The government's argument was based primarily on the fact that Sec. Thus, a corporation that must change a method of accounting as a result of the revocation of its S corporation election within the prescribed period would include any income resulting from that change over six tax years (as opposed to four years under the normal rule). Under the regulation, if different blocks of stock are created for separate qualifying investments to track basis in such qualifying investments, the separate blocks are not treated as different classes of stock for purposes of S corporation eligibility under Sec. The onwer does not get to deduct this compensation until it is paid - resulting in increasing his current net income (he only has 65K cause he does have to pay taxes on this money). 2019-13: Stock redemptions in PTTP. 1.83-3(b), (c), and (d). By 2002 the high-end institutional life insurance (ILI) contracts used to informally fund NQDC (COLI /BOLI) had evolved into a greater individual value than the NQDC plans they were informally funding more effective for the individual to personally own, fund and manage the ILI policy than risk their paycheck in a NQDC plan 409A simply exacerbated the NQDC problems. 2019). The election, which is irrevocable for all future years, must state: The return, including Schedules K-1 and Form 8992, U.S. Although not the law, these practice units serve as a primer on the tax consequences of distributions in kind or of cash to shareholders by an S corporation with positive AE&P. Therefore, Treasury does not have the authority to disallow basis to partners or shareholders, or to disallow deductions for payments resulting from forgiven loan proceeds, under any current or prospective PPP loan forgiveness law.17. There is also required reporting of beginning and ending shareholder loans to the corporation. Although the corporation was dissolved administratively under state law, it continued to carry on a business. I create our ILI admin company and The STAR Plan in 2002 to facilitate individual access to ILI in a professionally managed program. The year you receive your deferred money, you'll be taxed on $200,000 in income10 years' worth of $20,000 deferrals. This. For example, S corporation K-1 distributions (corporate profits) are not included when making the contribution limit calculation. Also described is how the S corporation may electively change the ordering rule and the consents required to do so. Although neither the loan nor the forgiveness would create shareholder basis, would the nondeductible expenses reduce basis? With respect to preparing returns of S corporations, certain new requirements went into effect for the 2020 tax year (relating to Schedule B-1/K-1 reporting), and others will commence in 2021 (international reporting). The AICPA S Corporation Taxation Technical Resource Panel, a volunteer group of practitioners who pay close attention to guidance under Subchapter S, offers the following updates from this past year, as summarized below by Code section. 1361-1(m) that explicitly or implicitly prohibit a nonresident alien from potential current beneficiary status. The entity then converted to a corporation under state law, thus terminating the partnership agreement on profit and loss sharing. This site uses cookies to store information on your computer. Sec. Treating Medical Insurance Premiums as Wages. There are specific rules about the timing and nature of your future withdrawals. A shareholder departing from either a C corporation or an S corporation may sell his or her shares of stock to some or all of the other shareholders. 57-47. After an S corporation terminates its S election and becomes a C corporation, there is a PTTP. Z, a single-member LLC, acquired portions of the stock in corporations W, X, and Y, all of which had previously made timely S corporation elections at incorporation. Under current regulations, that treatment is only available to shareholders that were shareholders at the time of the S termination.19 The ruling concludes that these "distribution equivalent redemptions" are afforded the same treatment under Sec. A nonqualified deferred compensation (NQDC) plan is a broad, general description for any arrangement under which the employer or the employee can defer taxation of compensation that is earned in one year so that it becomes included in taxable compensation in a later year (because payment occurs more than 2 months after the year in which the ben. In fact, S corporation distributions are far more common than dividends for privately held C corporations. These losses gave rise to an NOL, which the taxpayer carried back to his 2006 tax year as an NOL carryback deduction and carried forward to his 2012 tax year as an NOL carryover deduction. This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction. Assuming that the election was valid, all of the shareholders filed their individual income tax returns including their pro rata shares of S corporation items. For example, if a calendar-year S corporation made the election for 2020 and distributed all transition AE&P before Jan. 1, 2021, it would use the aggregate method for 2021. The IRS held that based on provisions in the amendment, the S election did terminate on date 4. 1361(c), before amendment by TCJA 13541. However, the corporations will all continue to be treated as S corporations effective as of their respective dates of incorporation, provided they take the appropriate corrective measures as indicated above. 481 adjustment arising from an accounting method change attributable to the corporation's revocation of its S corporation election will be taken into account ratably during the six-tax-year period beginning with the year of the method change. In general, deferred compensation plans allow the participant to defer income today and withdraw it at some point in the future (usually upon retirement) when taxable income is likely to be lower . The IRS ruled that both Agreement 1 and Agreement 2 were deferred compensation plans under Regs. There are two important rules for the PTTP: Regs. 6662 penalty on the taxpayers for the 2004 tax year. Can a sole shareholder of an S-Corp set up a nonqualified deferred compensation plan for himself/herself? 