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11 00am   s-corp updated 11 00am s-corp updated Presentation Transcript

  • S Corporations: 2013 Tax Update and M&A Issues & Considerations November 15, 2013
  • 48th Annual Bank & Capital Markets Tax Institute S Corporations: 2013 Tax Update and M&A Issues & Considerations November 15, 2013
  • Agenda I. Introduction II. S Corporation Basics Overview III. Recent Developments IV. Application of Final Section 336(e) Regulations for Sale of S Corporation Stock V. Other S Corporation Transaction Considerations VI. Due Diligence Considerations VII.Wrap Up and Questions 2 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Advantages & Disadvantages of Using an S Corporation • Advantages – One level of tax – Limited liability – Flexibility with succession planning – No self employment tax • Disadvantages – Eligibility requirements for both corporation and shareholder, including the following: • Number of and type of shareholders • Limited to one class of stock • Passive income limitation if the corporation has accumulated E&P – Additional compliance burden for shareholders – Current differential in individual vs. corporate rates 3 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • S Corporation Qualification: One Class of Stock • S corporations can have only one class of stock – Stock should confer identical rights to distributions and liquidation proceeds • Such a determination is based on the corporation’s governing provisions • Differences in voting rights among shares of stock are disregarded in making this determination – Preferred stock is not allowed – Restricted stock issued for services without an section 83(b) election is not considered outstanding stock – Incentive compensation may not be considered a second class of stock depending on the facts • Options cannot give the owners different rights to distributions and liquidation proceeds must meet certain requirements • Consider debt or other arrangements that may potentially be considered a second class of stock 4 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • S Corporation Qualification: Shareholders • Only eligible shareholders include: – US citizens or resident individuals, – Estates, including certain bankruptcy estates, – Certain types of trusts (grantor, Electing Small Business Trust (ESBT), Qualified Subchapter S Trust (QSST) or voting), – Certain section 501(c)(3) charitable organizations, section 401(a) pension plans and ESOPs, or – Certain IRAs or Roth IRAs of certain banks¹ • The S corporation must not have more than 100 shareholders – All members of a family (and their estates) for up to six generations may be treated as one shareholder – Husband and wife (and their estates) treated as one person Copyright © 2013 Deloitte Development LLC. All 581. 5 ¹ IRA orDeloitte Tax LLP to have been an existing shareholder as of 10/22/2004. The bank needs to be a corporation qualifying as a bank under section rights reserved. Roth IRA needs
  • Qualified Subchapter S Subsidiary • An S corporation can own up to 100% of another corporation • If the S corporation owns 100% of a corporation that generally meets the qualifications to be an S corporation, the S corporation may make a qualified subchapter S subsidiary (“Qsub”) election for the subsidiary to be disregarded for most federal tax purposes • Must make a Qsub election for the subsidiary – Election is made on Form 8869 – Can become effective at any time during the taxable year and the election may be filed within two months and 15 days of the effective date – Must be signed by the S corporation parent – QSub election is not itself an S corporation election 6 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • III. Recent Developments
  • Section 1411 Application to S Corporation Shareholders
  • Passthrough Income • Generally, income passed through from an S corporation will be subject to the section 1411 Net Investment Income (“NII”) tax if from – Income from working capital – Trading in financial instruments or commodities – Activity not treated as a trade or business – Trade or business activity of which shareholder does not materially participate within the meaning under section 469 • Grantor Trust and Qualified Subchapter S Trust – deemed owner and income beneficiary must materially participate • Electing small business trust – generally the trustee must materially participate 9 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Passthrough Income (cont.) • Gain on distributions under section 1368(b)(2) to passive shareholder are subject to NII • Gain on portion of installment payment is presumptively NII irrespective of year of disposition • Distribution out of an S corporation’s former C corporation’s earnings and profits account is treated as a dividend and subject to the tax 10 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Passthrough Entity Not Engaged in a Trade or Business • Income allocated to an individual from an entity that is not engaged in a trade or business will not qualify for the ordinary course of a trade or business exception, even if the individual or an intervening entity is engaged