Depreciation between Sch C & S corp

[oceanlovin'ea]

Client started a business during 2006 and in August of 2006 she incorporated the business.

She bought furniture and equipment before incorporating but put all of it into the corporation. I set up the furniture and equipment on depreciation schedule, not section 179. The tax program took the depreciation for the year on the schedule C. Then I transferred assets into corporation showing original cost and depreciation taken.

Should I have shown the items as disposed of on the schedule C? I guess the depreciation would not have shown up on the schedule C. But that was the original purchase date (before S corporation).

I am second guessing myself now as to where the depreciation should actually show up - on the schedule C or the s corp return.

HELP.

Thanks Linda F

[veritas]

Just curious-To the authors

but is there something in TTB for Sec 351? Worksheet or something. I didn't see it.

[Bees Knees]

The depreciation shows up on both. You have to allocate it between the portion of the year the Schedule C business was operating, and the portion of the year the S corporation was operating. Assuming the assets were transfered under a tax free Section 351 transaction, the S corporation picks up where the Schedule C business left off.

There is an example of this in TTB, page 25-5, first column under Contributed Property Depreciation.

[Bees Knees]

but is there something in TTB for Sec 351? Worksheet or something. I didn't see it.

Not exactly a worksheet. TTB, page 24-1 and 24-2 provides the information you must attach to the corporation return and the shareholder's return when there is a Section 351 transfer.

Otherwise, the tax rules under Section 351 are discussed on page 18-5.

[veritas]

Thanks!

........................

duh

I looked in the index Under Sec. 351 and there it was!

However someone unfamiliar with the specific code section would have a tough time.

[outwest]

One of the tough things sometimes..

........................

duh

I looked in the index Under Sec. 351 and there it was!

However someone unfamiliar with the specific code section would have a tough time.

is that certain issues commonly use the code section for shorthand. Section 179 expensing, 1031 exchanges, and this one, section 351.

[Bees Knees]

......However someone unfamiliar with the specific code section would have a tough time.

The index also lists it under:

Depreciation - contributed property, 25-5, and
Nontaxable transfers to C corproation - section 351, 18-5.

[Bees Knees]

is that certain issues commonly use the code section for shorthand. Section 179 expensing, 1031 exchanges, and this one, section 351.

For anyone who is used to dealing with tax free transfers to corporations in exchange for stock, Section 351 is similar in code section recognition as Section 179 and 1031 are to 1040 tax preparers. If you don't do corporations, Section 351 would be meaningless to you.

[veritas]

The words that jumped into

my mind were:

"tax free transfers to corporations"

[oceanlovin'ea]

Sect 351?

Okay, guys. I guess I am glad that I asked this question because I have never heard of Sect 351 transfer. I guess that is because the S corporation clients that I have had mostly started the s corporation at the beginning of their business or I have taken the account over and followed the previous returns. So never had this situation before.

Let me see if I understand this correctly....For the assets that she puts in the business, she receives stock. The basis of the assets would be the amount paid for the assets less the depreciation taken on the schedule C for the period she owned them before foriming corporation.

Now the corporation has 3 members.....herself, husband and son. This would deal with individual basis in corporation. Since she and husband jointly paid for assets and paid for other expenses out of own funds (and have in corporate minutes that corporation will reimburse them for these expenses until corporation can meet obligations) then her and her husbands basis would be different than son's. The 3 would be equal partners in income but individual basis would be different.

The expenses that were paid with personal funds would be additional paid in capital, is that correct?

Is this right or straighten me out if I am wrong. I REALLY appreciate all your help.

Linda F

[Bees Knees]

Let me see if I understand this correctly....For the assets that she puts in the business, she receives stock. The basis of the assets would be the amount paid for the assets less the depreciation taken on the schedule C for the period she owned them before foriming corporation.

That is true if it qualifies under Section 351. The key is that at the time the assets are transferred, those who transferred the assets in exchange for stock control at least 80% of the total of the stock. It is possible, for example, that the father and son already owned stock in a corporation 50/50. Then later, mom decides to join and contributes her Schedule C assets in exchange for 33% of the total stock. Since her Schedule C assets were exchanged by someone owning 33% of the stock after the transfer, it doesn’t qualify under Section 351, and mom would have to pay tax on the appreciation of her Schedule C assets at the time she transfers them. Then her basis in the stock would be based on FMV of the assets transferred, since she paid tax on the difference between their FMV and her basis.

