How to document type sign assignment of partnership interest nebraska
alright let's talk about c-corporations okay now although most small businesses in the United States are sole proprietorships most large companies in every company that's publicly traded basically if you've seen on the new york stock exchange that's going to be a c-corporation large companies in the US are C corporations okay which means they are taxed under subchapter C of the Internal Revenue Code if you want to sell stock on the open market and get investors that's what you have to be alright it has to be a secret all right now a C corporation is basically treated like its own person under the law and sometimes you will even hear like legal jargon that says that a C corporation has personhood which means if you think about it this way it makes it easier to think about how C corporations are taxed if you have another person then they're gonna be taxed on their own income that person can own its own assets that person can own a building and a house and everything else that's basically how a C corporation is treated okay the shareholders who own stock in a corporation do not own the corporation's individual assets like I said it's it's treated like its own person okay so the C corporation can only property the C corporation can get sued the C corporation can make its own money okay all right but one of the other big benefits of a C corporation other than the fact that you can sell stock on the open market and raise revenue is that shareholders are protected from legal liability most of the time except in very unusual circumstances sometimes if the lawyers come in and they can prove that there's fraud or whatever then the shareholders can be liable but that's difficult to do it's not difficult to do when you have a sole proprietorship you know a sole proprietorship is just one guy and even with a partnership sometimes if it's a general partnership definitely then those individual partners can definitely be sued but a C corporation is it's much more difficult to suit individual shareholders ok the C corporation itself can get sued but the whole idea behind the whole idea behind the limited liability of a C corporation is that the shareholders their personal assets are protected ok alright so now some businesses are required to be taxed as corporations by law and remember I went over a similar list with partnerships businesses that couldn't be taxed as partnerships and if you look a lot of the same businesses are on this list which means they can't be a partnership and they have to be treated as a C corporation under the law ok so if a business is formed under federal or state law that refers to it as a corporation it's going to be a corporation if a business is formed under a state law that refers to it as a joint-stock company or a joint-stock association remember but this was on the list of the companies that can't be treated as partnerships and that's because they have to be treated as corporations insurance companies certain banks any business owned by a state or local government a business specifically required to be taxed as a corporation there are certain publicly traded partnerships because they're selling partnership interests on the open market like a C corporation would those have to be taxed as corporations ok they have to be taxed as corporations a certain foreign businesses and then any other business that elects to be Texas or corporation and files form 8832 entity classification election the most common situation where you're going to have this is somebody that forms an LLC and chooses to be taxed as a C corporation okay instead of a partnership or sole proprietorship okay all right basic concepts so you have to know the basic concepts of a C corporation a C corporation enjoys what they call perpetual life and limited liability this is a benefit okay so a perpetual life means that if an individual shareholder dies then the shares passed to the estate but the c-corporation continues on if you buy a thousand shares of coke and you died tomorrow then the coke is not going to stop doing business they're just gonna keep doing business and whoever gets your shares once you pass on they can sell them to someone else or they could do whatever they want but the corporation itself is going to continue alright so it has perpetual life the corporation will continue on if the shareholders pass away or if the shareholders sell their shares to someone else the corporation just keeps going okay double taxation now this is a drawback so the earnings of a C corporation may be taxed twice okay if a secret version doesn't have any earnings then those earnings aren't going to be taxed twice okay but if a C corporation has earnings the C corporation has to pay tax on those earnings and then the shareholders have to pay to pay tax again when those earnings are distributed to them as dividends okay so that is a drawback all right shareholder meetings a corporation must maintain a list of all of its shareholders can you imagine how difficult that is when you have a gigantic corporation like Coke or Ford or Nike or something like that but the corporation has to maintain a list of all of its shareholders and generally must conduct at least one shareholder meeting per year thus the minimum organization a C corporation must file a charter issue stock and be overseen by a board of directors now this is true even with a one shareholder C Corp so even if you have just one guy who owns the C corporation that that person has to still file a charter issue stock to himself and then he's the board of directors it's just one guy running the show but still he's the board of directors he's the president he's the vice president he's the treasurer and when you fill out these forms for the Secretary of State you generally have to fill out the articles of organization and then you know fill out at least something once a year with the Secretary of Secretary of State in your state where whatever state you're doing business in or whatever state that corporation is doing business in and then the Board of Directors list is just the same guy you know but if it's obviously a big C corporation then the Board of Directors is going to be multiple people all right now a C corporation can have a single owner shareholder can just be one person or can have an unlimited number of shareholders there's no limit so this is a benefit because you can have foreign shareholders you can have domestic shareholders you can have shareholders that are other entities any entity type and that's also possible okay ss corporation has a limit okay which is one of the big drawbacks of an S corporation but a C corporation can have an unlimited number of shareholders which is why C corporations can sell stock on the open market okay now Articles of Incorporation a corporation's existence starts when Articles of Incorporation are filed with the state office that handles in corporations now this is usually in whatever state you're in that's usually going to be the Secretary of State okay you got a file paperwork you can't just say I'm the corporation today that's not how it works you have to end this costs money so you have to pay to to create a corporation in whatever state you're planning to do business in and then along with any required filing fees in some states it's really cheap like I think in Wyoming it's 15 bucks Wyoming is really really business