in a trade or business • Thus, the items of pro rata share from an investment partnership retain their character as they are allocated through a tiered structure to the ultimate taxpayer – NII includes the amounts a general partner or manager receives as distributive share of interest, dividends, and capital gains on its carried interest from an investment partnership 11 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Dispositions of Interests Partnerships & S Corporations (cont.) • In the case of a disposition of a partnership interest or S corporation stock, gain or loss is taken into account only to the extent gain or loss would be taken into account by the owner if the entity had sold all of its property for fair market value immediately before the disposition • Extremely complicated rules if partnership or S corporation has at least one trade or business that is not trading in financial instruments or commodities and if the transferor of the interest is not passive in at least one trade or business (that is not trading in financial instruments or commodities) 12 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Dispositions of Interests Partnerships & S Corporations (cont.) • Attempts to isolate the gain excluded from NII to only the gain on the assets of trade or businesses that are neither passive nor trading in financial instruments or commodities • If the entity only has a non-passive business that is not trading in financial instruments and commodities, a portion of the net gain might still be NII if there is excess gain in the interest above the gain in the underlying assets 13 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Sale of S Corporation Stock B A A is passive in T/B 1 and active in T/B 2 50% 50% B is passive in both T/B 1 and T/B 2 PRS T/B 1 T/B 2 • Any gain on the sale of B’s interest would all be NII • Any gain on the sale of A’s interest would be reduced by the hypothetical gain on the sale of T/B 2’s assets to yield the net gain (gain not reduced below zero) included in the net gain calculation for NII • Any loss on the sale of A’s interest would be reduced by the hypothetical loss on the sale of T/B 2’s assets to yield the net loss (loss not reduced below zero) included in the net gain calculation for NII 14 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Revenue Procedure 2013-30
  • Rev. Proc. 2013-30: Purpose • Facilitates the grant of relief to taxpayers that request relief previously provided in numerous other revenue procedures by consolidating the provisions of those revenue procedures into one revenue procedure and extending relief in certain circumstances • Modifies and supersedes Rev. Proc. 2003-43, Rev. Proc. 2004-48, and Rev. Proc. 2007-62 for taxpayers to make late S corporation elections, ESBT election, QSST elections, QSub elections and late corporate classification elections 16 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Rev. Proc. 2013-30: Purpose (cont.) • Incorporates certain relief provisions included in Rev. Proc. 97-48 • Provides exclusive simplified methods for taxpayers to request relief for late S corporation elections, QSST elections, ESBT elections, QSub elections and late corporate classification elections 17 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Rev. Proc. 2013-30: General Requirements • In addition to specific requirements – – The Requesting Entity intended to be classified as an S corporation, intended the trust to be an ESBT, intended the trust to be a QSST, or intended to treat a subsidiary corporation as a QSub as of the Effective Date; – The Requesting Entity requests relief under this revenue procedure within 3 years and 75 days after the Effective Date; – The failure to qualify as an S corporation, ESBT, QSST, or QSub as of the Effective Date was solely because the Election Under Subchapter S was not timely filed by the Due Date of the Election Under Subchapter S; and 18 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Rev. Proc. 2013-30: General Requirements (cont.) – In the case of a request for relief for a late S corporation or QSub election, the Requesting Entity has reasonable cause for its failure to make the timely Election Under Subchapter S and has acted diligently to correct the mistake upon its discovery. In the case of a request for relief for an inadvertently invalid S corporation election or an inadvertent termination of an S corporation election due to the failure to make the timely ESBT or QSST election, the failure to file the timely Election Under Subchapter S was inadvertent and the S corporation and the person or entity seeking relief acted diligently to correct the mistake upon its discovery. 19 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Rev. Proc. 2013-30: General Procedural Requirements for Relief • Generally, the Requesting Entity may request relief for a late Election Under Subchapter S by properly completing the Election Form(s) and attaching the supporting documents. • In addition - must include a statement (the "Reasonable Cause/Inadvertence Statement") from the Requesting Entity that describes (i) its reasonable cause for failure to timely file the Election Under Subchapter S (in the case of late S corporation or QSub elections) or that the failure to timely file the Election Under Subchapter S was inadvertent (in the case of late QSST or ESBT elections), and (ii) its diligent actions to correct the mistake upon its discovery. The applicable Election Form must state at the top of the document "FILED PURSUANT TO REV. PROC. 2013-30." 