However, not to worry because in your case, mom probably formed the corporation herself and let dad and son join her at the time she transferred her Schedule C assets. If they all joined the corporation at the same time, mom, dad, and son control 100% after the transfer and the transfer is tax-free under Section 351. Mom’s basis in her stock is equal to her adjusted basis in assets transferred to the corporation.

Now the corporation has 3 members.....herself, husband and son. This would deal with individual basis in corporation. Since she and husband jointly paid for assets and paid for other expenses out of own funds (and have in corporate minutes that corporation will reimburse them for these expenses until corporation can meet obligations) then her and her husbands basis would be different than son's. The 3 would be equal partners in income but individual basis would be different.

I’m not sure how son gets stock. Did they gift stock to him, or did he pay cash for his shares?

You have to be careful not to create two classes of stock. You can’t have them be equal in sharing profits, but have them unequal in the number of shares of stock each has. An S corporation can only have one class of stock.

However, you are correct that equal shares of stock can have unequal basis. For example, mom and dad buy a machine for $1,000 out of joint funds and are co-owners of the machine. Mom uses the machine in her Schedule C business and depreciates $400 worth of the machine. Dad doesn’t depreciate any of his share since he is not in business yet. Then the two jointly contribute it to the corporation in exchange for 500 shares of stock each. Mom has 500 shares of stock with a basis of $100 and dad has 500 shares of stock with a basis of $500.

Now lets say 6 months later, mom and dad each gift 166.67 shares of stock to son so he can be a 33.3% owner. His stock has a basis of 33.3% of mom’s basis, plus 33.3% of dad’s basis in stock. All three own 333.33 shares of stock after the gift, with different basis for each.

The expenses that were paid with personal funds would be additional paid in capital, is that correct?

If the corporate minutes says the shareholder’s will pay for certain expenses out of personal funds and call it a capital contribution. If you are going to have the corporation eventually reimburse the expenses, then it is not paid in capital. It is either a loan, if set up as a loan, or it is a reimbursable expense under an accountable plan. No different than if an employee buys something for the business and the employer reimburses the employee.

[Bees Knees]

The problem with calling something paid in capital that will eventually get reimbursed is that you have to go through a stock redemption to get the money back if it is tied up in stock. You don't want to deal with that.

[oceanlovin'ea]

All 3

When the corporation was established, they just set it up with the 3 of them as officers of the corporation. I really don't think any thought was given to contributions to the business. The son is 24 and has his own job. He is just an officer (sec/treas) or the corporation. Really doesn't do anything in business. Same with father, he works in IT department at Fed Ex and is VP of corporation. Neither of them really have any responsibility. I think they did it partially in case something happened to wife (owner/shareholder) they would be able to take care of business for her.

She is a massage therapist and the only one that works in the business.

It was just set up as each 1/3 of corporation.

What would you do now, Bees?

Linda F

[Bees Knees]

I would probably just say that mom gifted a percentage of her assets to the son prior to forming the corporation, so that the son could join mom and dad as an equal partner, and not stay up all night worrying about it. Family businesses operate that way all the time, and if he truly received one third of the stock with nothing coming out of his pocket, it was a gift. That could also equalize the basis issue as you could say mom and dad owned assets jointly while it was a Schedule C and technically were a partnership as she deposited all of her profits into a joint checking account. That makes mom and dad’s basis equal after depreciation, and son’s basis equal since his receipt of one third of the assets was after mom depreciated them.

None of that really bothers me. The only thing I don’t like about your situation is the idea that the corporation will eventually reimburse the shareholders for every dime mom put into the corporation. Don’t do that. You don’t want to deal with a stock redemption. Tell them the initial contribution of money and assets has to stay in the corporation until sold. Any money put in after the initial formation can be reimbursed either as a loan, or as an expense reimbursement under an accountable plan.

[oceanlovin'ea]

other thread

From reading the other thread about s corp: loan vs APIC, I got the idea that I shouldn't do it as a loan because it brings the interest or imputed interest into the situation and that it would be better to consider it APIC.

I got confused on what I decided would be the best to do. I actually considered it APIC and not a loan for 2006. Probably 2007 will be the same way. I think the business is picking up and by next year will be paying own way.

I think that part of the reason the son was put in the corporation was because even though he is 24 and would like to be on his own, he was willing to stay at home and help father pay household expenses so mother could get the therapy business going. So it probably would be considered a gift to him for being willing to help family.

Thanks so much for your help.