1367: Adjustments to basis of stock of shareholders, etc. And because this is an individual program, employer initiative, good will, tax structure, 409A, Top-hat, high tax rates and qualified plan caps are irrelevant. With respect to the latter provision, two issues from the proposed regulations are worth highlighting. Sec. If designed correctly, deferral plans have tax benefits for the company and its employees. Special rules apply for S corporations that were unaware of the termination until a subsequent audit. The memorandum held that when a shareholder deducted a loss in excess of basis, the IRS does not adjust the loss deduction, and the loss year has closed, the shareholder must reduce basis in future years. The change to Sec. With respect to the latter provision, two issues from the final regulations are worth highlighting. 1 2 Next Page 1 of 2 HJ Registered 1 Posted May 22, 2018 For a S Corp owner making $300k per year, what is his best option in saving money for himself and getting a tax advantage? IRS Letter Ruling 201935010 addressed an inadvertent defective election from multiple classes of stock. In the S corporation context, uncertainties included: There were no apparent unambiguous answers to these and other issues. The Tax Court held that Deckard had no beneficial ownership rights as a shareholder under state law and the articles of incorporation because Waterfront's articles of incorporation provided, among other things, that: Deckard was thus prohibited from making an S election for Waterfront and was not permitted to claim any losses of Waterfront on his individual return. The Fourth Circuit did not accept the taxpayers' contention that their surrender agreements effectively rescinded all but $4 million of the $46 million of income that the taxpayers would otherwise have to recognize under Sec. While the adjustment to AAA under the holding of the revenue ruling arrives at an appropriate policy result, it is not readily clear under what authority such an adjustment is permitted or required. 1371(f). GILTI inclusions of S corporation shareholders: Notice 2020-69, issued Sept. 1, 2020, applies to S corporations that hold stock in controlled foreign corporations (CFCs). The taxpayers were individual shareholders in three S corporations that transitioned between S corporation and C corporation status several times. Tap into expert guidance, tools, news, and career development. Your go-to source for tax developments and professional insights. The IRS made the following arguments: The federal district court granted partial summary judgment for the government on the first argument, concluding that the AAAs of corporations with terminated S elections reset to zero after the expiration of the corporations' PTTPs. 6:17-cv-02017-AA (D. Or. Even if the recalculation rules would allow an S corporation's AAA to be reduced below zero as a result of distributions, the rules resetting a corporation's AAA to zero at the beginning of a new S period would preclude a beginning negative balance in the AAA. Specifically, the 2017 tax law provides that, in the case of an eligible terminated S corporation, any Sec. . Examples include pensions, retirement plans, and stock options. According to Notice 2020-75, the proposed regulations also are intended to clarify that certain state and local income tax payments, described in the notice and made by a partnership or an S corporation, are not taken into account in applying the state and local tax deduction limitation under Sec. Since ESOPs are tax-exempt retirement plans and taxation only occurs upon distribution to the beneficiaries, the McKennys would pay no tax on the S corporation's earnings. X represented that all shareholders had taken into account their pro rata shares of income and distributions and properly adjusted their stock basis as required under Sec. "The Organization is organized exclusively for charitable and educational purposes"; "The Organization shall not have members"; and, "Upon dissolution of the organization, its assets shall be distributed as directed by a two-thirds majority vote of the directors in office for (i) one or more exempt purposes . By distributing . The CAA reiterated the rule that forgiveness of loans is exempt from tax.14 However, the CAA specified that forgiven loan amounts are tax-exempt income, within the meaning of Secs. On date 5, the agreement was amended to remove both of those provisions. 1366(a)(1)(A). "22 In 2019, the Tenth Circuit upheld the Tax Court decision, finding that an S corporation and the participants in an employee stock ownership plan (ESOP) established by the S corporation are related persons for purposes of applying Sec. 1371(e)). 333, 335 (1939), and Rev. The entity election for GILTI inclusion amounts is being made; and. In year 2, upon notification of the termination, Z's member represents that the company relied on its tax and legal advisers to take corrective action, but no action was taken. Not-for-profit corporation was not allowed to make S election: In Deckard,1 the Tax Court addressed the ability to make an S election for a nonstock, not-for-profit corporation. The updates are intended to provide greater clarity for shareholders on how to compute their U.S. income tax liabilities with respect to international tax matters, including how to compute deductions and credits. 46The forms have yet to be finalized as of this writing. Commercial agreements, such as contractual agreements, leases, and loan agreements, are not governing provisions unless a principal purpose of an agreement is to circumvent the one-class-of-stock requirement. Sec. 1.1361-1(l)(1). Sec. On Nov. 9, 2020, the IRS issued Notice 2020-75, which announces that Treasury and the IRS intend to issue proposed regulations to clarify that certain state and local income taxes imposed on and paid by a passthrough entity, such as a partnership or an S corporation, are allowed as a deduction by the partnership or S corporation in computing its nonseparately stated taxable income or loss for the tax year of payment. Upon liquidation of the partnership, the profits interest could only receive the assets attributable to income after the issuance of the profits interests. 1367. 