ACTG 451 Corp Tax: Reorganizations

Notes from ACTG 451 - Corp Tax
Questions to expect for exam 2 include: drawing a picture of an A merger, consolidation, C, Spin-off, etc. (not the B), reorganizations, partnerships, and Sub-chapter S

Chapter 17 Slides: Reorganizations

A B Reorganization means one company will merge with another, exchanging stock and giving up all their stock
Corporate Reorganizations generally require a Valid business purpose, Continuity of shareholder interest, and Continuity of business enterprise
Businesses acquiring a business with an NOL generally cannot use that NOL unless specific conditions are met
The NOL does not simply disappear when acquired
A business can utilize the NOL by integrating their business into the acquired business, allowing profits generated by the acquired business to offset the NOL
Purchasing a company solely to use the NOL may result in the transaction being disallowed

Type A - Statutory Merger or Consolidation

Boot can be 60% of consideration going to acquired corporation's shareholders
All liabilities of the acquired corporation are assumed by the acquiring corporation
Shareholders of both corporations must approve the plan

Basic Mergers

A Mergers: Parent Shareholder → Parent Corp
Both sets of shareholders must approve
Parent company has to pickup 70% of gross assets and 90% of net assets
Target Shareholders → Target Corp can get up to 20% boot and Non-Voting Shares
Parent must "accept" 100% of Target's liabilities/known/unknown and contingent
Valid Business Purpose, Continuity of S/H interest, and Continuity of business enterprise are requirements for mergers
Calculation are not needed/asked for 70%, 30% rule on test

B Reorganizations

There may be questions, but are not focus
C Reorganizations do not have to assume all liabilities
Spin-Off is "Spun away part of the company that you owned", it is useful in any company that is in multiple industries
A company that sells both smartphones and laptops might spin off its smartphone division, creating a new independent smartphone company
Split-Off is where a company sells pens and sweaters might split off both its sweater division and pen division, creating two independent companies: one for sweaters and one for pens
Shareholders of the original company can exchange their shares for shares in the new sweater and pen companies
Split-Up should be ignored

E Reorganization - Recapitalization

The owner of the liability is converting some of it to common stock.
F Reorganization - Name change
Ex: Hank's Pen Company → Bob's Pen Company
G Reorganization - Bankruptcy

How to liquidate a corporation

It is very expensive
Incorporation process is an easy in and expensive out
Liquidation is taxed as if the corporation sold all its assets at FMV
S/H's are taxed as if they sold their stock
Complete liquidation of a corporation occurs when a corporation exchanges its assets for its stock and ceases to do business
File Form 966. Signing this form agrees that if there are any unknown liabilities, you are then responsible for those
Tax Consequences: Corporate-level tax on asset sales at FMV and Shareholders are taxed as if they sold their stock
Special Rule: Corporate shareholders owning ≥ 80% of the stock of the liquidating corporation do not recognize gain/loss on the receipt of liquidation distributions

How to get money out of a corporation you own

Sell stock or Loan
Best options: Pay himself/herself a Bonus (deduction in the corporation, and have personal income) or Borrow against your stock
Last Choice: Dividends (will be taxed at the shareholder level, 20% tax)
Net Operating Losses: LLC > Partnerships
One level of tax, provides flexibility
80% test doesn't exist in partnerships

Tax Flow-Through Entities

Income/loss flows directly to the partner
The partner's income/loss is shown on their form K-1
Owners of flow-through entities are taxed on the entity-level share of income allocated to them, and only taxed once
Partnerships are not taxed, income and losses flow through to the partners, who report their share on their individual tax returns via Schedule K-1
Corporate tax rate: 21% and Top Rate for individuals: 37%

Bob, Basis, FMV

If they sell for $160,00 @ 50/50
Bob has to receive the first $80,000 → known as “Built in Gain”
Partners who contribute services instead of property frequently receive only profits interests
Generally, neither partnerships nor partners recognize gain/loss when they contribute property to partnerships
Losses cannot be allocated in excess of basis, as negative basis is impossible

Partnership may have recourse debt

Creditors can go after the partners personally if the partnership cannot pay.
Signing as a guarantor, is recourse debt
Creditors cannot go after the partners personally on non-recourse debt
Common in real estate partnerships, where the lender's only recourse is the property itself
Sch K-1 is used to report an individual's share of income, deductions, credits, etc.
All flows through to the individual taxpayer

3 Basic Principles

no 80% rule for partnerships: Recourse Debt → Means Personal Obligation
Non-Recourse Debt → No one is liable
Standard mortgage: Bank's only way to collect if not paid is by taking the property
Always preference to sign
Outside Basis includes share of debt capital
Important because it determines how much a partner can deduct and allocate liability among partners
When you sell two things happen, you get some cash and Relief of liabilities (Recourse Debt [R/D] + Non-Recourse Debt [NRD])
Cash + Relief of Liabilities = Purchase Price - Outside basis = Cash for investment
Cash for investment + R/D + NRD = Outside Basis

Allocation of Liabilities

Recourse Debt → allocated based on share of losses
Non-Recourse Debt → allocated based on share of profits
For LLC/Partnership: Built in gain stays with the partner

