Discussion:C to S, receivables question . . .

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Discussion Forum Index --> Advanced Tax Questions --> C to S, receivables question . . .


Discussion Forum Index --> Tax Questions --> C to S, receivables question . . .

Kendrick (talk|edits) said:

26 January 2011
C corp. Every year I do a cash basis adjustment. A/R usually between 300,000 and 400,000.

Want to elect S status. Of course on the Forms 1120 I have prepared for my client over the years, I present cash basis figures, no receivables.

I would like to think there would be no BIG tax problems with the A/R, since I prepare the taxes on the cash basis.

Anyone with any experience with this? I want to take advantage of the 5-year BIG avoidance period availabe to C corps electing S status in 2011.

Any comments would sure be appreciated.

JR1 (talk|edits) said:

January 26, 2011
No, sorry, this is where the plan fails. In the conversion, you treat it as if it were accrual, so the AR is recognized as soon as collected in the S subject to BIG tax, offset by whatever AP you have. But, look at it this way, you'd have paid the C corp tax on it anyway, right? Tho' it's a big check to write, hee hee.

MWPXYZ (talk|edits) said:

26 January 2011
And as noted in another ongoing post, If the corporation has no profits going forward (between 5-10 years depending on the Tax Code at the time)the BIG tax will not get paid.

I don't think the 5 year rule has to do with electing S status in 2011, but S corporations that have had 5 years pass of the recognition period; I think. Here is the tax code change for Section 1374 from the Small Business Jobs Act. I am unsure if the No Tax rule applies only to 2011 OR if the Recognition Period is now 5 years. The commentary I have read has confused me.

SEC. 2014. TEMPORARY REDUCTION IN RECOGNITION PERIOD FOR BUILT-IN GAINS TAX. (a) IN GENERAL.—Subparagraph (B) of section 1374(d)(7) of the Internal Revenue Code of 1986 is amended to read as follows:

‘‘(B) SPECIAL RULES FOR 2009, 2010, AND 2011.—No tax shall be imposed on the net recognized built-in gain of an S corporation—

‘‘(i) in the case of any taxable year beginning in 2009 or 2010, if the 7th taxable year in the recognition period preceded such taxable year, or

‘‘(ii) in the case of any taxable year beginning in 2011, if the 5th year in the recognition period preceded such taxable year.

The preceding sentence shall be applied separately with respect to any asset to which paragraph (8) applies.’’. (b) EFFECTIVE DATE.—The amendment made by this section shall apply to taxable years beginning after December 31, 2010.

Doug M (talk|edits) said:

26 January 2011
Kendrick: another planning idea is to not pay your bills in the final "C" return and build up your A/P, and accelerate the collections of your A/R. The BIG tax is on the FMV of the assets vs. the tax basis in the assets. I think it appropriate to think of "net" A/R.

And I agree with MWP about the confusion on the 5 year BIG tax. You can see in (ii) above how the wording in subparagraph (B) is displayed.

JR1 (talk|edits) said:

January 26, 2011
But it's obviously a service biz with those kind of AR's and no mention of AP, so there's profit, unless you comp it all out...

KatieJ (talk|edits) said:

26 January 2011
It helps if you read ALL of IRC Sec. 1374(d)(7). The shortening of the recognition period applies ONLY to built-in gains recognized in years beginning in 2009, 2010 and 2011. The 10-year recognition period (Sec. 1374(d)(7)(A)) is still in effect for gains recognized in years other than those three.

For some reason this is a common misconception. There is no provision for a 5-year recognition period for a corporation electing S status in 2011.

MWPXYZ (talk|edits) said:

26 January 2011
It helps if you read ALL of IRC Sec. 1374(d)(7).

But it did not help me KatieJ!! First of all I think it applies to Net Recognized Built In Gains for those years rather than built in gains recognized for those years, I think. The difference being that if it applied to built in gains recognized for 2011 one would create sales for all subject assets in 2011 and avoid any issues during the remainder of the recognition period (except for built in gains and built in items recognized during the first 5 years). HOWEVER, one website does explain that the new provision "shortens the holding period to five years in the case of dispositions in any tax year beginning in 2011".(???)

Actually, not knowing what this provision is supposed to accomplish makes understanding it difficult; I assume that certain important constituents benefit from this provision.

What does that last sentence regarding effective date mean since 1374(d)(7)(A)(i) is about 2009 and 2010. Also, wasn't 1374(d)(7)(A)(i) part of a previous tax law change? I guess the new provision is merely breaking (B) in to (i) and (ii).

Also the technical explanation of the tax provisions in Senate Amendment 4594 SEEMS to indicate in the section "Explanation of Provision" that the change is for future years. The phrase "For taxable years beginning in 2011" could mean taxable years that begin in 2011 or all taxable years beginning with the 2011 taxable year. And some commentary I read indicates that this latter interpretation is correct.

