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2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
2013 cch basic principles ch16 pi
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2013 cch basic principles ch16 pi

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  • 1. Chapter 16 Partnerships, Corporations, and S Corporations Part I: Overview©2012 CCH. All Rights Reserved.4025 W. Peterson Ave.Chicago, IL 60646-60851 800 248 3248www.CCHGroup.com
  • 2. Chapter 16 Exhibits 1. What Entity Form Is Best for a New Business? 2. Selecting an Entity (Table 1)—Nontax Differences 3. Selecting an Entity (Table 2)—General Tax Differences 4. Selecting an Entity (Table 3)—Differences in Eligibility 5. Selecting an Entity (Table 4)—Differences in Tax Treatment 6. Formation of Entities—Owner Perspective 7. Effect of Operations on Owners 8. Effect of Nonstock Distributions on Owners 9. Effect of Nonstock Distributions on EntitiesChapter 16, Exhibit Contents CCH Federal Taxation Basic Principles2 of 25
  • 3. What Entity Form Is Best for a New Business?General rules for small businesses: Taxes should not be a motivator unless there are no nontax differences. If no need to incorporate, generally better to be a limited liability company taxed as a partnership. If there is a need to incorporate, generally better to be an S corporation. If there is a need to go public, a C corporation is usually the only choice.Chapter 16, Exhibit 1 CCH Federal Taxation Basic Principles3 of 25
  • 4. Selecting an Entity (Table 1)—Nontax Differences C Corps S Corps General Partnerships (G P/S) Exposure Limited liability to Same as Each general partner (GP) has personal of owners extent of investment. C corps liability for P/S debt, & a direct interest in the P/S assets. Owners of LLCs have limited liability; but may not appoint 3rd parties to board of directors. Continuity Going concern Same as P/S dissolves after of C corps 1. Departure of ≥ 50% GP(s); or ownership 2. Operations cease. Rights of Rights to investment Same as Actual rights to individual P/S assets; can owners in stock, but not C corps bind partnership; each GP has equal right corporate assets; to run business. cannot bind corp.Chapter 16, Exhibit 2a CCH Federal Taxation Basic Principles4 of 25
  • 5. Selecting an Entity (Table 1)—Nontax Differences C Corps S Corps General Partnerships (G P/S) Raising Equity capital can be Cannot go Cannot trade a general partnership equity raised through public public. interest on a public exchange, but can capital stock offerings; however, trade a limited partnership interest less flexible in bringing publicly; more flexible than in different forms of corporations with forms of equity ownership (i.e., must (e.g., can give out common or maintain preemptive preferred P/S interest with no tax ownership %. ⇒ the consequences.) preemptive restrictions are waived if employees are offered equity participation through treasury stock.)Chapter 16, Exhibit 2b CCH Federal Taxation Basic Principles5 of 25
  • 6. Selecting an Entity (Table 1)—Nontax Differences C Corps S Corps General Partnerships (G P/S) Raising debt Banks may be Same as C Can more easily write custom capital more willing to corps financing instruments (e.g., preferred lend to debt with conversion rights). corporations. General Simplified with Same as C Can be too cumbersome to operate administration centralized corps effectively without centralized management. management like corporation, since G P/Ss may exceed 100. G P/Ss are subject to jurisdiction of the state. (For LLC partners, control by states not yet tested in the courts.) Only if nontax differences weigh equally should one weigh the tax differences.Chapter 16, Exhibit 2c CCH Federal Taxation Basic Principles6 of 25
