2003 changes §1(h) and 1371
how to deal with change from S corp to C corp, or vice-a-versa
1(h)—qualified dividends are now subject to capital gains tax
i. if corp distributes profits, SH reflect by adding to taxable dividend income. (used to be ordinary income)
ii. If corp retains and invests profits, resulting in increased share value, the SH will reflect the increased profits upon sale of stock as taxable gain on the appreciated value of the stock. (capital asset—less tax)
1. typically, this is how many TPs used to bailout corporate profits, trying to get capital gains rate instead of ordinary income.
2. penalty taxes on accumulated earnings and personal holding companies.
a. 533—accumulated earnings tax; tax when corp holding profits for purpose of avoiding income. Disputes arise over identifying reasonable needs of the business. Look to 537. 535.
iii. However, now a problem b/c corp prefers nondividend payments b/c can deduct. But SH wants dividend payment b/c taxed at capital gain rate.
how to compute corporate tax
i. determine gross income
ii. subtract available deductions to determine taxable income
1. 163—can deduct business interest expense
2. 162—can deduct compensation to employees
iii. 35% rate of tax
iv. capital losses can only be used to offset capital gains
1. short term or long term (long term being held for more than a year)
2. maximum capital gain rate is 15%
capital asset definition 1221
i. property held by the taxpayer except 8 listed items, excludes stock in trade, inventory, or property held by TP primarily for sale to customers in the ordinary course of TP’s trade or business. Thus, when corp sells inventory or property, profit or loss will be treated as ordinary.
ii. Also excludes accounts or notes receivable, depreciable trade or business property or real property
1. however, special rules in 1231 for depreciable equipment or real estate—can deduct as capital gains or losses when sale of 1231 assets exceed losses from 1231 assets for the taxable year.
2. “quasi-capital assets”
iii. puts alternative minimum tax on individuals so they won’t avoid all tax liability, 56-58
61—must recognize realized gains and losses unless code provides otherwise (ex. like kind exchanges and involuntary conversions)
i. use substituted basis rules to preserve unrecognized gain or loss
ii. can also be reorganization
LLC-Partnership Overview
Partnership not subject to tax—pass-through entity for income, loss, deductions, and credits and reported on each participant’s individual tax return
S corps can do the same thing.
For C corp, SH pays no tax until corp makes distribution or SH sells the shares.
i. In addition, can’t deduct losses—reflected in the
asses of stock entitled to vote, and
§ At least 80% of the total number of shares of all other classes of stock.
o Control group—can transfer as party of an integrated plan of incorporation
o Underwriter (using best efforts to sell stock or buys stock) does not count as part of control group. But buying public is part of control group.
o Must have control immediately after exchange
§ American Bantam Car—immediately after transfer, met 80% control test. Then, underwriter got some stock from escrow account and failed control test. Court held that immediately after control was satisfied and nonrecognition was fine. B/c underwriter’s right to the escrowed shares were contingent and ownership remained with the incorporators under the underwriter satisfied the best efforts contract conditions
· 354—SH who exchange stock in one corporation for stock in another corp as part of a reorganization transaction.
§ Exceptions to nonrecognition:
· Transfer of property to an investment company
§ Disproportionate contributions—
· If each receive 50% ownership, but one contributes 90,000 and the other 10,000, then mom will be viewed as getting 90% of stock and making gift of 40%–may have to pay gift tax. Daughter contributes 10% and gets the gift.
o Basis Rules—deferral of gain or loss (351 and 358)
§ TP transfer land to corp. in exchange for all its stock
· Basis of 20,000
· FMW of 200,000