friendly and they're really really really try to get corporations to do business there and then in some states like California it's really really really expensive and you have to pay a franchise fee every year just to exist it's 800 bucks that's whether you make money or not so it depends on the state and everything else but regardless of the state you still have to file these okay and then the cost depends on whatever the state decides to charge you okay now liquidation you have a c-corporation liquidates it will recognize gain or loss on the sale or distribution of his assets and that's actually a drawback because because a lot of times in a liquidation the shareholders have to read as a gain on the distribution of assets okay because the C corporation is not a pass-through right corporate shareholders the actual shareholders are the owners of the corporation then recognize a gain or loss on the surrender of their stock to the corporation the shareholders surrender their stock and then the corporation distributes its remaining assets whatever it has left after it's done paying its debts to the shareholders and sometimes if a corporation gets into a lot of debt then there's not any money left over to give to the shareholders and that's when you have worthless worthless stock right okay now stock a C corporation may sell common or preferred stock with different voting rights and S corporation cannot do that so this is actually a benefit of a C corporation an S corporation cannot sell different classes of stock which is why I mentioned before when I was going over the partnership rules that's how a partnership has a benefit over an S corporation a partnership can have different allocations of income and loss to the partners based on the partnership agreement the partners can decide that but an S corporation can't because an S corporation can only sell one class of stock and that class of stock has to be basically has to have the same distribution rights for all of the shareholders but a C corporation does not have to have stock that has the same distribution rights I mean that's the definition of of preferred stock preferred stock can have different distribution rights preferred stock can get paid this preferred stock holders can get paid before the common stockholders so you can a corporation can sell multiple classes of stock and classes of stock that has different voting rights and that's all fine okay and then a C corporation this is another benefit a C corporation can have tax-free fringe benefits you know what I was talking about partnerships and also S corporations they don't get to deduct the partners in the partnership they don't get to deduct their health care costs dollar-for-dollar and either do the S corporation owners that as corporation owners the their health insurance costs it ends up on the w2 and then the partners they only get it as an adjustment to income the health insurance it ends up coming out of the partnership as a guaranteed payment so the drawback of the partnership and the S corporation is that they don't get a dollar dollar production dollar-for-dollar deduction for health insurance but with a c-corporation even if you have just a single owner he could put all of his health insurance costs and even have an accountable plan that reimburses him for his medical costs and that is perfectly fine and it basically turns something that isn't a business expense into a business expense that's allowable okay because a C corporation is not a pass-through it's considered like a separate person from the owner shareholder so if you have even just one owner shareholder if he wants to basically have all of his insurance costs paid for by the corporation health insurance vision dental and also set up a health reimbursement policy he can all right now there are some limitations because of the ACA but with small corporations it's absolutely still allowable alright so that's the that's actually one of the biggest benefits of a C corporation that other entities do not have and only C corpse get to do this okay alright the tax-free fringe is where it's at for a seaport okay so finally requirements finally requirements for a secret we're going to be the same as a filing as the filing requirements for an S corporation of corporation in existence for any part of a tax year including any corporations that are in bank with bankruptcy are going or if they're going through a liquidation they have to file an income tax regardless of their taxable income or activity they have to keep filing until the corporation is formally dissolved okay that's the rule remember I said you know with the sole proprietorship and a general partnership if there's absolutely no activity which means no income or loss for the year then you don't have to file a Schedule C and you don't have to file a partnership return either although sometimes the IRS will still send you a notice with a partnership asking for a tax return and then you have to respond with a letter but but it's in the code that if a partnership has no activity for the year then they don't have to file the partnership does not have to file but a C corporation always has to file even if it has no activity for the year so once you the corporation paperwork is filed and accepted by the Secretary of State and you get your corporate charter that's it you have to file a tax return for the C corporation even if it's all zeros and no activity has begun yet okay so the C corporation follows form 1120 US corporation income tax return there are also there's actually lots of permutations of this form for special entities there's specialized forms for other types of corporations such as foreign corporations they have to file a Form 1120 F for foreign but what they're gonna ask you on the exam if they ask you about the form number they're gonna ask you about the form 1120 and then the other one that I think you have to memorize is the one for S corporations which is form 1120s so it's pretty easy to remember but remember a partnership is form 1065 a C corporation is 1120 and then an S corporation is 11 20s I think you have to know those form numbers for the test all right tax-exempt organizations organize this Corporations file Form 990 rather than form 1120 this is always true okay even if even if a tax-exempt organization has business income its treated as unrelated business income and it goes on a separate form but tax-exempt organizations never file form 1120 ever they always file Form 990 if they're tax exempt even if they're organized as corporation this is their this would be their legal entity type but for tax purposes this is what they file before they file Form 990 okay all right a corporation must continue to file tax returns even if there is no business activity or profits however it does not have to file after it has been formally dissolved okay the tax return due date for corporation is the 15th day of the fourth month following the end of its tax year so a calendar year corporation has to file its tax return so if it's a calendar year Secor it's due on the same date as an individual taxpayer all right okay so late filing penalties the late filing penalties are almost exactly the same as the late filing penalties for an individual taxpayer the penalty for late filing is 5% of any unpaid tax for each month the return is late up to a maximum of 25 percent of the unpaid tax on the return the late filing penalty is reduced by any