In any case, if they made the provisions for S elections effective xx/xx/xxxx to xx/xx/xxxx the provision would be easier to understand.

The IRS website seems to (properly) explain that the provision only deals with 2011.

This sentence in the provision does not seem to make sense, "The preceding sentence shall be applied separately with respect to any asset to which paragraph (8) applies." Does that mean the five years applies to 1374(d)(8) but the seven year rule does not? The way that paragraph 8 is written led me to believe that the seven year rule applied to paragraph 8 (before this provision).

It gets really interesting when one has an installment sale. The Polish lady at BNA mentioned that it is not clear what the tax treatment is of installment payments over a period of time that starts before 2009, especially if it ends after 2011.

Kendrick (talk|edits) said:

26 January 2011
Thanks for all the info. So what is the consensus? If I convert my C corp client to an S corp in 2011, does the corp or doesn't the corp avoid BIG tax if he sells his business in 2016 or later?

This is the BIG question, if you will. C corp (yes, a service business) will have as its most valuable asset goodwill. Trying to find a way to avoid double taxation if the C corp cannot sell its underlying stock (which is unlikely in today's world). Client can't wait for 10 years, I got all excited at a Spidell seminar where the speaker (and the book) suggested a shortened wait period (5 years vs. 10 years) if S election made in 2011.

I expected it was too good to be true.

But I am not grasping the A/R situation. Every year for years now, I take the current year-end accounts receivable out of income and add the prior year-end receivables to income, when converting from accrual to cash.

So if I make an S election . . . I guess the corporation would have to pay tax on the receivables collected from the prior year - ouch - and then I would back out the receivables at the end of the year, lowering the amount of net income passed through to the shareholders. Assuming there are no payables at the end of the C corp year - I reckon the corporation will have no deductions to offset the receivables? So I am looking at 44% tax (35 IRS 9 CA) on 400K in receivables from C corp? Again, ouch.

Anyone with experience looking for a new client? The corporation expects to sell for 7 to 10 million eventually. I have advised the shareholders for 3 years now that they need to find a bigger accounting firm to take over until the saale. I have told them I don't have the experience to handle such a large transaction, but of course I get the old response, but we have been with you since inception 20 years ago, you can handle it.

MWPXYZ (talk|edits) said:

26 January 2011
Who or what is the potential buyer of your client? I had a client that never made a profit for 15 years and had equipment that was more of a liability than an asset. He sold his business for $1.5 million to a Nation wide company based on the value of intangibles. Traded stock for stock. No double tax; no tax at all for a few years.

As mentioned above, the key to avoiding BIG is to have no little or taxable income during the 10 year recognition period. Read Section 1374 carefully. (Could an S corporation have unreasonably high stockholder compensation?)

If it is any help, my mind processes 1374 best if I start with (d)(1); read (d)(3), (4), and (5). once I comprehend those terms I read (d)(2)(A), and note (d)(2)(B). Then subsection (a) and then subsection (b). Reg 1374-4 is also helpful, I think.

ZL28 (talk|edits) said:

26 January 2011
Why is the key to avoiding BIG to have little or no taxable income during the 10 year recognition period?

Isn't the key to assess what are your receivables and appreciable assets less your liabilities at the date of conversion?

Anyone know how goodwill comes into play....if there is 100k of g/w at date of conversion...that's a BIG asset also, is it not?

JR1 (talk|edits) said:

January 27, 2011
BIG tax is only assessed if there is profit. So no matter how big BIG is, make the profit go away and you don't pay it.

There's some debate about goodwill. I've always been taught, consistently, that it does not count (purchased goodwill would be, of course), others suggest pretty strongly that it does. But every class I've ever had say to list the assets, compare cost and fmv, same for liabilities, that's your BIG. Others seem to think that you appraise the whole company and compare to cost.

Kendrick (talk|edits) said:

27 January 2011
Say MWP, I'm curious like ZL28. Why little or no taxable income during recognition period???

Your situation is like mine, ZL28. My client's basic asset is goodwill. If you elect S status for a client with sizable goodwill, I would recommend getting a valuation as close to 1/1 of the first S corp year. Then if the corp sales the goodwill before the 10 (or 7 or 5) recognition period expires, the BIG will only apply to the 1/1 valuation. Anything over that would pass through to the shareholders.

Oh yeah, I reread the Spidell manual, and it sounds like the only S corps that can benefit from the new 5 year rule are those that elected S corp status in 2006. So they would escape any BIG in 2011 only. So if such a 2006 S corp sold their assets in 2012, vaboom, they now get hit with BIG again, or until the original 10 year period is up.

