Question

After reading the Bartz Corporation article, you are left with two alternatives (alternative A and alternative B), for tax purposes what would be the better alternative for liquidating the S Corp.? Please explain your answer. When determining the gain when the stock is liquidated, what would be the "liquidation proceeds" under each alternative? What would be the shareholders "stock basis" under each alternative?   

1 1 of 2 r tz formed Bartz Corporation in 1989 and elected S status immediately. The entity was wn and manage four-unit apartment buildings in their Mississippi town of Quintet. Over entity was slightly profitable. About a decade ago, the Bartzes began to sell off their buildings, and only one now remains in the corporation's name. Four years ago, the entity sold off the realty management operations to a local entity, the Quintet Life LLC. The Bartzes have no children or any other direct descendants. They are not related to any of the owners of Quintet Life. The couple wants to wind down the activities of Bartz Corp, cashing out of the remaining apartment unit, the Delta Digs, and retiring to a lakefront condo in Arkansas. The couple anticipates that their average state and federal income tax rate will fall from 33 to 26 percent for next year. The Bartzes are not subject to the alternative minimum tax, and Bartz Corp carries no exposure to the corporation built-in-gain or passive investment income taxes. The Bartzes own all of the stock in their S corporation, in equal shares. A long-time employee, Jill Thompson, is the only other member of the board of directors. The board has discussed the status of the corporation after Delta Digs is sold off to a third party; Jill is a registered nurse and has no interest or capacity to stay involved in the real estate business if and when the Bartzes leave town. The Bartz Corp board is indifferent as to whether the corporation should be liquidated after the last property is disposed of, or whether the entity should live on "just in case" another opportunity arises in Quintet and a corporate entity needs to be available and active on a short-term basis. The annual legal and compliance costs are negligible if the board decides to continue Bartz Corp as a shell corporation in this manner. Ignore any other transaction costs that would arise in the context of a corporate liquidation of the entity, or of continuing its existence. Current figures as to Delta Digs is as follows. Bartz Corp owns no other assets and has no outstanding liabilities other than those indicated for the building. The entity uses a June 30 year-end for tax and accounting purposes. Bill and Jan both have a $650 basis in their Bartz Corp shares. Bartz Corporation Balance Sheet as of June 30 (SK) Tax Basis Fair Market Value Delta Digs Apartments Mortgage Payable, Delta Digs 4,500 2,000 6,000 2,000 Paid-In Capital Retained Earnings, AAA 100 2,400

Answer 1

In general, stock liquidation occurs when stock shares are converted into cash. In most instances, stock liquidation occurs when shareholders sell their shares on the open market for ready cash. Other examples are when one company acquires another and sells off its shares and when a company ceases operations. Each of these transactions has specific rules that allow the sellers to comply with federal securities trading and tax laws.

The most frequent method of stock liquidation takes place when an individual or group of investors sell shares of stock in a portfolio. These investors order their sales through stockbrokers, who must follow regulations set by the U.S. Securities and Exchange Commission. If the sale price is higher than the purchase price, the investor makes a profit. If the sale price is lower than the purchase price, the result is a capital loss. The Internal Revenue Service enforces specific rates and rules on capital gains and losses.

If the proceeds from a stock liquidation result in a profit for the investor, the profit is subject to the capital gains tax rate. The capital gains rate is typically lower than the earned income tax rate. If the investor took a loss on the sale, up to $3,000 of that loss can be claimed on that year's income taxes. Any losses over $3,000 can be carried forward to income tax returns in future years.

The basic federal income tax considerations for both the corporation and its shareholders.

Corporate-Level Tax Results

The sale of assets results in taxable gains and losses for the corporation that must be calculated on an asset-by-asset basis. Most gains and losses are then reported on an IRS Form, which is filed with the corporation’s Form 1120, U.S. Corporation Income Tax Return, for the year of sale.