late payment penalty for the same period so almost exactly like individuals the minimum late filing penalty for form 1120 if filed more than 60 days late so if it comes in to more than two months late is 210 or the amount of the tax owed whichever is smaller so if the corporation doesn't owe any tax they're still gonna owe a penalty for late filing all right they're gonna owe a minimum penalty the penalty for late payment of corporate income tax is one-half of one percent of the unpaid tax for each month that the text is not paid up to a maximum of 25 percent of unpaid tax so corporations have to pay estimated taxes - just like sole proprietors do and just like partners in a partnership do but their threshold is a lot lower so you know how when we were talking about in part one that an individual taxpayer will not owe a penalty if when they follow their tax return they only owe $1,000 or less the threshold for C corporations is a lot lower the corporation itself has to pay estimated tax unless it expects to owe $500 or less by the end of the tax year or by the time they file their tax return and that's that $500 threshold applies even if it's a million dollar corporation so corporations have to pay estimated tax - but there's no $1,000 you know threshold that where they wouldn't pay where they wouldn't have to owe an estimated tax penalty the threshold is actually $500 which is even lower than it is for
individuals okay corporate refunds in amended returns so corporations are kind of in that there's multiple forms that a corporation can file in order to receive back or refunds of overpaid estimated tax because it's as you can imagine with a million dollar company or a billion dollar company then sometimes the amount of money that they're gonna owe at the end of the year is going to fluctuate so that corporation might not want to have you know five hundred thousand dollars of an overpayment tied up with the IRS until they actually file their tax return to receive a refund so corporations can use a different form in order to receive a tentative refund it's called an application for a tentative refund it's formed 1139 and this is unique to corporations they can use this form or they can use form 1120 X which is an amended US corporation income tax return to apply for a refund of overpaid tax if they've already filed their tax return and they've made a mistake or whatever then they can follow form 1120 X but this is this form they can use in it's shorter and it's called the corporate corporate an application for tentative refund form 1139 now the corporation has to file form 1139 if they're going to use this form within 12 months of the end of the tax year in which it has an net operating loss and net capital loss an unused credit or a claim of right adjustment arose now a claim of right adjustment is we're in very in very simple terms it would be like where they had to pay somebody back for something they sold something maybe the person found out it was a fake and that person returned it to them and now they have to pay this person back so that's kind of what a claim of right adjustment is it's very simple terms but if that happens then the corporation obviously lowers their taxable income so they can they can request a refund using this form instead of having to file an amended return this form is shorter and simpler now if a corporation doesn't file form 1139 like if it's not within 12 months that this that these things happen it has to file form 1120 x2 apply for a refund so it actually has to file a full amended return and make the adjustment and then request a refund that way form 1120 X must be filed within three years of the tax due date including extensions for filing the return for a year in which it sustains a loss so if you'll notice this is the same deadline that the individuals get and of course there's exceptions to this three-year rule where some of those are covered in your book but as you can see it's the same you know refund deadline it's a three-year deadline if an individual taxpayer amends their tax return and they do it more than three years after the due date then they're not going to get a refund of any overpaid tax right it's the same if a corporation accidentally over pays its estimated tax during the year but before the end of its tax year it may use form four for 66 which is the corporation application for a quick refund of overpayment of estimated tax to obtain a quick refund of its estimated tax payments so that's the only thing that this form is used for is if a corporation over pays its estimated tax and it and then they figure it out before the end of the year and they want a refund before they've even filed their tax return for the year okay this is the form that's used I guess it's a lot of different forms but these are unique to corporations so this form the 4444 66 has to be filed before the corporation follows its tax return for the year so if the corporation hasn't filed its tax return then they can use this form which is a short form and it's only used to get a refund of its estimated tax payments so the corporation's been making estimated tax payments the whole year and then they get to the end of the year and they have a big loss in December let's say and now they want some of their estimated tax back alright so in that case they would use this form if it's a it's a refund that they want to obtain before they've actually filed their tax return all right form 44 66 may be used if a corporation's overpayment is at least 10 percent of its anticipated tax liability and at least $500 so remember it's not $500 thresholds where they have to pay estimated tax so that's that's what the $500 is here but it has to be at least 10% of its anticipated tax liability as well so if you're talking about a big corporation billion-dollar corporation then it's gonna be more than $500 obviously for them and meet this threshold in order to follow this form and get a refund all right so here's my example so you can understand how this quick refund of overpayment works assurance Holdings Inc is a C corporation that reports its income and loss using the cash method assurance holdings made regular estimated payments throughout the year based on its current year tax liability so it was making money throughout the year and making its estimated payments as normal which is what most corporations do it's they're earning revenue they're paying their estimated payments and generally that's what a sole for prior does - or they're supposed to I know that a lot of sole proprietors don't make estimates but just let's just say that assurance Holdings is paying its estimates on time based on the amount of income that it's earning and they're doing everything right right however on December 1st 2018 assurance Holdings suffers a financial loss when a fire destroys its main office building so they had a big financial loss at the end of the year after this catastrophic event assurance Holdings expects to have a net operating loss for the year so they were making their estimates based on their revenues like any other business would and then they've suffered a big financial loss at the end of the year and now once they calculate all of these losses and their income this financial loss is going to put them into net operating loss territory so they know that they're gonna have a net operating loss for the year all right after this catastrophic event assurance Holdings