4Sec. The new shareholder received 50% of the stock. M&A pitfalls for deferred research expenditures, Impact of business interest expense limitation regs. 30Tomseth, 413 F. Supp. 30% of adjusted taxable income (ATI), plus. Among the issues were losses deducted from a purported S corporation. 162 ordinary business expense of the S corporation consulting business; and. In addition, there were two classes of ownership interests a capital interest and a profits interest. Instead, specified income tax payments must be reflected in a partner's or an S corporation shareholder's distributive or pro rata share of nonseparately stated income or loss reported on a Schedule K-1 (or similar form). 1361(b) lists several conditions that are necessary for a corporation to be eligible for S corporation status. 1367(a)(2) stating that basis cannot be negative at the end of any period, the government opinion in the FSA states that basis in an open period can be reduced by "recalculations" involving losses in excess of basis erroneously deducted in a closed period. On date 5, the amendment was corrected to remove the language for the separate liquidating provision and to provide that all distributions will be made in accordance with ownership percentages. 702 or Sec. and the name and TIN of the person responsible for reporting the nominal shareholder's items on a tax return. In Tomseth,8 three corporations had each twice elected S corporation status and three times terminated S corporation status, observing the five-year minimum period between terminating and reelecting S status. Special rules apply for S corporations that were unaware of the termination until a subsequent audit. 1371(f). 301 pursuant to Sec. 1362(f) relief for an inadvertently invalid S election or an inadvertent termination of an initially valid election from the IRS through the private letter ruling process. The IRS and Treasury declined to broaden the scope of the rule to tiered partnerships, S corporations, or loans to partnerships by other members of the same consolidated group as a corporate partner. Please describe the benefits of nonqualified deferred compensation to the sole shareholder of an S corporation. First, if a corporation's S election has terminated, any distribution of money by the corporation with respect to its stock during a PTTP is applied against and reduces the adjusted basis of the stock to the extent that the amount of the distribution does not exceed the AAA. Tax professionals must be on the alert for rulings or other announcements from the IRS that may address these issues. As expected, the IRS's focus was on the provisions of the LLC's operating agreement. "12 If any AAA survived the termination of a corporation's S election, the court observed, there would be no point in having a PTTP. The IRS ruled that the initial flaws concerning the class of stock and the ineligible shareholder were inadvertent, so the entity could be treated as an S corporation from the initially intended effective date. The court, quoting from Rev. This ruling clarified the application of Sec. International reporting (beginning in 2021): On July 14, 2020, Treasury and the IRS proposed changes to Form 1065, U.S. Return of Partnership Income, for tax year 2021 (filing season 2022) and noted that such changes were also intended to apply to S corporations.46 The TCJA enacted numerous international tax changes. 26McKenny, 973 F.3d 1291 (11th Cir. 1.1400Z2(b)-1(c)(7)(iv), which became effective in March 2020, addresses an S corporation operating a mixed-funds investment in a QOF. The S corporation reported significant losses as a result of the 2009 transactions losses that the shareholder claimed on his 2009 individual tax return. The second provision Sec. 1.1362-5(a), a more-than-50% change in stock ownership from the ownership on the date of termination tends to establish that consent should be granted. The draft Schedules K-2 and K-3 intend to standardize the way an S corporation reports international tax information to shareholders, offering greater transparency to the IRS and clarity to both S corporations and their shareholders. (S corporation basis is typically a function of capital contributions, earnings and distributions.) 453 (d), realizing a capital gain of $175 million. Under the tax law, S corporation shareholders determine the New York-source portion of their pro rata share of the corporation's . 19-35979 (9th Cir. The McKennys were audited in 2005 and assessed additional tax of $2.2 million. It's easy! 1.1377-2(b). The determination of whether any transition AE&P remains is made at the beginning of each subsequent year. PPP Expense Deductibility and Forgiveness Raises Basis, Other Issues, M&A pitfalls for deferred research expenditures, Impact of business interest expense limitation regs. 19Regs. 301. In the letter ruling, the IRS concluded that the terms of the operating agreement created a second class of stock. Let me suggest you shift your perspective from pre-tax employment deferral to lifelong after-tax deferral. The S corporation makes the entity treatment election for the first tax year ending on or after Sept. 1, 2020, on its timely filed (including extensions) tax return, or on an amended return filed by March 15, 2021. The items are arranged by Code section and often contain a short description of the relevant provision. For S-corporations and other flow-through entities, not so much. The regulations adopt a "snapshot approach" under which an ETSC generally calculates AAA and AE&P only once at the beginning of the day on which revocation of the corporation's S status is effective (as opposed to recalculation of amounts before each qualified distribution). Effect of the CARES Act and CAA: In general, a shareholder in an S corporation includes tax-exempt income of the corporation in adjusting basis for a tax year.31 However, if an S corporation excludes COD income under Sec. The stock of Y was transferred to eligible S shareholders. On date 3, the original founding members entered into an agreement providing that all distributions would be made according to their membership interests. He also compensated the corporation's legal secretaries out of pocket for work performed on these cases. 2Secs. 18See Scott, "PPP Expense Deductibility and Forgiveness Raises Basis, Other Issues,"The Tax Adviser(Dec. 27, 2020 ).