I find this so weird. I will try to find something that elucidates the logic in this 5 year plan. Why should 2006 corps benefit? Hmmmm.

Again, my goal now is to understand how the A/R of the C corp gets taxed the next year once the cash basis S Corp collects them. This is sort of twisting my brains a little.

Doug M (talk|edits) said:

27 January 2011
Kendrick, thanks for the clarification on the 5 year, that is how I understand the law. And somebody in Congress has a planned sale in 2011 that elected in 2006.

Assume you elect "S" 1/1/2011. BIG resulting from A/R for $400K.

Assume taxable income of $300K in year 1 (2011).

The law considers this a part of the built in gain. Your taxable income is the removal of the 12/31/2011 A/R and the inclusion of the 12/31/2010 being reinstated. It really is coming from the 12/31/2010 collection made in 2011. Hence the triggering of the BIG tax.

This is taxed at the highest marginal corporate rate of 35%. I will ignore CA. Write the check for $105,000.

K-1 income that is passed out to the shareholders is for $195,000. They now pay individual tax of 35% on the $195,000 or another $68,000. Net amount realized by the shareholders is $127,000 and we have ignored the CA tax. Only 42% realization. But if you wrote salary checks to zero out the net income, shareholders net $195,000.

Hence, the need to max out the salaries, profit sharing, bonus' etc to the shareholders and getting the taxable income down to -0- during the BIG recognition period. Taxed once and only once.

But you have to do it every year, once a component of the BIG tax has been recognized. In my above example, with $300K, you have $100K to worry about in the next 9 years, even though all the A/R have been collected.

MWPXYZ (talk|edits) said:

27 January 2011
Say MWP, I'm curious like ZL28. Why little or no taxable income during recognition period??? See JR1's answer AND carefully read Section 1374(d)(2)(A). Actually read Section 1374 carefully.

Isn't the key to assess what are your receivables and appreciable assets less your liabilities at the date of conversion? There isn't much you can do about the taxpayer's receivables and payables. Remember that Recognzed Built In Gains are limited to the Net Unrealized Built In Gain Fair market values BUT Built In Items (AR, AP)must reflect actual collections and payments.

Whether Goodwill is a corporate asset can be a controversial issue on it's own.

Doug M, remember the deduction allowed under 1366(f)(2) for the payment of the BIG tax. It may be wise to pay the tax in the taxable year it is created.

But you have to do it every year, once a component of the BIG tax has been recognized. The reason for this is 1374(d)(2)(B).

ZL28 (talk|edits) said:

27 January 2011
Wish there were some long term guidance where they are going with BIG....like to say for the future it'll just be 5 years...and stop changing the

law year after year. It was 10 years, then 7 years, now 5 years...I think the logic is that lowering hte years will spur up the economy a bit...ie someone will sell their business now and take advantage of the 5 year rule in 2011 rather than wait until they've exceeded the usual 10.

anyone have any ideas or leads on how can find some people who invest with 1202...have client with assets locked into C...was wondering if someone with a 1202 corp may be interested in buying the stock

Doug M (talk|edits) said:

27 January 2011
MWP--could you clarify your statement about "remember the deduction allowed under 1366(f)(2) for the payment of the BIG tax

Thanks

MWPXYZ (talk|edits) said:

27 January 2011
My mistake: I was recommending that the cash basis taxpayer pay the BIG tax during the year the BIG tax was incurred. BUT, the regulation states that a loss (equal to the BIG tax) is taken in the year the BIG tax is incurred, irrespective of accounting method.

With better punctation I would have (incorrectly)stated: Doug M, remember the deduction allowed under 1366(f)(2) for the payment of the BIG tax? It may be wise to pay the tax in the taxable year it is created.

KatieJ (talk|edits) said:

27 January 2011
"For taxable years beginning in 2011" could mean taxable years that begin in 2011 or all taxable years beginning with the 2011 taxable year. And some commentary I read indicates that this latter interpretation is correct.

There is a difference between "years beginning in" a calendar year and "years beginning on or after" a specified date. A year beginning in 2011 is a year that begins on a date within that calendar year. I don't think that is ambiguous at all, despite commentary to the contrary. If they had meant "years beginning on or after January 1, 2011" they would have used that language.

Doug M (talk|edits) said:

28 January 2011
Katie--what is your conclusion??

KatieJ (talk|edits) said:

28 January 2011
The shortened recognition periods apply only to net unrecognized built-in gains that are recognized in calendar or fiscal years that began in 2009, 2010, or 2011. IRC Sec. 1374(d)(7)(B) and (C) are applicable only for gains recognized in those years. They have no future effect. I think that's pretty clear from the statute and also from the committee reports.

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