expects to have a net operating loss for the year the corporation then files form 44 66 on December 15th 2018 to obtain a quick refund of its overpaid estimated tax because there at least if especially if their calendar your entity they might not follow their tax return until April so why would you leave those tens of thousands of dollars sitting with the IRS if you don't have to get it back so the corporation can file this form before it's before it's tax return is due even in order to obtain a quick refund of its overpayment because after this loss they know they're gonna have an NOL for the year so if they had the corporation has an NOL then it's not gonna owe any tax all right okay so we can get back he estimated tax that they paid all right corporate taxation let's talk about how C corporations are taxed so C corporations are not a pass-through so C corporations are taxed on their earnings in that way they're different from any other entity type a partnership a S corporation sole proprietorship they're all taxed once they're all passed through entities a C corporations biggest drawback is that potentially the C corporation can be taxed twice which means that the C corporation pays tax on its earnings and then the shareholder itself pays tax again when the shareholder receives a dividend okay there's also benefits to C corporations that don't apply to other entity types for example a C corporation gets a dividends received deduction but no other entity gets that and then a C corporation can sell stock too on the open market and raise capital that way and when a c-corporation sells stock the money that comes into the corporation from the sale of stock is not taxable income those are investors so those investors are giving some of their capital they're giving money the corporation in exchange for ownership a part ownership but really there's no other entity type that can do that on a grand scale I know I've already mentioned that some partnerships are publicly traded and then of course as corporations can have up to 100 shareholders but you know every other entity type really has limitations on how they can you know gather investors in order to raise capital if you want to expand and become a franchise or raise money from you know outside sources as C corporation is really the only way to do that if you want to raise a lot of money there's really no other way to do that with another entity type and like I said there's some exceptions I know for partnerships there's publicly traded partnerships out there but for the most part if it's a big company or a company that wants to go big then a C corporation is really the only way to do it okay because you can issue a million shares and have a million investors all right now a C corporations income does not retain its character when it's distributed to the shareholders if a state corporation for example invests in muni bonds I feel like this might be the best example if it's a corporation invests in muni bonds the muni bond interest is tax exempt just like it would be to an individual taxpayer so if an individual taxpayer invests in muni bonds then the income is tax exempt now a C corporation that invests in muni bonds the income is tax exempt to the C corporation to the C corporation gun isn't going to pay tax on muni bond interest but if the C corporation issues a dividend to a shareholder then that the income doesn't retain its character when it gets issued out as a dividend it's not like an S corporation or a partnership if partnership has a residential rental and the partnership has rental income when it gets passed through the partner on schedule k-1 it's still rental income the nature of the income does not change but with a corporation the income that the corporation earns is just like that it's the corporation's income and it's not going to retain its character when it's passed through as a dividend and think about it this way if you're working for someone else and that other person makes money then that that money is not gonna retain its character when it comes to you I mean your boss can pay you a wage right if you're working for someone else your boss can pay you a wage but those are wages the income that he earns is separate from any income that you might earn working for him and that's exactly how a shareholder employee is treated that's why with a C corporation you can have 100 percent deductible fringe benefits because it's like you're working for a different person if you're working for a C corporation even if you're the one that formed that C corporation it's like you gave birth to another human being and now you're working for that person and maybe you control everything that they do but under tax law they're still treated like a separate person the C corporation is treated like a separate human being all right and that you're working for so the income that is earned by the corporation doesn't retain its character when it's passed through to the shareholders and of course it doesn't retain its character when it's passed through the employees either so if a shareholder employee earns a wage they just earn a wage they earn a wage like they would working for any other company the fact that the employee might own some of the stock is really irrelevant in that regard it's like he's working for another human then he created alright that's how a sequel that's how you have to think about a C corporation all right okay now dividends are taxable to the shareholder that receives them and not deductible by the corporation all right so that's why they say the corporation is taxed twice a corporation that distributes a dividend doesn't get to deduct that dividend when the dividend is distributed to the shareholders that's the biggest drawback of a seaport all right now this also applies that the corporation earns tax-exempt income because it's like the corporation earned the income they're not going to pay tax on it at the corporate level but if it gets distributed as a dividend it's all the income loses its character when it gets passed through as a dividend all right okay accumulated earnings tax so the accumulated earnings tax is something to the IRS really likes to test on this is a tax specifically for C corporations if they accumulate what the IRS believes is too much income and the thresholds are really low this is the safe harbor but an accumulation of $250,000 or less is generally considered reasonable for most businesses and then if it's a personal service corporation remember I said all C corporations are taxed the same now they're all taxed at 21 percent but PFCs still exists there's special rules specifically for PSCs which are which are corporations or C corporations where the primary business activity is like accounting law a doctor so a medical professional veterinarian is also included in the medical medical professionals that sort of thing so when it's a PSC there's some specific rules for PSCs that don't apply to like for example a manufacturing business but for the most part most entities are going to get this $250,000 safe harbor for the accumulated earnings tax and then personal service corporations are going to get the lower limit of 150 now I want you to understand how this works because I've actually had tux professionals ask me oh so I have a c-corporation that's accumulated five hundred thousand dollars and where do I put that accumulated earnings tax on the tax return and the answer is you