20 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Rev. Proc. 2013-30: General Procedural Requirements for Relief (cont.) • Filing the Election Form with the IRS Service Center. The Requesting Entity must file the applicable Election Form with the applicable IRS Service Center by either: • Attaching the Election Form to the S corporation's current year Form 1120S. In the case of an S corporation that has filed all Forms 1120S for tax years between the Effective Date and the current year, the Election Form(s) can be attached to the current year Form 1120S as long as the current year Form 1120S is filed within 3 years and 75 days after the Effective Date. An extension of time to file the current year Form 1120S will not extend the due date for relief under this revenue procedure beyond 3 years and 75 days following the Effective Date; • Attaching the Election Form to one of the S corporation's late filed prior year Forms 1120S; or • Filing Election Form independent of Form 1120S. The Requesting Entity can submit the Election Form directly to the applicable IRS Service Center within 3 years and 75 days after the Effective Date. 21 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Rev. Proc. 2013-30: General Procedural Requirements for Relief (cont.) • Supporting statements must be signed under Penalties of Perjury. 22 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Rev. Proc. 2013-30: Time Requirement • Generally, Rev. Proc. 2013-30 may be applicable to request relief if the request is filed within 3 years and 75 days after the S corporation election, ESBT election, QSST election, QSub election, or corporate classification election is intended to be effective 23 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Temporary Reduced Section 1374 BIG Period
  • Temporary Reduced Section 1374 BIG Period • Five-year built-in gains tax under new section 1374(d)(7)(C) – The American Taxpayer Relief Act of 2012 amended section 1374(d) by temporarily reducing the section 1374 BIG period to five years for dispositions that occur in 2012 and 2013 for purposes of determining net recognized built-in gain – This shortened period applies if the S corporation has completed five of its 10-year BIG period as of January 1, 2012 for dispositions occurring in 2012 or January 1, 2013 for dispositions that occur in 2013 – Unless Congress extends this temporary shortened period, dispositions made after 2013 may be subject to the corporate level BIG tax for the remainder of the S corporation's 10year BIG period Note: The recognition period was also five years for a taxable year beginning in 2011 (section 1374(d)(7)(B)(ii)) 25 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Temporary Reduced Section 1374 BIG Period (cont.) • Installment Sales added new section 1374(d)(7)(E) – If an S corporation sells an asset and reports the income from the sale using the installment method under section 453, the treatment of all payments received will be governed by the provisions applicable to the taxable year in which the sale was made • Technical amendment to section 1374(d)(2)(B) – Clarification that the net recognized built-in gain carryover provision applies for any taxable year described in section 1374(d)(2)(A) 26 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Section 1367 Temporary Basis Adjustment – Charitable Contribution
  • 2013 Charitable Contribution of Appreciated Property • Adjustments to stock basis for charitable contributions of appreciated property by S corporations – For tax years beginning between 2005 and 2013, S corporation shareholders may decrease their stock basis by their pro rata share of the S corporation’s basis in contributed property. Section 1367(a). – This rule will not apply for tax years that begin in 2014 or later. This means that the nonrecognized gain in contributed property will be recognized if the shareholders dispose of their stock. 28 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • IV. Application of Final Section 336(e) Regulations for Sale of S Corporation Stock
