User talk:JRE

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Tax Accruals

JRE:

The OP stated that the entity had a fiscal year end and was switching status this year; therefore, this set of F/Ss will be the last year of C status and everything must run through the P&L directly (i.e., without a VA). That being said, you bring up an interesting thought when you said, "booked upon contemplation of the change in status".

1) What if, for whatever reason, the owner said, "I am thinking about changing to S status."? My position would be that nothing changes upon the mere thought. However, what if . . .

2) The owners were definitely going to convert, but for whatever reason it would take over one year to effect the change (and, therefore, run across the issuance of two sets of F/Ss)? I believe you would still do your normal VA analysis (just as you always must do when there are material gross DTAs on the books) and set up a VA for applicable DTAs. However, for DTAs / DTLs that are simply going to "disappear" because of the status change I believe those have to run through the P&L currently and treated similar to a rate change. (The federal rate is going to 0%.)

I have fleshed it out more fully below, and I am sure you know most of what follows. I would be interested in your thoughts.

Valuation Allowances (VAs) are set up if, and only if, it is "not more likely than not" that the DTA can be realized. This, of course, means that a DTA must exist. Additionally, you must look at the gross DTAs and DTLs (if any) when performing the VA analysis.

In a status change situation, some of the DTAs and DTLs may be accelerated (i.e., become taxable or deductible) upon conversion. Those would run through the "final" T/R of the C corp and the "final" P&L of the F/S. That is, you do not set up a VA for something that is gone anyway. I believe that the first comparative F/Ss of the S corp has to show an "as if" (i.e., pro forma) presentation for the prior year. That is, even though the entity was a C corp in the prior year, the F/Ss would have to be re-cast as if the entity had been an S corp.

Other DTAs and DTLs may "disappear"; e.g., assets that would be subject to the built-in gain tax (BIG tax) if disposed of within 10 years of the conversion. However, you would have to analyze those as well. For instance, if the taxpayer had definite plans to sell an appreciated asset subject to the BIG tax within 10 years, then the DTL would have to stay on the books because the S corp would be liable for the tax. The analysis would then look at any DTAs that remain post-conversion and determine whether a VA is required.

Look at it from a state tax perspective. In California, S corps are taxed at a 2.5% rate and C corps at an 8.84% rate. The deferred inventory remains in place; however, there has been a tax rate change. What happens when you have a rate change? You run the change through the P&L. You do not set up a VA against the DTAs to reduce the tax-effect of the realizability. (The result would be the same for a C corp that was not changing status, but whose multi-state blended rate or single-state rate changed.)

Regards,

Peter C. Gatto, CPA 00:56, 3 May 2006 (CDT)

Your Post

JRE:

I saw that you just posted a lengthy reply in Discussion:LEASE VS. PURCHASE. May I ask where this information came from? Did you write that up yourself?

Thanks!

- Tim Doyle, TaxAlmanac Moderator - Talk to me 11:57, 7 November 2006 (CST)