Distributions in excess of basis vs. loss carryforward

[David]

I need a sanity check please.

Single SH S Corp began in 2013 and had beginning basis of zero in 2015.

If the company takes full advantage of sec 179 deductions, there will be no taxable distributions in excess of basis. However, there will be $39K loss carry forward.

If the company takes no sec 179 deductions there will still be $5K loss carry forward for charitable contributions and $3K distributions in excess of basis.

I am thinking that it would be better to not have a $39K loss carryforward and instead have the $5K loss carryforward.

Regarding the $3K distributions in excess of basis, I am thinking of classifying that as due from shareholder and discuss with the client that they need to take less distributions in 2016 to make up for the $5K loss carryforward and the $3K due from shareholder.

Does anyone see a problem with how I am approaching this situation?

If the distributions in excess of basis is reported, will it be taxed at the LTCG rate since the SH has held his stock since 2013? Or since the SH had zero basis at the beginning of the year, will the distributions in excess of basis be taxed at the ST rate?

Thanks.

[Abby Normal]

They would need a salary of at least 39k for the S corp to be able to take 179.

Excess distributions would be LTCG possibly taxed at 0% for federal.

Don't do due from shareholder. Taking money out at LTCG rates is the best option.

[David]

Thanks. I didn't think of the salary being reported on the TP's 1040 and the impact to the loss carryforward. He has more than $39K W-2 salary from the S Corp.

So even though the basis statement shows a $39K loss carryforward, will he still be able to take the sec 179 portion of the loss carryforward on his 1040? I thought his losses were limited by his basis.

[jklcpa]

Sec 179 has limitations at both the corporation and shareholder level.  Have you done the calculations within the S corp return to calculate the 179 allowed at the corp level?  If you look at that calculation, stockholder compensation is an add-back, that's why Abby said he'd need at least $39K in compensation to allow it. If not, the 179 won't show on the K-1, won't flow onto the 1040 at all. 

[David]

Thanks for your help, Judy.

Yes, I see where the SH compensation is added back to the 179 calculation. So the K-1 shows the full amount of 179 deduction.

However, the SH's basis statement shows $39K loss carry forward. The loss items are $44K 179 deduction and $5K charitable contributions. Even though 179 is allowed at the corporation level, won't these loss carry forwards limit the amount of 179 deduction and charitable contributions allowed on the SH's 1040?

Thanks.

 

[Abby Normal]

Shareholder has no basis for deducting the loss, so it's carried forward regardless of the 179. Personally, I would still take the 179 and get the deduction to the 1040 where it can be used as soon as the corporation shows a profit, instead of depreciating over 5-7 years.

[jklcpa]

Whether it's an operating loss or the sec 179 deduction, they will be disallowed and carried forward until the owner has basis.

If not taking the sec 179 deduction, does the S corp have ordinary income in excess of $3K?  With a starting basis of -0-, that is the only way those excess distributions of $3K could be nontaxable because of the ordering rules.

I don't like the idea of switching the distributions to being due from shareholder, although it's a common practice. What do the books and records of the company reflect the transacton to be? If its a distribution, report it as such. If the owner had the intention to repay it, is that documented with a promissory note or in minutes of a meeting, or anywhere?

Finally, to answer the easiest of the questions you asked, if the stock of the S corp has been held more than one year, and if we are only talking about stock basis (no debt basis), then the excess distributions would be long-term.

Edited August 29, 2016 by jklcpa
added "ordering rules", fixed punctuation

[David]

The corp has 222K of ordinary income and the SH took $212K distributions. 179 deductions are $44K and charitable contributions are $5K. Even though the corp can take the 179 deduction, this creates a $39K loss carry forward. Therefore, am I correct in thinking that the TP will not be able to take the full 179 deduction and the charitable contribution on his 1040?

If no 179 deduction is taken then ordinary income is $209K and distributions are $212K resulting in $3K excess distributions. This also results in a loss carry forward of $5K for the charitable contributions.

Am I missing something by thinking that the second scenario is better for the TP?

Thanks for your help.

