the depreciable tax basis for such asset would also be $1,000. Thus, there would be no Sch-M adjustment for anything other than the difference in years calculating depreciation for GAAP and Tax. However, you must realize that the shareholder has not complied with §351 for a tax-free contribution in exchange for stock and would therefore have a taxable sale to report on his personal tax return.

No, in my example, I contribute the machine worth $1,000 for 1,000 shares of stock at a par value of $1 per share. You contribute $1,000 cash for 1,000 shares of stock at a par value of $1 per share.

It qualifies as a tax free exchange under Section 351 because you and I own as a group over 80% of the stock after the exchange.

The fact that my tax basis in the machine was only $200 at the time of the exchange is irrelevant for book purposes.