Chapter 20

Outside Basis includes: Cash put up, basis put in, share of R/C & NRC Debt
When determining the holding period → it starts with the partner

Profits Interest

All allocations must make sense → so they have an economic effect
A partner can have a negative capital account, but if that partner is not required to put money in or if it's non-recourse debt, it's impossible
At risk rules, passive, and Excess business losses is from another class: 450

Chapter 21

Hot assets are Ordinary income-producing assets in a partnership
Inventory and receivables, ordinary assets that have depreciated
Unrealized receivables are income not yet received (e.g., cash-method A/R)
Inventory items are assets generating ordinary income if sold
Tax impact: Gain from hot assets is taxed as ordinary income, not capital gain
To the extent that new investor shares in the partnership liabilities, his share of partnership liabilities increases his outside basis
As long as you don't receive a distribution in excess of your capital account, you don't have taxable income
Operating Distributions: Partner reduces their (outside) basis to zero and recognizes gain (generally capital) to the extent the amount of money distributed is greater than their outside basis
Partnership's basis in its remaining assets remains unchanged and partners never recognizes a loss from an operating distribution
Primary objective is to allocate the partner's entire outside basis in the partnership to the assets the partner receives in liquidating distribution
Liquidating Distributions depends on the partnership's basis in distributed assets relative to the partner's outside basis, and the type of property disturbed—whether it is money, hot assets, or other property
Subchapter S → Taxed as partnerships, it was incorporated to avoid high rates
Small Company → based on number of shareholders
Anything the partners make in the subchapter S is subject to the medicare tax rate, which is 1.45 for company and 1.45 for individual

S Corporation Elections

Shareholder has to be an individual, a U.S. citizen and there are limits on corporation type
Corporation has to be a regular corporation, one class of stock, and cannot have preferred shares
If a shareholder becomes a non-resident alien, the S corporation status is terminated, and the company is taxed as a C corporation unless corrective action is taken
Voluntary terminations are elected by shareholders with > 50% of stock
Passive investment income > 25% of gross receipts for three years are restricted to S corporations with “earnings and profits”
Passive investment income, gross receipts result in Involuntary terminations
S corporation shareholder's allocable share of ordinary business income (loss) is not classified as self-employment income
Royalty income from a book you wrote would not be passive income
Distributions are tax-free to the extent of shareholder's basis for S corps with no E&P
Distributions from AAA are nontaxable to extent of shareholder's basis
Shareholder's Basis: Initial basis & Exchange
Tax basis of property transferred, less any liabilities assumed by the corporation on the property contributed (substituted basis)
Increased by any gain recognized; reduced by the fair market value of any property received other than stock
Straight-loans are generally a fixed amount of money and simple
Take the loss in the year you take the straight-loan
Annual Basis Adjustments can Increase for contributions or decrease for distributions and shareholder's share of nondeductible expenses
Basis can never be < 0
Tax basis limitation occurs when losses are first limited to the shareholder's tax basis in their S corporation stock and then to the basis in any direct loans they have personally made to the corporation
Losses not deductible due to the tax-basis limitation are suspended until the shareholder generates additional basis
At-risk limitation for S corporation shareholders are deemed at risk only for direct loans they to S corporations
Self-Employment Income: S corporation shareholder's allocable share of ordinary business income (loss) is not classified as self-employment income
S corporation consequences: Recognizes gain on distribution of appreciated property and does not recognize loss on distribution of property whose value has declined
Built-in gains tax only applies if S corporation has net unrealized built-in gain at conversion and if it recognizes net built-in gains during the first five years as S corporation
Double taxation is the gain when you distribute the appreciated property
As a sole proprietorship LLC, you cannot avoid self-employment tax on active business income, but you can reduce its impact legally through the following options
Form 2553 can be filed to have the LLC taxed as an S corporation: Pay yourself a reasonable salary and Take remaining profits as distributions, not subject to self-employment tax
Lowering the base net income reduces the base on which self-employment tax is calculated
Set up a Solo 401(k) or SEP IRA as a tax-deductible
Pay for your own health insurance, you may deduct premiums, reducing your SE income.
If S corp benefits outweigh the compliance costs, it's often the only real way to significantly reduce self-employment taxes
As a default single-member LLC (sole prop), all net income is subject to the 15.3% self-employment tax, you must elect S corp status to separate wage income from business distributions and lower SE tax

State & Local Taxes

Sovereign Entities like Sanctuary Cities/States
Taxed any place that you have Nexus
Taxpayer's commercial domicile
If operations are not excluded by law: If a company is incorporated in Delaware but the CEO, headquarters, and main operations are in California, then California is likely the commercial domicile
Taxpayer has nexus: Nexus is the link between a business and a state that makes the business subject to that state's taxes
California does not tax social security to individuals
Accumulated earnings: do not use corps just to store money and hide from taxes
Accumulated earnings come without penalties
Too much in R/E & it's liquid means that the government has the right to come in and tax you
When accumulating lots of money, have a plan to spend that money to legally avoid taxes
Spin-off: Company moving a portion of it's business and giving it to it's shareholders