Discussion:C to S Corporation Conversion
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Discussion Forum Index --> Tax Questions --> C to S Corporation Conversion
| 16 July 2006 | |
| Cash basis C corporation wants to convert to an S then hopes to make it to the 10 year presumption of no more BIG. It knows it needs to get an appraisal of the value of the business, and all of that, but it has $250,000 of receivables at any time, and files on the cash basis. Because it is a cash basis, these receivables will have a zero basis at time of conversion, and then will be subject to BIG tax as collected.
Does anyone out there see any problem with doing the necessary IRS filing (Change of Method) switching the corporation to the accrual basis, then after a year of that converting to an S (when the receivables will have a basis equal to FMV, which should mean no BIG problems)? Any other traps and pitfalls in converting a C to an S anyone can warn me about, from someone who has been there and done that? Thanks in advance for any help here. | |
Gregg Gillaspy, CPA, CFP (talk|edits) said: | July 16, 2006 |
| Won't you have the same effect by changing to the accrual method this year and changing to an S-corp 1 year later? Meaning, you will recognize about $250,000 extra income over the previous cash basis. I know there are some minor differences and it may two years to get all that $250,000 recognized as income but the effect seems to be the same. And if you expect the basis to equal FMV for those receivable by the end of yr 1 then you will have to recognize all $250,000 as income in yr 1. | |
| 16 July 2006 | |
| I agree with Gregg. The change in accounting method will probabaly not save anything in taxes, especially since the 481(a) adjustment will most likely be taken into account over the next 4 years. | |
| 17 July 2006 | |
| Thanks for the replies. I guess one solution, if the client is adamant about converting to S status, is just informing him that he will have to pay top corporate rates on the receivables as they are collected - that is, up to the amount of taxable income each year.
This cash basis corporation generally breaks even or shows a small loss. So even if it paid the top rate on that income every year (until the ten year presumption period is up), it might be better than suffering a whopping tax difference when he sells the assets of the C corporation in the future. Too bad it is not more common for small companies to sell the underlying stock when it is time to sell. Of course, buyers generally only want to buy the assets. Do you go with me on this? He will have to pay BIG on those receivables in the future - but only up to the amount of taxable income each year until year 10 is up. But then that presents the question, if there is a remaining balance on those "conversion date" receivables after year 10, is that it? No more BIG on them? | |
| 25 July 2007 | |
| I am planning to buy a motel in NY state but it is currently a C corp. The owner wants to sell me his C corp so he does not have to pay double tax and then wants me to convert to an S corp. After reading most of the conversation, I know it is not a good idea but I like this property and he is only willing to sell me his C corporation. Should i consider it or is it just a bad idea to do so? | |
TheTinCook (talk|edits) said: | 25 July 2007 |
| You can if you want, but you'd have to watch out for any liabilities lurking in the corp's past that could come back to haunt you. You should also be paying less for it too. Another downside is that you're stuck with the motel that's partially deprieciated.
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| July 25, 2007 | |
| corptaxhelp is your man, but in this case, you've already got a deal to do. Rpatel, go for it. You know the risks of real estate in any corp, but esp. a C corp. Buy it at a discount, elect S...and hang on. Do note that moving that real estate out of the corp, even into your own name, triggers a taxable event, just how it is. But if you plan owning and running it forever, who cares, right? | |
| 25 July 2007 | |
| Depending on the circumstances, though, this may not be a case of owning and running it forever. Consequently, be careful to consider the tax consequences based on your own goals.
I once worked for a firm which had a number of Indian hotel owners as clients, and I handled many of their accounts. Most started out with very small hotels and then every 6 or 7 years sold and bought larger establishments. If that is your plan, make sure you adjust the discount mentioned by JR1 accordingly. A couple of my old clients did get burned badly taxwise when selling and buying without consulting us first. | |
| July 25, 2007 | |
| Thanks for being more transparent. I noted the Patel name, and when I was in Indy, nearly every motel was owned by a Patel. Finally, I asked one, one day, if they were all related...he laughed and explained how common the name is. Perhaps so, but I've not met many not in the motel business! So indeed, if there will be a transfer down the line, to a brother, son, or other family member which can be quite common, inside of that 10 year period will be heavy tax. And again, even after, a taxable event occurs unless you can sell the corp along with the deal. | |
Corptaxhelp (talk|edits) said: | July 25, 2007 |
| RPatel06: Make sure you get a discount when you buy the stock of the corporation versus the assets. If you want to discuss exactly what sort of discount you should receive, please let me know.
Also, you'll want the seller to indemnify you against all liabilities (except those specifically agreed upon such as the tax) which are known by *or should have been known by* the corporation prior to the closing. There is absolutely no reason you should pick up all liabilities just by purchasing the stock. If for some reason that is what the seller is requiring, you should make sure to get a hefty discount to the purchase price. Buying the C corporation to get the real estate can be a very good deal for both parties. If you need the name of a good attorney who can help you craft the Share Purchase Agreement (SPA), contact me by email. | |
Bushmaster (talk|edits) said: | 25 July 2007 |
| Also, a VOLUNTARY conversion from cash to accrual results in all tax being paid in year one. No 4 year spread. | |
Zvibenrueben (talk|edits) said: | 17 February 2009 |
| Query:
Client with Aug 31st year end wants to convert its corporation from a C Corp to an S Corp to help resolve some internal mangement problems. Can the C Corp run its year from September 1 2008 to January 31, 2009 and then elect within the prescribed period to operate as an S corp from February 1 to December 31, 2009? Thank you. | |
| 17 February 2009 | |
| No. They must file an S corp election within 75 days of the beginning of their fiscal year. Since they did not, they can not change to an S corp until the next fiscal year starts. | |
| 18 February 2009 | |
| The C corporation can have either an 8/31 year end or it can change to a December 31 year end. | |
