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Posted by Tony Cox on January 6, 2007, 12:01 am
Please log in for more thread options > Tony Cox wrote:
>> Can some kind soul give me an overview of the issues
>> involved in converting an existing C corporation to an
>> S corp? The C corp has some appreciated real estate,
>> a NOL carryover from previous years, no inventory to
>> speak of, and some retained earnings.
>>
>> Are the real assets appraised when doing the conversion, and
>> tax assessed at that point? Or do these assets get treated
>> differently when eventually sold. Other net resources aren't
>> too specific on the details.
> The real estate should be appraised at the time of
> conversion to fix its fair market value. The built-in gain
> will be the FMV less the tax basis in the real estate. This
> gain will only be paid if the S corp sells the asset(s)
> within 10 years of converting from a C corp. If that
> happens, then the tax on the gain is calculated and paid at
> the corporate level at corporate rates. The tax is then
> deducted form ordinary income or gain on schedule K and the
> net gain is passed to the shareholders and taxed again on
> Form 1040. After 10 years, the built-in gain tax is no
> longer in effect.
Thanks for your response. So lets say the current basis
(cost - accumulated depreciation) is 50K. At the time of
conversion from C to S (which is when, BTW -- the date of
the request, or the date of IRS approval?) the appraised FMV
is $75K. Some years later (< 10) the property is sold for
$90K.
Then, nothing is paid until the asset is sold (< 10 years).
At that time, tax is calculated on $75K - $50K at corporate
rates as if there were no other income (i.e. 15% of $25K).
This tax is then counted as a deduction & passed pro-rata to
the (now S-corp) shareholders as usual in a Sch K.
So what happens to the other $15K (increase from FMV at
conversion to final sales price)? Presumably, its taxed at
the usual individual rates, with the cost basis adjusted
from the FMV for depreciation. Does the length of ownership
(which determines capital gains rate) start way back when
the original C corp acquired the asset, or when the
conversion was made? IOW, would a conversion to S corp
followed by sale in the same year make the proceeds liable
for short-term gains rate?
And finally, if the sale were made 11 years after the
conversion, tax would be on the $90K-$50K at the LTG rate.
It would seem, then, that there is NO immediate tax
consequences in converting appreciated real-estate. Is my
understanding correct?
> The NOL can only be used to offset corporate income so it
> will be of little use unless the S corp shows a built-in
> gain at some point.
This suggests that a NOL can be resurrected even after the
C-corp is no more. If there is a $10K NOL, in the example
above, does this reduce the corporate tax bite to 15% of
$75K - $50K - $10K ?
>> Since retained earnings have previously been taxed, and
>> possibly (although not in our case) at anything from 15% to
>> 35%, how do they end up being taxes when transferred to the
>> individual shareholders? It seems on the face of it that the
>> whole process is likely to be quite complex!
> The retained earnings remain with the corporation. The C
> corp retained earinings may come into play if the
> shareholders are taking distributions.
Surely there must be an implicit distribution at conversion
since "retained earnings" doesn't apply to S-corps? Are they
taxed at regular income rates to the S-corp shareholders?
I can't believe the IRS would leave a loophole here!
> You should speak to
> someone familiar with S Corp AAA and C corp earnings who
> could do a better job of explaining the options than I can
> on a message board.
It's not the options I need at this stage, just an overall
understanding. And you're doing a pretty good job at
describing the mechanism.
> Depending on the size of the NOL, it might be better to
> remain a C corp until the only NOL left is about the same as
> any anticipated built-in gains.
Yes, I see the wisdom in this.
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