I formed a S-corp this year after being a sole proprietor. I understand that the lower of fixed asset adjusted basis or FMV would be counted as owner’s contributed capital into the new S-corp – thus no capital gain/loss.
What about the sole proprietor’s receivables as of the date of transfer into S-Corp? Would that be considered capital gain as if I sold the AR to the S-Corp? Or, if I have $100k of receivables at the time of transfer, I would increase my owner’s basis in the S-Corp by $100k.
KISS (Keep it Simple), there should be no tax consequence when you incorporate. Simply begin using the corporation by making deposits and paying bills as soon as you open the bank account. The F&E are transferred at book value, no FMV adj is necessary. Generally continue with your regular depreciation schedule as though nothing happened.
There may be some one-time tax planning opportunities involved so please talk to your CPA. Here’s some information from IRS government: (The link http://www.irs.gov/publications/p542/ar02.html#d0e283 )
Property Exchanged for Stock
If you transfer property (or money and property) to a corporation in exchange for stock in that corporation (other than nonqualified preferred stock, described later), and immediately afterward you are in control of the corporation, the exchange is usually not taxable. This rule applies both to individuals and to groups who transfer property to a corporation. It also applies whether the corporation is being formed or is already operating. It does not apply in the following situations.
• The corporation is an investment company.
• You transfer the property in a bankruptcy or similar proceeding in exchange for stock used to pay creditors.
• The stock is received in exchange for the corporation’s debt (other than a security) or for interest on the corporation’s debt (including a security) that accrued while you held the debt.
Both the corporation and any person involved in a nontaxable exchange of property for stock must attach to their income tax returns a complete statement of all facts pertinent to the exchange. For more information, see section 1.351-3 of the Regulations.
Control of a corporation. To be in control of a corporation, you or your group of transferors must own, immediately after the exchange, at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the outstanding shares of each class of nonvoting stock.
Property of relatively small value. The term property does not include property of a relatively small value when it is compared to the value of stock and securities already owned or to be received for services by the transferor if the main purpose of the transfer is to qualify for the nonrecognition of gain or loss by other transferors.
Property transferred will not be considered to be of relatively small value if its fair market value is at least 10% of the fair market value of the stock and securities already owned or to be received for services by the transferor.
Liabilities. If the corporation assumes your liabilities, the exchange generally is not treated as if you received money or other property. There are two exceptions to this treatment.
• If the liabilities the corporation assumes are more than your adjusted basis in the property you transfer, gain is recognized up to the difference. However, if the liabilities assumed give rise to a deduction when paid, such as a trade account payable or interest, no gain is recognized.
• If there is no good business reason for the corporation to assume your liabilities, or if your main purpose in the exchange is to avoid federal income tax, the assumption is treated as if you received money in the amount of the liabilities.
For more information on the assumption of liabilities, see section 357(d) of the Internal Revenue Code.
Basis of stock or other property received. The basis of the stock you receive is generally the adjusted basis of the property you transfer. Increase this amount by any amount treated as a dividend, plus any gain recognized on the exchange. Decrease this amount by any cash you received, the fair market value of any other property you received, and any loss recognized on the exchange. Also decrease this amount by the amount of any liability the corporation or another party to the exchange assumed from you, unless payment of the liability gives rise to a deduction when paid.
Further decreases may be required when the corporation or another party to the exchange assumes from you a liability that gives rise to a deduction when paid after October 18, 1999, if the basis of the stock would otherwise be higher than its fair market value on the date of the exchange. This rule does not apply if the entity assuming the liability acquired either substantially all of the assets or the trade or business with which the liability is associated.
The basis of any other property you receive is its fair market value on the date of the trade.
Basis of property transferred. A corporation that receives property from you in exchange for its stock generally has the same basis you had in the property, increased by any gain you recognized on the exchange. However, the increase for the gain recognized may be limited. For more information, see section 362 of the Internal Revenue Code.
Election to reduce basis. In a section 351 transaction, if the adjusted basis of the property transferred exceeds the property’s fair market value, the transferor and transferee may make an irrevocable election to treat the basis of the stock received by the transferor as having a basis equal to the fair market value of the property transferred. The transferor and transferee must make this election by attaching a statement to their tax returns filed by the due date (including extensions) for the tax year in which the transaction occurred. For more information on making this election see section 362(e)(2)(C) of the Internal Revenue Code, and Notice 2005-70, 2005-41 I.R.B. 694.