  • Section 336(e) Election Application for S Corporation Stock • Why do we care? – Allows an election to treat the sale of S corporation stock to multiple corporate or noncorporate purchasers as an asset sale instead of a stock sale, if certain requirements are met – Allows acquirer to benefit from a step-up in the basis of the entity’s assets upon a disposition thereby reducing built-in gain upon a future disposition – Allows purchaser to be any person including individuals, trusts, estates and partnerships 30 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • May Avoid Cumbersome Transactions • The Internal Revenue Service permitted the rescission of a transaction in order to allow individual purchasers of S corporation stock to form holding company to properly elect section 338(h)(10) treatment – Although the IRS has decided to no longer issue rescission private letter rulings, individual purchasers may now accomplish their goal without the need to form a holding company • Section 336(e) now allows those same individual purchasers to purchase S corporation stock individually and obtain a step up in basis of the inside assets if certain conditions are met 31 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Statutory Requirements • Section 336(e) authorizes the Secretary to issue regulations that – Allow a corporation to elect to treat a sale, exchange, or distribution of stock of another corporation as a disposition of all of the assets of such other corporation if • The selling corporation owns stock in another corporation meeting the requirements of section 1504(a)(2) (i.e., among other requirements, the seller must be a corporation and the seller and target cannot be foreign corporations); and • The selling corporation sells, exchanges, or distributes all of such stock – Enacted as part of the legislation repealing General Utilities 32 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Overview of Final Regulations • On May 10, 2013, the IRS and Treasury published final regulations under section 336(e) that permit taxpayers to elect to treat certain sales, exchanges, and distributions of the stock of a corporation (the “target”) as taxable sales of the target’s assets 33 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Overview of Final Regulations (cont.) • The regulations apply to any “qualified stock disposition” for which the disposition date is on or after May 15, 2013 – Treas. Reg. § 1.336-1 sets forth general principles and defined terms – Treas. Reg. § 1.336-2 sets forth general mechanics and consequences of a section 336(e) election – Treas. Reg. § 1.336-3 sets forth the rules for determining aggregate deemed asset disposition price – Treas. Reg. § 1.336-4 sets forth rules for determining adjusted grossed-up basis – Treas. Reg. § 1.336-5 sets forth the effective date 34 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Key Differences Between Statute and Final Regulations • The regulations permit a “qualified stock disposition” to occur over a12-month period • The regulations require that only an amount of target stock meeting the requirements of section 1504(a)(2) be disposed of, not every share of target stock owned by the seller • Although the seller must generally be a corporation, the regulations expand the scope of the provision to include the disposition of S corporation stock by its shareholders 35 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Who Can Benefit from a Section 336(e) Election? • A section 336(e) election is most important for the following types of transactions, although this list is not inclusive of every type of transaction where a section 336(e) election can be made: – Acquisitions of S corporation targets; – Acquisitions of C corporations by private equity investment groups or partnerships; – Morris Trust transactions; – Corporate acquisitions where there is no single 80% purchaser (beware the related party and section 338 overlap rules, discussed later) 36 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • General Principles • Treas. Reg. § 1.336-1(a) provides that principles similar to those of section 338(h)(10) should apply to the extent not inconsistent with section 336(e) or the regulations • The results of a section 336(e) election generally coincide with those of a section 338(h)(10) election 37 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • General Principles (cont.) • The section 336(e) regulations refer to principles under the section 338 regulations regarding – Allocation of consideration; • Aggregate deemed asset disposition price (ADADP) vs. aggregate deemed sale price (ADSP); retain adjusted gross up basis (AGUB) – Application of the asset and stock consistency rules; – Treatment of new target after election; and – Availability of the section 453 installment method 38 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • General Principles (cont.) • The section 336(e) regulations differ from section 338: – Focus on seller, rather than purchaser – Use the term “disposition” rather than “acquisition” or “purchase” – Use the term “sale, exchange, or distribution” rather than “sale” – Do not require a corporate purchaser, but do require a corporate seller or the sale of the stock of an S corporation – Do not require single purchaser of target’s stock, but rather a disposition (by sale, exchange, or distribution) of 80% (section 1504(a)(2)) of the target’s stock by the corporate seller (or S corporation shareholders in the case of an S corporation target) – The election to apply section 336(e) is made with the seller’s and target’s tax returns (not on a separate form) and the seller and target must enter into a written, binding agreement to make such election 39 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • General Principles (cont.) • The section 336(e) regulations extend and modify the asset and stock consistency principles in Treas. Reg. § 1.338-8(b)(1) to apply to an asset if the asset is owned, immediately after its acquisition and on the disposition date, by a person (or by a person related to such person) that acquires, by sale, exchange, distribution, or any combination thereof, 5% or more (by value) of the stock of target in a qualified stock disposition. • Treas. Reg. § 1.1502-13(f)(5) is modified to clarify that the election is available with respect to deemed liquidations under section 336(e). 