  • 7. Selecting an Entity (Table 2)— General Tax Differences C Corps S Corps General Partnerships Highest 35% if income is not distributed (but Same as 15% whether or Marginal tax 15% accumulated earnings tax or general not income is Rate personal holding company penalty partnership distributed. possible); 44.75% if income is distributed. (35% + 15% x 65%) ⇒ possibly higher if corporate shareholder receives dividends, then distributes them again. Lowest 15% on taxable income (TI) up to Same as 15% on TI up to Marginal Tax $50,000. general $35,350 in 2012 Rate partnership for individuals; $70,700 for joint filersChapter 16, Exhibit 3a CCH Federal Taxation Basic Principles7 of 25
  • 8. Selecting an Entity (Table 2)— General Tax Differences C Corps General Partnerships Tax accounting. Personal Service Cash, accrual or Cash, accrual or methods Corporations (PSCs) and hybrid (all three hybrid, unless Qualified C corporation available, partner is a “non- (i.e., annual gross receipts ≤ regardless of qualified” C $5mm in 3 preceding years) size). corporation. Then may use cash, accrual or accrual method hybrid; non-qualified C required. corps must use accrual only.Chapter 16, Exhibit 3b CCH Federal Taxation Basic Principles8 of 25
  • 9. Selecting an Entity (Table 2)— General Tax Differences C Corps S Corps General Partnerships Tax Easier to administer with Complex if Very complex. With no administration centralized management. owned by limits on # of general (However, conflicts of many partners (GPs), large interest may arise shareholders. partnerships (P/Ss) between shareholders and would require very management ⇒ e.g., complicated tax management may prefer administration. Also, tax methods that IRS can now audit P/Ss maximize earnings while at P/S levels; each shareholders may prefer partner (P) is put on tax methods that postpone notice to toll the 3 year earnings and taxes.) statute of limitations.Chapter 16, Exhibit 3c CCH Federal Taxation Basic Principles9 of 25
  • 10. Selecting an Entity (Table 2)— General Tax Differences C Corps S Corps General Partnerships Subject to at-risk No, (except for personal Same as general Yes, to Ps (except and passive holding companies or partnership PALs do not apply activity loss personal service if the general (PAL) rules? corporations.) partner (GP) materially participates and business is a non- rental activity).Chapter 16, Exhibit 3d CCH Federal Taxation Basic Principles10 of 25
  • 11. Selecting an Entity (Table 3)— Differences in Eligibility General C Corps S Corps Partnerships # Owners No limit 100 (related taxpayers can be treated as one At least 2. taxpayer). Owner None S corp. S/Hs NOT allowed: S corp. S/Hs None identity 1. Nonresident aliens; allowed: limits 2. C corporations; 1. Individuals; 3. Partnerships. 2. Estates; 4. Banks; 3. Qualified 5. Insurance cos. trusts. Affiliate None None after 1996. Before 1997, could not None limits own > 80% stock of another corporation. Capital None Only one class of common stock. Code Sec. None structure 1361(b)(1)(D). However, differences in limits voting rights among common shares are OK.Chapter 16, Exhibit 4a CCH Federal Taxation Basic Principles11 of 25
  • 12. Selecting an Entity (Table 3)— Differences in Eligibility Treatment of Equity Owner C Corps S Corps General Partnerships Undistributed No tax to Current tax Current tax income shareholder Current losses: General No deduction Current deduction Current deduction Limit N/A Outside basis at risk Outside basis at risk Character No Yes Yes conduit (Code Sec. 1366(b)) Owner’s basis: Constant Adjusted annually Adjusted annually General (unaffected by corporate Outside basis AND at- Effect of entity None (neither basis nor risk amount affected activity) debt AAA affected; only (Code Sec. 752) None “at-risk” amt)Chapter 16, Exhibit 4b CCH Federal Taxation Basic Principles12 of 25
  • 13. Selecting an Entity (Table 4)— Differences in Tax Treatment C Corps S Corps General Partnerships Entity Any fiscal year Limited: Limited: taxable end is OK. 1. Calendar year; or 1. Calendar year; or year 2. Business purpose 2. Majority interest; or satisfied if 25% gross 3. 5-Percenters’; or rev. earned during last 4. Min. deferral rules; or two month of adopted FYE during past 3 years. 5. Business purpose. Code Sec. 1378 Code Sec. 706.Chapter 16, Exhibit 5 CCH Federal Taxation Basic Principles13 of 25
