Hello, I'm looking for some help on calculating end of 2018 shareholder basis for a business operating in 2017 as a SMLLC and as an SMLLC with an S Corp election effective 2018, plus a few other related questions.
Pre-S Corp Election Contributed Capital (2017): $A
Post-S Corp Election Contributed Capital (2018): $B
Pre-Election losses, flowed through to personal return (2017): ($C) - assume not counted towards basis? Does retained earnings go to zero for 2018 beginning balance on my S Corp 2018 balance sheet? What would the journal entry be for these retained earnings to zero out?
Pre-Election Section 179 Carryover of disallowed deduction, carried forward due to NOL: $D
Post-Election NOL for 2018: ($E). I assume I can take the loss on my 2018 personal return against other income and I do not have to carry forward the loss as my basis remains positive if calculated in the method shown below?
No loans, distributions, or wages up to now.
Proposed basis calculation: $A + $B + ($E)
And in the year with sufficient revenue that I take the Section 179 depreciation expense (should be this year), -$D to my basis calculation.
Can I continue carry over the pre-election Section 179 to a future tax year that has sufficient net income? Any other recommendations on this basis calculation?
It would be in your best interest to consult with a tax professional to grasp how S corps work and getting you started down the right path. Having said that, I will provide some discussion:
- When you made the S election, what ever you contributed into that entity is your beginning basis. Property will carry over based on the adjusted basis and cash is just cash. If the S corp assumes liabilities, then this adjusts your basis as well.
- From here on out (once beginning basis is determined) you will adjust your basis annually based on the applicable lines of the K-1 issued to you.
- Anything that occurred before the S election, will have no impact on your basis.
- Your beginning balance sheet will not have any retained earnings. It will simply be debits and credits related to the items discussed in bullet 1 above. The remaining balancing entry will be to shareholder equity.
- Any Section 179 carryover is a personal item and will have no impact on the S corporation.
- You will be able to take losses on your personal return only to the extent you have basis; either capital or debt basis.
- Maintaining an accurate basis schedule is extremely important as it determines allowable losses, tax impact of distributions, etc.
- While the attached link to the IRS is based on 2015, it will generally still hold true; the line numbers on the K-1 may have changed somewhat (I did not check this). https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-stock-and-debt-basis
- Also make sure that you prepare your 1120S first as the K-1 reporting will impact your personal tax return. We see instances where individuals have already prepared their 1040 and then start asking questions about the 1120S.
To respond to your questions:
1) Kudos to you for attempting to grasp an understanding of what is going on.
2) You can't put in "negative retained earnings". This ties into my comment that what occurred while a SMLLC does not carry over to the S corp. Retained earnings will start at zero.
3) Section 357(c) is somewhat complicated. Based on the limited facts, it does not appear that you will have to recognize any gain as a result of Section 357(c). Discussed below.
4) As noted previously, your beginning basis equals your contribution of property (including cash) less any debt assumed by the S corp upon incorporation. The basis of depreciable property is the adjusted basis in the hands of the transferor (you) not the FMV of the property. So if you are contributing property which has a FMV of $10,000 but an adjusted basis of $5,000 (due to depreciation), then your beginning basis is the $5,000.
5) There are also rules covering depreciable property which is that the property has a "step into the shoes" concept. You need to make sure you understand this if applicable.
6) As you have alluded to, Section 357(c) can cause recognized gain. There is one very important exception to the general rule under IRC Sec. 357(c) and that is liabilities which would lead to a deduction upon payment (i.e cash basis salaries or rents payable or accounts payable of a cash basis taxpayer) are not to be included in the total amount of liabilities which are in excess of the assets basis transferred.
7) So based on your limited facts, your beginning basis would essentially be the sum of cash contributed plus adjusted basis of your inventory.
Your capital account would be the net of these accounts.
Since you were a cash basis entity prior to the S corp (which is an assumption), the payables from the prior SMLLC will be addressed as they are paid. This will then have the proper effect on your basis at the time they are paid.
From the start I have been on accrual basis so deferred revenue is cash received but not recognized because the order was not yet delivered. Regarding the 357(c), most examples talk about putting assets with a debt component tied to the asset like a mortgage. So if my firm's assets (cash+adj. basis of inventory) exceed liabilities (not counting deferred revenue, I just have a small accounts payable number and no other liabilities) then there should be no recognized gain? Or does deferred revenue count? I have no depreciation of anything so far.
But to provide some additional guidance:
1) Since you indicate that you were on the accrual method, not sure why but don't know your gross revenue, then I would assume that your payables were deducted when you were a SMLLC. If that is the case, these will impact your Section 357(c) calculation. Section 357(c) addresses where "liabilities" are assumed by another party to an exchange; payables are a liability.
2)The deferral of income needs to be discussed further as if you are on the accrual method in order to defer any advance payments you need to have made an election. I don't know if this has been done.
3) Examples generally only cover simple and easy situations, so you just need to keep this in mind. There is generally not an example for all situations. One just needs to read the statute and regulations when looking at all situations.
4) The other issue to keep in mind, is that generally when these types of transactions occur, there are multiple parties involved and the rules are meant to avoid shifting of tax consequences between parties. Here I am assuming that you are the only shareholder of the S corp.
If you think through the liability issue it makes sense as upon formation your capital should equal your beginning basis.
If you just had cash $1,000 accounts payable $50 putting together your balance sheet you would have capital of $950 to balance the balance sheet.
If the only thing the S corp does is pay the payable, then you have cash left of $950 and this is the same as your basis. If you then liquidate, there is no gain or loss and that is the way it should be; cash distributed $950 equals your basis of $950.
Just to conclude, there is a lot going on and seeking professional help would be encouraged to get you started on the right path.
Am a bit confused on your beginning basis/contributed capital point. Assuming no debt or liabilities, I should be able to withdraw the exact amount of my contributed capital without a taxable event, no? For the sake of the example my end of 2017 contributed capital is $1 of the $8 of the above example.
I'm having a similar problem the person asking the question about the conversion is. It's not my business but a client's. I like using accrual accounting, because it gives a clear picture of what your business is doing. In QBO, you can just select a cash basis I/S to get to cash basis(which I do for some clients who started on a cash basis), but I understand the answer regarding the equity except in the case where you are using accrual basis and have negative equity. You can't start with negative contributed capital, so I'm not sure about this answer. I'm a CPA and am currently researching using Bloomberg software, but have been unable to find an answer. I will probably have to ask someone with more tax experience than I do. If you treat it as cash basis and eliminate payable and receivables, you will have positive equity, so that might be the answer. As liabilities and receivables are realized, you would just realize them then if you had been using cash basis as a SMLLC sole proprietorship. However, if they were already booked, because you were using accrual, I don't know what the answer would be. Since liabilities other than loans to the shareholder do not affect shareholder basis in an S-Corp, it's more of an accounting issue than a tax it seems