40 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Applicable Transactions – Qualified Stock Dispositions • A section 336(e) election generally can be made with respect to “Qualified Stock Dispositions” (QSDs) in which stock meeting the requirements of section 1504(a)(2) is disposed of in one or more of the following transactions: – A taxable sale or exchange of target stock; – A taxable distribution of target stock; and – A distribution of target stock in a transaction to which section 355(d)(2) or (e)(2) applies • A QSD can occur at any time during the 12-month period beginning with the date of the first sale, exchange, or distribution of a target’s stock and can include stock disposed of after the “disposition date” 41 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Applicable Transactions – Qualified Stock Dispositions (cont.) • The “disposition date” is the first day on which there is a QSD with respect to the stock of a target corporation • The regulations exclude the following from a QSD: – Transactions between related persons (related persons are generally determined by applying the principles of section 318(a), other than section 318(a)(4), with a modification for partnership attribution); and – Transactions in which either the seller or the target is a foreign corporation 42 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Qualified Stock Disposition Requirements • To determine if one or more transactions results in a QSD, sales, exchanges, and distributions to related parties are not taken into account – For this purpose, two persons are related if stock of a corporation owned by one of the persons would be attributed to the other person under section 318(a), without regard to section 318(a)(4) – However, the rules attributing stock ownership from a partner to a partnership and from a partnership to a partner do not apply unless the partner owns at least a 5 percent interest (by value) in the partnership – Treas. Reg. § 1.336-1(b)(5); Treas. Reg. § 1.336-1(b)(12) • To determine if one or more transactions results in a QSD, sales, exchanges, and distributions to which any of sections 351, 354, 355, or 356 applies are not taken into account 43 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Qualified Stock Disposition Requirements (cont.) • The Overlap Rule – Treas. Reg. § 1.336-1(b)(6): – If a QSD also satisfies the requirements for a qualified stock purchase under section 338(d)(3), such transaction generally will not be treated as a QSD 44 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Making the Election • Seller and target must enter into a binding, written agreement to make a section 336(e) election – Treas. Reg. § 1.336-2(h) – If seller and target are members of a consolidated group, on or before due date of return that includes the disposition date – If seller and target are not consolidated, on or before the earlier of due date of target or seller return that includes the QSD • A section 336(e) statement is attached to a timely filed federal income tax return (or the group’s consolidated return if seller is a member of a consolidated group) for the taxable year that includes the disposition date 45 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Making the Election (cont.) • The information required is similar to that required on Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases – If target is an S corporation, all S corporation shareholders must enter into agreements on or before the due date of the S corporation return • Old target and new target are required to report information concerning the deemed sale of target’s assets on Form 8883 (or any successor form prescribed by the IRS) 46 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • ADADP – Treas. Reg. § 1.336-3 • The ADADP is the price at which the target is deemed to sell its assets. It equals – – The grossed-up amount realized on the disposition of recently disposed target stock (discussed on next slide), plus – Target liabilities. • The target determines its realized gain or loss by allocating the ADADP among its assets using the seven-tier residual method described in Treas. Reg. § 1.338-6. 