 

[jklcpa]

20 hours ago, David said:

am I correct in thinking that the TP will not be able to take the full 179 deduction and the charitable contribution on his 1040?

ordinary income is $209K and distributions are $212K resulting in $3K excess distributions.

Both statements are correct.

20 hours ago, David said:

Am I missing something by thinking that the second scenario is better for the TP?

 

Have you thought about a partial, smaller 179 deduction that reduces some of that ordinary income but doesn't limit the deduction while still eliminating the excess distribution?

Perhaps these answers might be discovered by running a couple of scenarios in the tax planner for this individual?

[Abby Normal]

If the corporation has 222k of ordinary income (taking the 179) and 212K of distributions, then there should be 10K of basis which will be allocated between the 179 deduction and the charitable deductions, pro rata. In other words, you get 10k in deductions and none of the distributions will be taxable. You should be able to see this in ATX basis worksheet.

[jklcpa]

1 hour ago, Abby Normal said:

If the corporation has 222k of ordinary income (taking the 179) and 212K of distributions, then there should be 10K of basis which will be allocated between the 179 deduction and the charitable deductions, pro rata. In other words, you get 10k in deductions and none of the distributions will be taxable. You should be able to see this in ATX basis worksheet.

It may be close to that, yes, but the partial 179 will still allow some amount of regular depreciation and there may also be other depreciation expense on prior years' asset additions that won't be affected by electing 179 in 2015. From his post above ordinary income without any sec 179 is $209, and in the scenario with $44K of 179 (before subtracting it out) has $222K ordinary income.

I wasn't trying to be flip in suggesting to David that he run projections, because beyond discussing theory, the projections are needed to fine tune what level of 179 may be optimal for his client's particular situation, and no one here will be able to answer that for him.

David never did say what shareholder's compensation was, but now we have information that the company has significant ordinary income, and David's original statement about a loss being created by the 179 and being disallowed that isn't the case at all.  The company has this ordinary income that will flow through, and the potential disallowance was only the 179 deduction and contributions, all due to the amount of distributions and the ordering rules when figuring basis. With that level of ordinary income flowing through, other income possibly on the return, the possible excess distribution, filing status, etc, then items such as the Sch A and exemption phase-outs, and the add-on Medicare tax may be affected.

We are also late enough into 2016 that David may be able to see the level of income this S corp will generate this year, the distributions to date, whether or not the owner is willing to adjust distributions for the remainder of this year, and whether or not it is beneficial to take that 179 in 2015 so that it comes over into the current and possibly future years, and just when the depreciation or 179 deduction will have the most bang for the buck.

 

Edited August 29, 2016 by jklcpa
added about ordering rule & last paragraph

[David]

Thanks Abby and Judy.

Yes, I already ran several scenarios. If $6K sec 179 deductions are taken then ordinary income will be $213K, no excess distributions and $11K loss carry forward.

The taxable income that will flow to the SH's 1040 will be $212K. This is the same taxable income if the corp takes $44K sec 179 deduction and the loss carry forward will be $39K.

For these two scenarios, I thought it would be better to go with the same taxable income but $39K loss carry forward. That's why I didn't mention the 3rd scenario earlier.

Is there something I'm missing in thinking the $39K loss carry forward is better than going with the $11K loss carry forward scenario?

The SH's salary is $48K.

Thanks for your help.

[jklcpa]

Did you run the personal 2015 tax calculations and 2016 projections related to those various scenarios?  Which one works out better? 

What stands out is that if this is a typical year for the S corp, it has significant ordinary income, distributions of almost that same amount, and relatively low shareholder salary in comparison. Have you considered that the salary may be considered unreasonably low and should possibly be raised?  

Besides the reasonable comp issue and even though it will mean higher payroll taxes, it would be wise to increase the salary so that earnings reported to social security are higher and increase benefits at retirement. I had a client that refused to do this for many years, and then the year before he was ready to sign up for his benefits he asked me how he could impact those figures. Sorry Charlie, too late now.  

[David]

I still need to do those additional analyses. 

Yes, I agree that the salary may be considered unreasonable. I plan to discuss this with the client. 

Thanks for your help.