don't you don't put it anywhere on the tax return there's no place on the tax return to put the accumulated earnings that's the accumulated earnings tax is always assessed which means the IRS comes in you filed your tax returns the corporation has files its tax returns and the IRS comes in and goes hey so we found that your C corporation has been making a lot of money in these last couple of years and you haven't been distributing the money why are you hoarding income and actually they use the word hoarding so the tax was is designed it was instituted to prevent corporations from hoarding income in order to avoid income tax on distributions to their shareholders so a lot of corporations like to retain their cash which is understandable they don't want to distribute all the money out they want to keep it because that's what allows them to you know fund operations and expansion and you know hire fantastic employees and everything else but the IRS doesn't really like that they want the corporation to make money obviously because then the corporation pays tax but the IRS also wants the corporation to issue a dividend buyers doesn't want corporations to hoard money now this threshold is absolutely what the IRS deems to be a reasonable threshold but this first hold is ridiculous I'm just gonna put that right out there because what kind of real estate or expansion could you do with $250,000 I mean if you wanted to buy a building or California New York he wouldn't even be able to buy like a postage stamp house with this amount of money I mean maybe you could buy a tiny empty lot but that I mean there's no that's not it's not reasonable so if the IRS does come in and try to assess the accumulated earnings tax the best way to defend yourself is to have feasible plans for the use of the accumulator of the accumulated earnings in the business now specific examples include the expansion of the company to a new area or a new facility say oh we're planning to expand sorts we need to accumulate two million dollars we have our eye on a warehouse in this blah blah blah State that's what we want to do okay you can acquire you can accumulate earnings to acquire another business through the purchase of stock or assets oh we want to take over this company over here and we need ten million dollars to do that all right sounds like a reasonable reason to be accumulating income and then providing for reasonable estimates of product liability losses Oh so hmm we just found out that the back of our car is exploding the car that we manufactured and now we are expecting to get sued so we're gonna set aside a hundred million dollars for any potential product liability losses you I mean for you younger folks you don't know what I'm talking about right I'm talking a
out the Ford Pinto my father when I was growing up was obsessed with the frito because the Ford Pinto was one of the big huge cases this was eons ago obviously before the internet or anything else like that and the Ford Pinto was like a scandal because the the manufacturers of a Ford Pinto Ford knew that the gas tank was unsafe but they didn't do anything about it because they their lawyers I guess did the math and figured out that even if people were dying I don't know all the details but I'm saying that I heard this throughout my childhood constantly that enlarged Firestone tires exploding apparently that happened in the 70s too so the Ford Pinto exploded on people and somehow these people got together and figured out that Ford had been hiding the fact that they knew that there is a danger so when these people came together for a class-action lawsuit Ford actually got hit with not just damages but huge punitive damages because they knew that basically their faulty design was going to kill people this was in the 70s so this is a very long time ago but I'm telling you that product liability losses are no joke so if a company is ever in a situation where they have exploding tires like Firestone I guess my father would never has never bought a fires don't tire ever since that day but or like you have an exploding car like the Pinto then even though those lawsuits might not have happened yet so I'm trying to say you can accumulate a reasonable estimate in income for any potential product liability losses now the whole idea behind this is that the IRS actually does come in and assess this tax they they really don't like corporations to be accumulating income but Microsoft for example got away with accumulating billions of dollars of income for a really long time and you can actually look up the news about this there was a point in the 90s where they had to issue a huge distribution to all their shareholders because they couldn't like put off the IRS anymore but my point is that the IRS position is that this is the only this is the amount that you can accumulate as kind of a safe harbor so the corporation can make this money and not distribute it and just like basically hoard this money but if you accumulate more than this you need to have a reason and that reason should be in like your corporate minutes or every year and even if you have just a single shareholder somebody needs to write this down all right because if a corporation accumulates a million dollars and the IRS comes in and comes knocking and they go home you know I think we're gonna the 20% accumulated earnings tax this is basically they assess it against the entire amount that's accumulated now the corporation has already paid tax on that money right they've already the corporation has already paid tax on that money so the IRS wants to it wants to hit them with another tax of 20% merely for accumulating this income and not distributing it all right but I never lay down for this I mean like I said this 20 $250,000 is nothing you want to buy a building in California you need like millions of dollars if you want to buy even an office building so as long as you have feasible plans for the use of that money then the corporation can accumulate as much as they need in order to you know make their plans a reality this is what I'm saying okay all right now there's one more good reason or something that IRS thinks is a good reason for an accumulated earnings for a corporation to accumulate earnings now this doesn't have to do with future plans or any business decisions or or anything that where the corporation might expand or anything else okay this is this is different it's a unique scenario now if a corporation has a shareholder that dies and then the stock passes to the estate which is what it usually does especially if it's a wealthy person sometimes what ends up happening is that in order to pay the estate tax the stock has to be either redeemed or sold and you know there's a threshold which we're going to talk about in the estate tax webinar there's a threshold 11.1 8 million this year where that's anything under that if a person dies we've got many assets then they don't have to pay estate tax but let's say you have a wealthy person that dies and they have 50 million dollar and assets anything over that 11.1 eight million is going to be subject to estate tax and the estate tax is 40 percent forty percent the estate tax is not an income tax it's a tax on a person's assets so what ends up happening a lot of times with wealthy people when they do die if they haven't done good estate planning then basically the estate assets have to be sold in order to pay the estate tax so if you