47 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Grossed-up Amount Realized – Treas. Reg. § 1.336-3(c) • The grossed-up amount realized for recently disposed target stock equals: – The sum of • The amount realized on the sale or exchange of recently disposed target stock, and • The fair market value of recently disposed target stock (determined on the distribution date) distributed in the QSD – Divided by the percentage of target stock (by value, determined on the disposition date) attributable to the recently disposed target stock. – Less the seller’s selling costs for its sale or exchange (but not distribution) of recently disposed target stock 48 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Tax Consequences – Basic Model for a Sale or Exchange • For a sale or exchange (i.e., not including a distribution of target stock) – Seller (or S corporation shareholders) disregards the actual sale or exchange of target stock; target is treated as selling all of its assets to an unrelated person in a single transaction at the close of the disposition date in exchange for the ADADP – Old target recognizes the deemed disposition tax consequences from the deemed asset disposition at the close of the disposition date while it is owned by the seller (or S corporation shareholders) • Old target recognizes gain or loss on the deemed asset disposition – Old target is generally treated as liquidating after the deemed asset disposition – New Target is treated as acquiring all of its assets from an unrelated person in a single transaction at the close of the disposition date (but before the deemed liquidation) in exchange for the AGUB 49 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Related Parties under Section 318 Applicable Constructive Ownership of High Net Worth Families • Three types of applicable constructive ownership under section 318 – Family attribution – section 318(a)(1) • An individual is deemed to own stock owned by her spouse, children, grandchildren and parents – Does not include sibling attribution – Stock attributed to one family member is not reattributed to yet another 50 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Related Parties under Section 318 Applicable Constructive Ownership of High Net Worth Families (cont.) – Entity to owner attribution – section 318(a)(2) • Stock owned, directly or indirectly, by partnerships, estates, and trusts is attributed to beneficial owners in proportion to ownership interests • Stock owned by a corporation is attributed proportionately to any person owning (actually or constructively) 50% or more by value of the corporation’s stock • For purposes of determining whether S corporation stock is constructively owned by any person, the S corporation is treated as a corporation – the special partnership rules do not apply • Stock owned by a trust (other than a section 401(a) employee trust) is constructively owned by trust beneficiaries in proportion to their actuarial interest (regardless of how small, remote or contingent) • For grantor trusts, the person taxable on income is the constructive owner of stock owned by the trust 51 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Related Parties under Section 318 Applicable Constructive Ownership of High Net Worth Families (cont.) – Owner to entity attribution – section 318(a)(3) • Stock owned, directly or indirectly, by beneficiaries of an estate or trust is attributed in full to the estate or trust • Stock owned by a trust (other than section 401(a)) beneficiary is attributed to the trust unless the beneficiary has only a remote contingent interest • Stock owned by the deemed owner of a grantor trust is attributed to the trust; and • Stock owned by a shareholder owning (actually or by attribution) 50% or more of the value of the corporation’s stock is attributed in full to the corporation 52 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Example: Sale of S Corporation SHs AB $8,000 FMV $10,000 AB $5,000 FMV $7,000 Parc el 1 Sale of all T shares A T Parc el 2 AB $4,000 FMV $3,000 • The shareholders of Target, an S corporation, sell all 100 shares of their T stock to A (an unrelated person under section 318) for $10,000 and make a section 336(e) election – Sale constitutes a QSD – A could be a sibling of one of the shareholders – A could be an unrelated individual, trust, estate or partnership 53 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Example: Sale of S Corporation: Deemed Consequences SHs A 3 Deemed section 331 liquidation X OT • Tax consequences: 2 1 ADADP $10,000 AGUB $10,000 NT Assets – Old T is treated as (1) selling all of its assets to an unrelated person (New T) in exchange for the ADADP, $10,000, allocated $7,000 to Parcel 1 and $3,000 to Parcel 2; and (2) liquidating thereafter and distributing the $10,000 to the Old T S corporation shareholders. • Old T recognizes gain of $2,000 on Parcel 1 and loss of $1,000 on Parcel 2. – New T is treated as having acquired all its assets from an unrelated person (Old T) in exchange for the AGUB, $10,000, at the close of the disposition date but before the liquidation of Old T. – Old T shareholder(s) treated as having received proceeds in liquidation. – A’s aggregate basis in New T stock equals $10,000, the amount paid for the stock. • New T must make a new S election if it wants to continue as an S corporation. 