  • 14. Formation of Entities—Owner Perspective Formation C and S Corporations General Partnerships Control requirement for 80% control after exchange. No control requirement tax-free treatment: Tax treatment for Always ordinary income. Always ordinary income. services contributed in exchange for ownership.Chapter 16, Exhibit 6a CCH Federal Taxation Basic Principles14 of 25
  • 15. Formation of Entities—Owner Perspective Formation C and S Corporations General Partnerships How is an Gain = Lesser of (a) or (b): Disguised sale rules: owner’s (a) = Realized gain; Gains: Yes; Losses: Yes except losses recognized (b) = Boot rec’d, where boot are not recognized if the disguised gain or loss on is any property received other sale involving a 50% + partner. “tax-free” than common stock. Debt Recognized Gain or Loss = formation relief is also boot to the extent [(a) - (b)] x [(c) ÷ (a)], where, determined? it exceeds the basis of all (a) = FMV of P/S interest property contributed. received; Realized losses are never (b) = AB of property contributed; recognized in a Code Sec. 351 (c) = FMV of other property exchange; realized losses are received within two years of always recognized in a non- Code Sec. 351 exchange. new ownership. [Note: (a) - (b)] = realized gain.Chapter 16, Exhibit 6b CCH Federal Taxation Basic Principles15 of 25
  • 16. Formation of Entities—Owner Perspective Formation C and S Corporations General Partnerships What is an The following formula applies Basis in partnership interest = owner’s basis in to both tax-free and taxable (b) x {[(a) – (c)] ÷ (a)} the ownership exchanges: AB in corp. stock = interest? + AB in contributed prop.; (a) = FMV of P/S interest + Shareholder’s recog. gain; received; – FMV of boot rec’d, including (b) = AB of property debt relief that is boot; contributed; – Debt relief that is not boot; (c) = FMV of other property – Shareholder’s recog. loss. received within 2 years of new ownership.Chapter 16, Exhibit 6c CCH Federal Taxation Basic Principles16 of 25
  • 17. Formation of Entities—Owner Perspective Formation C and S Corporations General Partnerships What is an owner’s Same as property Same as property contributed. holding period (HP) in contributed. Split HPs may Split HPs may be necessary. the ownership be necessary. received? What is an owner’s Same as the corporation’s FMV of prop. received. (Plus basis in property adjusted basis (not FMV, as postponed loss in the rare case of a other than equity in like-kind exchanges). 50%+ owner who postpones a received from an realized loss on a disguised sale) entity? What is an owner’s HP begins on the day HP begins on the day AFTER holding period in AFTER receipt. receipt. property other than equity received from an entity?Chapter 16, Exhibit 6d CCH Federal Taxation Basic Principles17 of 25
  • 18. Formation of Entities—Owner Perspective Formation C and S Corporations General Partnerships What is an entity’s Basis in property = (a) + Basis in property = (c) + {[(a) – (c)] adjusted basis (AB) (b), where, ÷ (a)] x (b)}, where, in property (a) = FMV of P/S interest contributed by a (a) = Shareholder’s AB in contributed received; new owner? property; (b) = AB of property (b) = Shareholder’s contributed; recognized gain (if (c) = FMV other prop. received any). w/in 2 yrs of new ownership. Does an entity No, never. No, never. recognize gain or loss on the exchange of an ownership interest for property in a tax-free exchange?Chapter 16, Exhibit 6e CCH Federal Taxation Basic Principles18 of 25
  • 19. Formation of Entities—Owner Perspective Formation C and S Corporations General Partnerships Does an entity Gains: Yes; Losses: No. Gains: Yes; Losses: Yes, except compute Gain = [greater of: (a) or (b)] – losses are not recognized if the recognized gain (c), where: disguised sale involves a 50%+ or loss on the partner. exchange of Gain or loss = [greater of: (a) or property other (a) = FMV of property (b)] - (c), where: than equity to distributed; (a) = FMV of property new owners? (b) = Corporation’s debt relief distributed; (if any); (b) = P/S’s debt relief (c) = Corporation’s basis in (if any); property distributed. (c) = P/S’s basis in property distributed.Chapter 16, Exhibit 6f CCH Federal Taxation Basic Principles19 of 25
