s-corporations owning multiple entities: mastering tax...

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S-Corporations Owning Multiple Entities:

Mastering Tax Reporting and Planning Opportunities

TUESDAY, MAY 10, 2016, 1:00-2:50 pm Eastern

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May 10, 2016

S-Corporations Owning Multiple Entities

Jason Watson

Watson CPA Group

[email protected]

Robert W. Jamison

Indiana University, Kelley School of Business

[email protected]



Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

S Corp Owning Multiple Entities Agenda

• Problems with S Corps – Jason Watson

• S Corp Owning SMLLCs – Jason Watson

• MMLLC Owned by S Corps – Jason Watson

• S Corp Owning S Corp – Robert Jamison

• Questions and Answers

5

Problems With S Corps

• Distributions in accordance with shareholder percentages.

• Does not allow for an eat-what-you-kill revenue split (such as two insurance salespeople who team up but want personal income to be determined by a formula).

• Ownership expansion within a “broad spectrum-ed” S corp.

6

S Corp Owning SMLLCs

• Married couple.

• S corp is holding company, owned by couple.

• S corp is sole member of two LLCs.

• One LLC is mortgage lending, other LLC is online internet sales (examples).

• Each LLC is disregarded entity (SMLLC), income flows onto S corp tax return.

• Payroll is handled at S corp level (efficient) versus multiple S Corps.

• Yes, you could have S corp do both business activities, but what if…

7

S Corp Owning SMLLCs Continued…

• What if the client wants to…

• To expand ownership of the internet sales company? Very easy to make one of the SMLLC a MMLLC with one member being the S corp and the other member being the new outside/third party member.

• Sell the mortgage lending company? Branding, financials, assets, basis history, etc. has been compartmentalized naturally.

• Provide some financial division and protection between business units?

8

S Corp Owning SMLLCs Continued…

• Self rental.

• If S corp is operating company and ownership is contained to one person or married couple, rentals should be owned personally or owned by LLC outside S corp.

• Allows for ownership expansion within the S corp without affecting other assets (e.g., office building).

• Rent paid must be market rate.

9

MMLLC Owned by S Corps

• Two insurance agents or real estate agents want to team up, and share costs such as E&O (scaled economies).

• Want revenue split based on eat-what-you-kill, fluctuating quarterly / annually.

• Joint venture? Perhaps.

• Create MMLLC owned 50%-50% by two S corps which are 100% owned by each “partner”.

• Operating agreement dictates revenue split, and ultimate K-1 issuance.

10

MMLLC Owned by S Corps Continued…

• Each S corp reports K-1 income from Form 1065 on respective Form 1120S. Salaries are paid commensurate to reasonable salary testing within each S corp.

• Flexibility is enhanced- home office, company car, for example.

• Limitations on 401k plans since controlled group exists (5 or fewer members controlling 80%).

• Operating agreement might need to be robust for death, divorce and incapacitation. Exits might be easy if the MMLLC has no value within itself.

11

Qualified Subchapter S subsidiaries and other

multi-entity arrangements

Robert W. Jamison, CPA, PhD

Professor Emeritus of Accounting

Indiana University (IUPUI)

Copyright © Robert W. Jamison 12

Qualified Subchapter S Subsidiary (QSub)


• S corporation may elect to treat a 100% owned domestic corporation as a QSub. • In general, the subsidiary is treated as a nonentity (in

the same manner as a single-owner limited liability company) for federal income tax purposes.

• Thus, this method can be effective for consolidating operations of various corporations.

Reno, Inc. and Rentco, Inc.

•Reno, Inc. • 100% active gross receipts

• Gross receipts $1,000,000 per year.

•Rentco, Inc.

• 100% Passive gross receipts

• Gross receipts $3000,000 per year.

• Substantial accumulated earnings and profits (AE&P)

• Subject to the passive investment income tax

• Will likely lose its S election unless it pays out its AE&P as dividends.

• Shareholders do not want dividend income


Hyco, Inc. and Loco, Inc.

Hyco, Inc. (S Corp.) • Willie owns all stock

• Consistent profits

• Lends to Loco

• Substantial stock basis

• Willie must pay tax

Loco, Inc. (S Corp.) • Willie owns all stock

• Consistent losses

• Borrows from Hyco

• Minimal stock basis

• No basis from Hyco’s loans

• May not deduct losses


Cashco, Inc. and Fixco, Inc.

Cashco, Inc. (S Corp) • Substantial liquid assets

• Little AAA

• Large AE&P

• Distributions would be dividends

Fixco, Inc. (S Corp) • No liquid assets

• Large AAA

• Distributions would be tax free


QSub Election Mitigates


• Reno & Rentco • The gross receipts of the combined entities would be

aggregated for purposes of the passive investment income test.

• Hyco and Loco • Shareholder would have one basis in stock and debt.

Income and losses of the different corporations would be combined.

• Cashco and Fixco • AAA of the existing corporations is also aggregated, and

distributions from one of the corporations would be treated as made by the combination.

Qualified Subchapter S Subsidiary (QSub).


• Creative use of the QSub can yield some significant tax planning for S corporations. • For example, using a QSub may enable a corporation to

effectively make a mid-year S election, which is not permitted under the general rules of Subchapter S.

• Similarly, the results of a §338(h)(10) or §336(e) election can be obtained in a stock sale, without the need to meet the qualifications or procedures for these elections.

Disregarded Entity Status of Qualified Subchapter S Subsidiary


• The subsidiary corporation is not treated as a separate corporation for federal income tax purposes.

• Thus all of the assets, liabilities, income, deductions, etc. of the subsidiary corporation are treated as belonging to the parent.