have a shareholder that dies and the shareholders stock goes to the estate sometimes this shareholders stock can pass to a surviving spouse and then and then most the time then this is not an issue but if the stock in the corporation passes to an estate if a corporation wants to redeem that stock what meet what that means is the corporation will buy that stock back from the shareholder they'll redeem those shares from the estate and they will give them give the estate enough money to pay the estate tax if they do that then that is also a good reason to accumulate earnings and the corporation will not be subject to the accumulated earnings tax if the reason why the corporation is accumulated earnings is to redeem stock back from an estate when the shareholder has died and don't think that this is like a minor thing we're going to talk about stock redemptions to don't think that this is a minor thing then I mean sometimes this can be huge and so the corporation is basically buying back its own stock from the estate after the shareholder has died and then that money is gonna go to pay in Harrington's taxes and estate taxes and here all expenses and everything else all right any expenses that are incurred by the shareholders estate all right so these are these are going to be the two reasons why a c-corporation can accumulate earnings beyond these two little safe harbor thresholds that the IRS gives you and then also remember this 20% the accumulated earnings tax is 20% if the IRS does manage to assess it against the corporation but it used to be 15 but it's very common for them to test you on this percentage this is a very common question is the 20% in cumulative earnings tax and then it's very likely that they might test you on these thresholds to what the IRS considers a reasonable accumulation for most businesses which I don't have to agree with but that's okay all right accounting methods for corporations so okay corporations can use account the same accounting methods that every other business can so they can use cash they can use accrual they can use the hybrid method and then the same safe harbors apply if it's a if it's a company that has twenty five million dollars or less in average annual gross receipts remember for the past three years and the current year the IRS takes the last three years it's then they can use the cash method now under the tax cuts and Jobs Act and then the personal service corporations are allowed to use the cash method regardless of their taxable income level and I don't I don't know why that is it just is but these these are this is personal service corporations if it's health law engineering architecture accounting actuarial science performing arts they're talking about like professional actors here most of the time but usually it's actors and then it can also be like musicians ballet artists whatever or consulting they're called these are personal service corporations then they can use the cash method for basically reporting their income and losses now the non-accrual experience method is the one unique thing that you might need to know for the test this is only four of cruel based corporations now accrual-based corporations they recognize income as it is earned so basically as soon as you send out the invoice to the client then you recognize the income not when the client actually pays you and then the same holds true in Reverse when you receive an invoice for a bill then you just record it as an expense when you've incurred that liability rather than when the corporation actually pays it alright that's a cruel now accrual for accounting purposes is considered more correct and it is because it gives you a better idea of how the corporation is actually making money and spending money because if a corporation is making basically ten thousand dollars every month from invoicing and then there they have like the same amount of expenses every month as well you can tell like steadily how they're doing but for example take the example of a sole proprietor a lot of times in the month of December they try to like pay off a bunch of bills or paid bills in advance and everything so they can take those deductions on their 2008 to 2018 tax return that's very common and it's a good tax planning device but if you were looking at there if you were looking at their income statements based on the month and you see this all of these tons of expenses in December it just looks like December is a terrible horrible month for every sole proprietor in the world but that's not accurate right they're just advancing their expenses for tax purposes but it's not an accurate measure of what the business actually earns every month and spends every month there's no reason for December to be some crazy month where you spend a ton of money on business expenses but the reason why businesses do that is for tax purposes they try to accelerate their expenses as much as they can and most of the time that's just good tax planning but under the accrual method you can't do that all right the accrual method you recognize income when it is earned and you recognize expenses as they are incurred all right now one of the rules that's unique only to accrual based businesses is something called the non-accrual experience method I know it's kind of a mouthful which might be the first time you've ever heard of it but the non-accrual experience method this phrase is a method of accounting for bad debts so if you can imagine if you have an accrual based business if they send out an invoice then most of the time when they do that then they have to recognize the income right cuz they're on accrual what happens if the vendor doesn't end up paying well then you then you have a bad debt but the IRS does allow businesses that are on accrual to basically estimate the amount of bad debt that they think they're gonna have based on you know prior calculations there's a safe harbor and stuff like that usually it's between two and three percent of invoices sometimes as high as five for certain business types but the IRS will allow you to SME your bad debts if you are on a cruel and one of the methods that they do that is the non accrual experience method what that means is that you're allowed to take kind of a percentage and there's like I said there are safe harbors out there I'm just telling you this for the desk because there's a good chance you're never gonna actually see this in practice because now that businesses don't have to be on the accrual method until they reach 25 million dollars I mean how often are you gonna see this unless you're working for a giant company but I have the artist tests on it so I'm going to tell you about it even though this might not be useful information for your life all right now if the business uses the non-accrual experience method it is not required to accrue service related income that it expects to be uncollectible which means if they if the corporation anticipates that a particular invoice is going to be uncollectible then they don't have to accrue the income all right and like I said they're safe harbors and everything else there are certain rules that I go over in the book if you I think if the corporation actually a charges interest for late invoices if they charge interest like say I'm gonna charge you 5% interest for every month of the invoices late then they're not allowed to use this method there's some specific rules I don't know if you're