If the corporation has a loss or tax credit carryovers, it can be used to offset gains and taxes resulting from the asset sale. However, if the corporation’s assets are highly appreciated, there may be substantial corporate-level income taxes to pay. The later distribution of the remaining cash sales proceeds to the shareholders will usually have no corporate-level tax consequences.

Shareholder-Level Tax Results

For federal income tax purposes, each shareholder’s receipt of the liquidating corporate distribution amount is treated as a sale of all the shareholder’s stock in exchange for the distribution.

This means each shareholder must recognize a taxable gain (or loss) equal to the difference between the distribution amount and the shareholder’s basis in the stock relinquished in the liquidating transaction. Assuming the shares have been held for investment for over a year, any shareholder profit will generally qualify for long-term capital gain treatment. Currently, long-term capital gains recognized by individuals are taxed at a maximum federal rate of no more than 20%. The 20% rate only affects singles with taxable income above $425,800, married joint-filing couples with income above $479,000, heads of households with income above $452,400, and married individuals who file separate returns with income above $239,500.

Capital gains on investments held less than a year are short-term capital gains and taxed at ordinary income tax rates of 10, 12, 22, 24, 32, 35 or 37% in 2018 (from 10, 15, 25, 28, 33, 35 and 39.6% in 2017).

There may be state income taxes to consider too. Special tax rules apply if the corporation sells assets on the installment method and distributes the resulting notes receivable to the shareholders as part of the liquidation process.

A corporate liquidation can potentially trigger income tax bills at both the corporate and shareholder levels. In other words, double taxation may apply. If so, the combined corporate-level and shareholder-level tax bills may be surprisingly expensive.

However, advance planning can often result in better tax results. Also, it may be possible to structure an asset sale in a way that doesn’t involve a corporate liquidation if that would mean lower taxes.

In this case, Bartx Corporation Balance sheet shows as on 30^th June is Delta Digs Apartments Cost is 4500 whereas Fair Market Value is 6000/-. If this happens Capital gain arises (6000-4500)1500 and Income tax to pay as per capital gain on sale of Assets.

The other alternative is the timing difference for two years, the 1^st year 2000/- and 2^nd year 4000/-the treatment will be for two years.

Shareholder Loss Limitations

The impact of the election is that Bartz Corporation’s items of income, loss, deductions, and credits flow to the shareholder and are taxed on the shareholder's personal return.

The two main reasons for electing Bartz corporation status are:

1. Avoid double taxation on distributions.
2. Allow corporate losses to pass through to its owners.

There are three shareholder loss limitations:

1. Stock and Debt Basis Limitations
2. At-Risk Limitations
3. Passive Activity Loss Limitations

Each limitation is addressed in the order shown above and must be met before a shareholder is allowed to claim a pass-through loss.

The fact that a shareholder receives a K-1 reflecting a loss does not mean that the shareholder is automatically entitled to claim the loss.

Bartz Corporation Shareholders are Required to Compute Both Stock and Debt Basis

The amount of a shareholder's stock and debt basis in the B Corporation is very important. Unlike a C corporation, each year a shareholder's stock and/or debt basis of a B corporation increases or decreases based upon the corporation's operations.

It is important to understand that the K-1 reflects the B Corporation’s items of income, loss, and deduction that are allocated to the shareholder for the year. The K-1 shows the amount of non-dividend distribution the shareholder receives; it does not state the taxable amount of a distribution. The taxable amount of a distribution is contingent on the shareholder's stock basis. It is not the corporation's responsibility to track a shareholder's stock and debt basis but rather it is the shareholder's responsibility.

If a shareholder receives a non-dividend distribution from a B corporation, the distribution is tax-free to the extent it does not exceed the shareholder's stock basis. A debt basis is not considered when determining the taxability of a distribution.

Computing Stock Basis

In a computing stock basis, the shareholder starts with their initial capital contribution to the B Corporation or the initial cost of the stock they purchased. That amount is then increased and/or decreased based on the pass-through amounts from the B Corporation. An income item will increase stock basis while a loss, deduction, or distribution will decrease stock basis.