The “Master” S Corporation


• Legal Structure of Master S Corporation and Subsidiaries

Holding company

Operating company

1

Operating company

2

Operating company

.....n

Share-

holders

The “Master” S Corporation


• Tax Treatment of Master S Corporation and Subsidiaries

Master S Corporation(Holding Company)

QSub 1 QSub 2 QSub ..n

Share-

holders

Tiers of QSubs


S Corporation

QSub

QSub

QSub

Share-

holders

QSub

Election


• The effective date of the QSub election may be not more than two months and 15 days before the filing of the election, nor may it be more than 12 months after the date on which the parent S corporation files the QSub election.

• Any date outside of the limit will be effective on the nearest date within the limit.

• The Qualified Subchapter S Subsidiary election need not be made as of the beginning of the taxable year of the QSub. • Reg. §1.1361-3(a)(3). • Reg. §1.1361-3(a)(4).

Election


• Example

• On May 10, 2016, PS Corporation, an S corporation, acquires all of the stock of Q corporation.

• PS may file QSub election by July 25, 2016 to take effect on May 10, 2016

Ceeco – Essco Example


• Ceeco is a C corporation with substantial net operating loss carryforwards. • Ceeco anticipates substantial profits in the near future. • There is the possibility of an asset sale in a few years. Ceeco would

like to have the benefits of an S election, but does not want to lose its carryforwards.

• Ceeco has one class of stock, is owned by U.S. citizens, and has no aspects that would disqualify it from S status.

• Ceeco uses the calendar year for tax purposes.

• If Ceeco makes an S election, it must start at the beginning of a taxable year. • If it does so within the first two months and 15 days of 2017, the

election will be in effect January 1, 2017. • If it files the election after March 15, 2017, the election will be

effective on January 1, 2018.

Ceeco – Essco Example (Cont.)


• However, as the income starts to materialize, Ceeco may find itself using up its net operating loss carryforwards before or after the next available effective date. • It can only postpone the election in increments of one full year. • Thus it may run the danger of under or over utilizing its loss

carryforwards.

• Essco is an S corporation that is owned by the same shareholders as Ceeco. • If the shareholders contribute their Ceeco stock to Essco, making

sure that Essco owns all of the Ceeco shares, they can gain some flexibility.

• Alternatively the shareholders could form a Master S corporation and contribute all of the Ceeco shares and All of the Essco shares

Ceeco – Essco Example (Cont.)


• At the time of the contribution, Ceeco will continue to be a C corporation. With the identity of ownership, the stock transfer will not trigger any Code Section 382 limitations on the losses. Thus, as long as Ceeco retains its C corporation status, it may use its net operating loss carryforwards to offset its current income. When it has determined that it has gotten full tax benefit from these losses, Essco can make a QSub election for Ceeco. Ceeco will be treated as liquidated on the effective date of the QSub election. Moreover, the parties have a two month and 15 day hindsight window period to decide on the appropriate time for the QSub election.

C Corporation Subsidiary


• Permitted

• S Corporation may be only shareholder or there may be others

S Corporation

Share-

holders

C Corporation

Uses of a C Corporation Subsidiary


• C corporation retains some viability.

• The S corporation is limited as to the excludable fringe benefits it can offer to a person who actually or constructively owns more than 2% of the corporation’s outstanding stock.

• A C corporation is considerably less restrictive. • The corporation can offer such fringes as accident and health

insurance, or meals and lodging for the convenience of the employer. • Although a shareholder of an S corporation cannot exclude these

benefits, any employee, even a 100% shareholder, of a C corporation is permitted this exclusion.

• To avail oneself of a fringe benefit exclusion, a person must be an employee of the C corporation.

• If the person is also an employee of the S corporation, the employers could be exposed to double payroll taxation.

S Corporation as Partner in Partnership


• Permitted

• Often used by professional organizations

S Corporation

Share-

holders

Partnership

Others

Forbidden Structure


• Partnership as shareholder

S Corporation

Share-holders

Partnership

Others

Forbidden Structure


• C Corporation as shareholder

C Corporation

Share-

holders

S Corporation

Forbidden Structure


• S Corporation as shareholder

S Corporation

Share-

holders

S Corporation

Balance Sheet Consolidation


P Corporation Q Corporation C&E Combined Cash 100 60 160 Receivables 150 130 280 IC receivables 75 0 (75) 0 Other assets 175 210 385 Total 500 400 825 Current libs 70 50 120 IC payables 0 75 (75) 0 Cap Stock 80 130 210 Retained earnings 350 145 495

Total 500 400 825

Income Statement consolidation (book)


• Q sold $90 to P

• Q paid $125 management fee to P

P Corporation Q Corporation C&E Combined

Sales 900 650 90 1,460

COGS 600 475 (90) 985

Expenses 180 220 (125) 275

Book depreciation 45 15 60

Other income 125 125 0

NIBT 200 (60 ) 140

Tax Return – page 1


Sales 1,460 COGS 985 Expenses 275 Tax depreciation 65 Taxable Income 135

Book – Tax Differences


P Corporation Q Corporation Combined

Book depreciation 45 15 60

Tax depreciation 55 10 65

To M-1 line 6a 5

Schedule M-1


S Corporation and C Corporation Returns


• S Corporation must file Form 1120S, with K-1 to each shareholder.

• C Corporation must file Form 1120. • After 2015, returns are due 3 months + 15 days after

year end

• Exception for June 30 year ends until 2026. 2 months + 15 days

S Corporation and Partnership Returns


• S Corporation must file Form 1120S, with K-1 to each shareholder.

• Partnership must file Form 1065, with K-1 to each partner. • After 2015 both are due March 15 if entity uses calendar

year.

• $205/month/K-1 penalty

Special discount by CCH


• S Corporation Taxation

• Multistate Tax Guide to Pass-through Entities

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