gonna need to know that but you definitely need to know what this is done on a cool experience method and like I said I don't know if you're ever going to see it in practice anymore now that the tux cuts and Jobs Act has raised the threshold for cash based businesses now that you know that's 25 million but just know that it exists for the test all right okay okay contributions of capital to a corporation my capital they mean money money money money that's how people usually contribute capital to a corporation oh there's coke or Ford I'm gonna give them money and they're gonna give me stock now the stock isn't intangible they're not actually handing me a bottle of coke they're handing me ownership right so stock is basically an intangible asset you can't see it or touch it but I've given the money so I've given them capital my capital from my wallet and then they've given me stock in return when I do that when I buy stock in a corporation then that is I'm getting I'm getting an ownership stake and the corporation doesn't have to treat that as income because like I said they're not selling a product there but I'm becoming a part owner in the company I might oan you know this little miniscule 100 millionth of 1% but I'm still an owner when you're when you're a shareholder you're an owner all right now contributions of capital to a corporation basically cash although like I said the IRS loves to test on property but most of the time when you buy stock you buy it with cash right so that's a contribution of capital to a corporation and that capital is not taxable to the corporation because it's not a taxable event I'm becoming an owner or an investor the shareholders basis in the stock is the amount of cash contributed so if I spend a thousand dollars on a hundred shares of coca-cola my basis is a thousand dollars in those hundred shares all right exactly the same whether you're buying stock in a huge corporation or whether you're buying stock in a tiny corporation with only one owner or two owners all right so he purchases 75 shares of Rock Cola stock in 2018 she is not a professional stock broker dealer remember for professional stock brokers or dealers they're not capital assets their shares are actually inventory for them but that's a really rare thing I don't do any of them and then one of my colleagues who is who does hundreds and hundreds and hundreds of touch with turns every single year he only has one one actual securities dealer who's a bonafide securities dealer where they have to like treat the stock as inventory so it's highly unusual let's just put it that way now he purchases the stock through her online brokerage account spending six thousand five hundred and twenty five dollars to acquire the shares so she bought 75 shares okay she spent eighty seven dollars per share it's that it's the amount that she put in divided by the number of shares and that gives you her basis per share Rock Cola does not recognize income from the transaction isn't that nice to Rock Cola and it is not a taxable event to either party later when Evie sells the shares if she decides to sell her ownership stake then she might have to recognize the taxable gain or loss at that time while Evie owns the shares they are treated as capital asset enhance all right easy enough okay now there are situations where property can be contributed to a to a corporation by someone who is not a shareholder and you might think when would this ever happen and I'm going to tell you when it happens the most common scenario where you will have property or money usually is property but property or money contributed to a corporation in return for nothing basically where they don't get stock ownership or anything it's basically a gift is when like a city or a municipality or a state is trying to entice a big company to come and like build a facility in their state or their city that is the most common scenario and it's actually pretty common where a city will say hey Amazon you know there was a big hub of in New York like just a couple weeks ago with this sort of thing where Amazon was gonna like build a facil
ty there and they got mad over something and then it didn't happen so that is when property units property will be contributed to a corporation in exchange for nothing in that case if the corporation receives property from anyone other than an actual shareholder so someone who is a non owner then they can do that it's not like it's an illegal event or anything like that but the basis of property that's contributed to a corporation's capital by anyone other than a shareholder is zero so obviously if I want sure I'm not gonna give coke money without them getting shares back like I I'm not gonna do that I don't they don't need my charity right so if I buy shares in a corporation if I give them money I'm gonna expect shares back so then I become a shareholder but it's actually pretty common for a city or a state or a county to actually go after a large corporation and say hey please come and like build a facility here because then they get a huge tax base and it brings jobs into the city and everything else if you have a big factory or a big corporation that comes to do business in a depressed city it can basically like revive the city which is why it's white cities and states and counties always try to get you know paid companies to come in so what they will do is they will give them land or say here use this building or you can have this a lot of times those sales are like way below market sales they like sell them a building for $1 lit literally really I'm not making a joke or they'll like lease land for a dollar a year for 20 years or something like that in order for them to just have a transaction and for it not to be like zero like a gift but it's like the crazy nominal amounts like it'll be a dollar a year for the next decade if they please just relocate that sort of thing so the City of Phoenix Arizona gives ales Motors Corporation a plot of land as an enticement to locate its new manufacturing facility there so the city is like hey come build one of your facilities here we'll give you this fantastic plot of land we'll give you all kinds of nice tax breaks come on down come on down and they do that in order to basically boost their tax base so it's not like the city's not getting anything out of it of course they are but they are contributing capital to an organist to a corporation in exchange for nothing so what ends up happening is this land that the City of Phoenix gives to this Corporation has a basis of zero okay all right all right section 351 non-taxable corporate transfers the eros has been testing on this concept a lot lately I heard from I heard that the virus was testing on this a lot in 2016 and 2017 I think you kind of need to know the rules regarding section 351 non-taxable corporate transfers this is a situation where a person will basically buy out another corporation or another corporation will buy out another corporation in this case the the actual transaction itself will be considered not a non-taxable transaction if the person or the corporation that's buying the other corporation that owns 80% of all of the stock in the corporation both voting and non-voting after the section 351 transfer is completed okay what that means is that if I go and if I go and buy another corporation and I contribute money or capital or even property to that corporation and then once I'm done I own 