A CPA is telling me that the AR I transferred from Schedule C to S-Corp will be treated as schedule C income for 2009 and the AP I transferred from Sch. C to S-Corp will be treated as expenses for Schedule C in 2009 since I earned the income and incurred the expense as schedule C sole proprietor:
So, he said the entry should be:
DR. Old Receivables transferred from being a sole proprietor
CR. Owner’s Equity
But, when I received payment against the old Schedule C-AR, S Corp journal entry would be:
CR. Old Receivables transferred from being a sole proprietor
Schedule C entry will be:
You mean the CPA didn’t know what category to use? That might give you a clue.
These are typical accrual basis entries. Are you cash basis as a sole proprietor? Your s-corp should be cash basis as well. No such entry is needed, assuming you’ll remain cash basis.
Does the above entry make sense? Would S-Corp need to pay Schedule C sole proprietor for all the collected AR from Schedule C.
If I were a cash-basis sole proprietor, why would I consider the transferred AR as income in Schedule C.
You wouldn’t. However, you can if that’s where you deposit it. Look, if you’ve been reporting and paying tax on production and not collections, then those entries make sense.
Can you point me to some IRS publication so I can study this further? Thank you.
You mean besides what I provided above? This issue doesn’t require all this time and energy. We’ve done this hundreds, if not thousands of times, with MANY of our clients that have incorporated over 30+years.
1. Create s-corp.
2. Open checking account.
3. Make deposits.
It’s pretty much that easy. Someone is really making a mountain out of a pimple on this one.
If you feel that strongly about following your CPA’s advice, don’t transfer the a/r or the a/p. Allow them to flow through your old Schedule c and just deposit collections from new production into the s-corp. There is no need for JE’s.
…or, hire us and pay for our advice which we’ll back up if it’s incorrect.
Tim, thank you for your explanation. This is where I’m getting confused. Since I was a Schedule-C cash basis taxpayer, if I book the following entry when I transferred the AR to S-Corp
CR. Owner Equity
In S-Corp, since I’m also cash-basis, every time I collected cash against the old receivables, I would
None of these entries are necessary. Since you’re cash basis in both entities, when you deposit cash from patients, you have income. If it’s entries you need, they would be the same in both:
There are no other entries needed in my opinion.
But, where do I pay “tax” on that income?
Cash basis-where ever you deposit it.
(Since I was a Schedule C – cash basis, so I have not reported that AR income under Schedule C, and under S-Corp, since AR was part of contributed capital, there’s also no income statement impact ever time I collected against the old AR under S-Corp).
Why “contribute” A/R? Why not simply assign the collections to the s-corp when you receive it? Again, you’re a cash basis taxpayer.
Maybe I’m missing something, but under which entity should these cash collected on these AR be taxed since both S-corp and sole proprietor are cash basis. Thanks.
I think you’re meshing the GAAP treatment and the tax treatment and it’s confusing the heck out of you. For GAAP (generally accepted accounting principles) your debits and credits are probably accurate. For tax, they don’t belong. When you are a cash basis taxpayer, you report taxable income (not GAAP income) when you receive it, NOT earn it (like GAAP).
As I said above, other than the “entries” you need to make for the other assets like F&E, with income:
1. Create s-corp
2. Open checking account
3. Make deposits
That’s all there is to it.
I don’t understand why you’re trying to put A/R on your s-corp balance sheet if you’re cash basis. You can do that if you like for GAAP, just don’t confuse it with tax reporting.
By the way, the details of the make-up of the A/R is irrelevant to your main question of where to report the income as are the questions about your new TIN and that process…unless you had questions about them that I missed.
PainlessPaulus (Doug) chimes in:
I have a question. What if he reports the insurance checks as income on his SS rather than the TIN… then transfer it to the K-1 and 1120s…. This would save alot of FD work.. I believe Carl said that on an asset sale to a new LLC the income can be report on the old TIN… This is a BIG PITA that other businesses don’t have….
This is a common issue and can be resolved very easily when doing tax reporting. I just did a return for an orthodontist who works in other GD offices. The offices receive the income and pay the orthodontist his percentage on a 1099. Well someone in one of the offices used the orthodontist’s social security number to file the claims instead of the GD’s TIN. We simply show the income incorrectly reported, take a deduction for the exact same amount, and label it something like “income reported incorrectly” or “income reported under TIN 12-345678”.
So… could you do this year after year?
If it continues to be reported wrong, why not just fix the problem?