  • 20. Effect of Operations on Owners General Operating Item C Corps S Corps Partnerships Undistributed No tax to Current tax Current tax income: shareholder Current losses: General No deduction to Current deduction Current deduction shareholder Limit N/A Outside basis at risk Outside basis at risk Character conduit: No Yes (Sec. 1366(b)) Yes Owner’s basis: Constant (unaffected Adjusted annually Adjusted annually General by corporate activity) Effect of entity debt None None (neither basis Outside basis AND nor AAA affected; at-risk amount only “at-risk” affected (Code Sec. amount) 752)Chapter 16, Exhibit 7 CCH Federal Taxation Basic Principles20 of 25
  • 21. Effect of Nonstock Distributions on Owners C and S Corporations General Partnerships How is “amount (a) – (b), where, Cash + debt relief distributed” to (a) = FMV of all prop. received by [i.e., for purposes of owners computed? shareholder; determining gain, only (b) = Corporate debt assumed by cash + debt relief are shareholder. subject to capital gains. Other property received by a partner is tax-free.]Chapter 16, Exhibit 8a CCH Federal Taxation Basic Principles21 of 25
  • 22. Effect of Nonstock Distributions on Owners C and S Corporations General Partnerships What is the C Corps. S Corps. Cash + debt relief: owners’ tax 1. Ordinary up to 1. Tax-free up to 1. Tax-free up to outside treatment for current earnings & the lesser of: basis; the “amount profits (E&P); • AAA Bal. 2. Capital gain to a distributed?” 2. Ordinary up to • Stock Basis partner on the excess of accumulated E&P; 2. Ord. up to cash or debt relief in 3. Tax-free up to accum. E&P from excess of outside basis. outside basis prior life as a C (Loss is never 4. Capital gain on corp. (if any) recognized.) remainder. 3. Other property: Tax- 3. Tax free up to free. any excess of stock basis over AAA balance. 4. Cap. gain on remainder.Chapter 16, Exhibit 8b CCH Federal Taxation Basic Principles22 of 25
  • 23. Effect of Nonstock Distributions on Owners C and S Corporations General Partnerships What is the basis Always FMV, even if an owner Same as the partnership’s inside of property assumes corporate debt. basis. [However, if a partner’s distributed to an outside basis is less than the owner? partnership’s inside basis in property distributed to a partner, then the partner’s basis of property received is taken from his outside basis, not from the partnership’s inside basis. This makes sense, given that a partner’s outside basis must be reduced by the “amount” of distributions and that it cannot be negative]Chapter 16, Exhibit 8c CCH Federal Taxation Basic Principles23 of 25
  • 24. Effect of Nonstock Distributions on Entities Does an entity recognize C and S Corporations General Partnerships gain or loss on the distribution of: Cash or its own bonds to No. No. owners? Other property (other than its Gains: Yes (compute gain No gain or loss, unless it is own stock)? in the same way as if the part of a disguised sale. In property were sold) a disguised sale, the partnership’s recognized gain or loss = (a) - (b), Losses: No (except in where: complete liquidation). (a) = FMV of property distributed. (b) = AB of prop. dist’d.Chapter 16, Exhibit 9a CCH Federal Taxation Basic Principles24 of 25
  • 25. Effect of Nonstock Distributions on Entities C and S Corporations General Partnerships What is the character of the If owner owns ≤ 50%, then The character of the entity’s gain or loss on the character of the entity’s partnership’s gain or loss distribution of property to gain is the same as the on a disguised sale is the owners? character of the property same as the character of the distributed. property before it is If owner owns > 50%, then distributed. the entity’s gain is ordinary. Losses are not recognized.Chapter 16, Exhibit 9b CCH Federal Taxation Basic Principles25 of 25

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