80 percent of it it's basically like a non-taxable transaction at that point right but the area's absolutely does test on this threshold because most of the thresholds when we're talking about related party transactions it's more than 50 percent and I don't want you to be confused by that because if they ask you a question like this for the 351 transfers though I guarantee they'll put fifty percent in there just to confuse you but in order for this to be a non-taxable exchange in order for the exchange to qualify for section 351 treatment whoever is buying the corporation whether it's a person or another corporation that's doing this they have to own at least 80% otherwise the the transaction itself doesn't qualify for non recognition treatment and sometimes either the corporation or the shareholder will have a gain okay a taxable gain which generally you try to avoid but if if the transaction if at the end of the transaction the buyer of the stock owns at least 80 percent so 80 percent or more then it's considered a non toxic 'el event the I think in one of the prior questions or at least in one of the pub examples when any examples in the pubs they have two people who are buying another corporation and then at at the end of the transaction they own 78 percent or 75 percent or something like that and then in that case it doesn't qualify for section 351 treatment and the and it becomes a taxable event so you have to remember that it's 80 all right now you also have to remember that this recognition rule for section 351 doesn't apply to certain corporations so it doesn't apply if the corporation is an investment company it doesn't apply if the taxpayer transfers the property in a bankruptcy proceeding in exchange for stock that is used to pay creditors just remember bankruptcy it's not going to be then it's not a good section 3051 exchange doesn't qualify for non recognition treatment and then if the stock is received in exchange for the Corporations debt other than a securities such as a bond or for interest in the Corporations debt including a security that accrued while the taxpayer held the debt so they don't want a situation where a taxpayer is basically like moving debt around between himself and the corporation just remember that all right that doesn't qualify for section 351 treatment either but I think if they're gonna ask you about the disallowed situations they're gonna ask you about the investment company one that's my guess I think that's what they're gonna ask investment company because it doesn't doesn't call it for section 351 treatment all right so Barney transfers property with the basis of $100,000 to a corporation in exchange for stock with a fair market value of $300,000 so let's say he exchanged a building office building let's make it business property just to make it easy for you guys to understand he bought the building for a hundred thousand or that's his basis and he's gonna transfer the building to the corporation for stock in order to basically control this corporation that's what he wants to do but the building when he transfers it has a fair market value of 300 thousand so let's say he bought it you know ten years ago for a hundred thousand but now it's worth three hundred thousand so it's worth a lot more this is the fair market value now remember when we were talking about property transfers between partners in a partnership and the fair market value never mattered with the corporation it matters all right because operation is not a pass-through remember I said it's treated like another human being and a partnership isn't a partnership is just a pass-through entity income and assets and everything passed through a corporation is not like that so what ends up happening is he he he makes the transfer his basis in the building is a hundred thousand but the building is actually worth three hundred thousand won that transfer is made and then when he does make the transfer he only gets 75% of this box he doesn't get eighty so this is a trick the it's eighty in order for it to be a non-taxable event he's not in control of the corporation for section 351 treatment I mean he is a majority shareholder he owns more than 50 percent he owns 75% but in order to get non-recognition from gain he had to own at least eighty and he doesn't the other 25% was already issued to other persons or another person or ten other people or whatever it doesn't matter what does matter is that he doesn't own at least 80 percent so what ends up happening is it's treated as a sale like he sold the building at fair market value in order to get the stock it's treated as an exchange but not not an exempt exchange it's a taxable exchange so he has to recognize a taxable gain of two hundred thousand dollars on the transaction bad and this only happens generally with property transfers obviously if he'd paid cash then it would just be he be paying cash and then the corporation would give him stock and then his basis in the stock would be the cash that he paid and then that would be it but in this case he's transferring property not cash and the property that he's transferring has a basis of a hundred thousand but a fair market value of three hundred thousand so the presumption is that the stock that he's receiving has a fair market value of three hundred thousand so it's treated as if he the buildings of the corporation for $300,000 so now he has a taxable gain of $200,000 on the transaction because the transfer does not qualify for section 351 non-recognition treatment instead it is treated as a sale and these are the situations that you really want to avoid as a tax professional you want to advise clients against doing this sort of thing but sometimes you know clients will do this sort of thing on their own you know if they have rope to hang themselves they little don't manage they'll manage to do it on their own so sometimes you know we're left holding the bag after a client does something like this I don't buy it to my sister's company whatever now this non-recognition rule does not apply to services that are rendered in exchange for stock so services that are rendered in exchange for stock are always taxable to the person who actually provides the services basically it's treated almost like a barter exchange so if you do see an example like this on the exam just remember that like if you provide services to a corporation and they give you stock in exchange it's all treat it's always treated as a taxable events regardless if the person owns the corporation afterwards or anything like that all right okay so Charles is an architect in 2018 he transfers drafting equipment worth $35,000 and provides architectural design services valued at $4,000 to a corporation in exchange for stock valued at 39,000 immediately after the exchange charles owns 85 percent of the outstanding stock no gain is recognized on the exchange of the equipment however Charles must recognize ordinary income of four thousand dollars as payment for professional services he rendered to the corporation he'd probably be better off just you know opening up his own corporation at that point right but in this case he he provided services and he also transferred equipment he owns 85 percent of the stock afterwards so it's a partially non-taxable exchange but the services that he provided he has to he has to recognize that his taxable income all right next unit is going to be unit 13 for corporate transactions