54 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Comparison of Terms Used in Determination of AGUB: Section 336(e) vs. Section 338(h)(10) Modifications to terms under Treas. Reg. § 1.338-5 • Section 338(h)(10) • Section 336(e) – Section 338 or 338(h)(10) election – Purchasing corporation – Selling cons. group/affiliate/S corp. shareholder – Qualified stock purchase – Acquisition date – 12-month acquisition period – Recently/nonrecently purchased stock – Aggregate deemed sales price (ADSP) 55 Deloitte Tax LLP – Section 336(e) election – Purchaser – Seller corporation or S corporation shareholders – Qualified stock disposition – Disposition date – 12-month disposition period – Recently/nonrecently disposed stock – Aggregate deemed asset disposition price (ADADP) Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Compliance and Tax Liability Issues • Federal tax fictions do not protect “New Target” from exposure to “Old Target” tax liabilities – Built-in gains tax liability is a liability of the target corporation itself – Inadvertent termination of S corporation status could result in unreported income tax liability • Final returns of Old Target must be filed by those officers with authority to sign at the time of filing • Selling shareholders may negotiate certain rights regarding preparation of old target returns • New S election required 56 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • V. Other S Corporation Transaction Considerations
  • Asset vs. Stock Sale Asset Sales • Purchaser takes FMV basis in each asset based on purchase price agreement (“PPA”) – Amortization of Goodwill • Liabilities do not transfer • Tax attributes do not carry over (i.e. NOLs, AAA, AEP) • Character of gain/loss to seller matched with underlying property • Potential for double taxation to the shareholders (i.e. BIG tax) 58 Deloitte Tax LLP Stock Sales • Purchaser must be an eligible shareholder for S election to continue • Purchaser takes carry over basis in assets & liabilities • Tax attributes carry over (i.e. NOLs, AAA, AEP) • Capital gain/loss recognized by seller • Avoidance of BIG implications • Section 338(h)(10) & Section 336(e) elections available Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Making a Section 338(h)(10) Election • A section 338(h)(10) election is made on Form 8023 • All of a target’s shareholders (selling or not) must agree to the election • The election is due on the 15th day of the 9th month beginning after the month in which P acquires T. • The election must be signed by both parties to the transaction. • Rev. Proc. 2003-33 grants automatic relief for inadvertent failure to timely file the election. (See criteria provided in ruling) – A letter ruling must be requested if automatic relief is unavailable. 59 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Making a Section 338(h)(10) Election (cont.) • State income tax law may differ from the federal law regarding section 338(h)(10) elections. – May have separate reporting requirements. – As mentioned previously, the computation of the state tax impact of the deemed sale of assets is often critical in the analysis of the tax impact of the election. 60 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Rev. Rul 2008-18 Illustration 1. B (individual) 2. B (individual) 100% 3. B (individual) 100% 100% NewCo (S corporation) Y (S corporation) EIN: 22-2222222 100% NewCo (S Corporation) D (individual) 99% 1% Y(Q sub) EIN: 22-2222222 Y EIN: 22-2222222 • B, an individual, owns all the stock in Y, a subchapter S corporation • Y’s S election continues for NewCo, which is able to make a valid qualified subchapter S subsidiary (“QSSS”) election – Transaction meets the requirements of section 368(a)(1)(F) – NewCo must obtain a new EIN – Y must retain its original EIN any time it is treated as a separate entity (i.e. Employment/excise taxes) • The QSSS election terminates and Y continues to use its EIN 61 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Impact of Section 1411 on the decision to make a stock versus an asset sale • Why will the target’s shareholders not want an asset sale (or stock sale with a Section 338(h)(10) election? TAX RATES Ordinary Income Net LT Capital Gains 2012 2013 - Active S/H 2013 - Passive S/H 35% 39.6% 43.4% 15% 20% 23.8% *Tax rates for an individual at the highest marginal tax rate and NII in excess of $200k/$250k thresholds. 62 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • VI. Due Diligence Considerations
  • Due Diligence Considerations • Confirm target is a valid S corporation – Complied with requirements of Section 1361(b)(1) – Made valid S corporation election – Highlight operating tax exposures that have successor liability – Entity-level tax exposures (BIG tax, PII tax) – Less concerned with other historical income tax liabilities (liabilities of shareholder) – Assess if Section 338(h)(10) election can be made 64 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
  • Confirmation of Qualifying S Corporation • Meets all requirements of section 1361(b)(1) – Appropriate number of shareholders – Qualifying shareholders – Maintained only one class of stock • Allocation of income/(loss) • Pro-rata distributions • Option agreements • Loan agreements • Valid S corporation election and Q-Sub elections • Corporate books and records 65 Deloitte Tax LLP Copyright © 2013 Deloitte Development LLC. All rights reserved.
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