S corporation officers compensation- Corporation owning real estate

[mircpa]

Hello

A client of mine who has an S corporation owned business and real estate, sold business and real estate  did 1031 exchange bought rental income generating real estate which was properly reported in previous year. For all previous years officers compensation was paid. Now going forward this corporation owns ONLY real estate reporting rental income on 8825. Does this corporation still needs to show and pay officers compensation Line 7 of 1120S ?

thanks

[Lee B]

Since the corporation is generating passive income, my educated guess would be, "no."

[kcjenkins]

If he chooses too, it could probably be a very token amount, based on the amount of time spent on corporate activities.  I always advise discussing this issue with the client, explaining the options, but always let [make] the client make the decision.  

[Richcpaman]

Mir:

 

File the "Check the box" and move down to a Disregarded entity filing Schedule E on the taxpayers 1040.

 

Then no SE tax nor "officers Compensation"

 

Rich

[Lee B]

Mir:

 

File the "Check the box" and move down to a Disregarded entity filing Schedule E on the taxpayers 1040.

 

Then no SE tax nor "officers Compensation"

 

Rich

 

i wasn't aware that you could use check the box on a S Corp that was already in existence ?

[Jack from Ohio]

OK, I am missing how the single owner of an S-Corp is allowed NOT to take a reasonable salary.  Have I missed a major point concerning S-Corps?

[Lee B]

 

Does this corporation still needs to show and pay officers compensation Line 7 of 1120S ?

 

thanks

 

I interpreted this as asking whether Officer's compensation still needed to be paid ?

[Jack from Ohio]

HelloDoes this corporation still needs to show and pay officers compensation Line 7 of 1120S ?

 YES.  Period.

[mircpa]

Thanks to all who responded. Based on my research so far, looks like if S corporation has passive income for three consecutive years or 25% or more of corporation's income is passive income, S election automatically terminates therefore so I have decided to float new LLC and move those assets to this newly floated LLC filing Schedule E. The reason for this move is after three years when S election terminates corporation needs to file 1120, net rental income will be taxable at corporate level

 

Thanks Richcpaman I am going to follow your advise. Oh by the way what box are you referring to "file the check the box ?

 

I plan to shut down S corporation and move assets to LLC

[jklcpa]

Thanks to all who responded. Based on my research so far, looks like if S corporation has passive income for three consecutive years or 25% or more of corporation's income is passive income, S election automatically terminates therefore so I have decided to float new LLC and move those assets to this newly floated LLC filing Schedule E. The reason for this move is after three years when S election terminates corporation needs to file 1120, net rental income will be taxable at corporate level

 

Thanks Richcpaman I am going to follow your advise. Oh by the way what box are you referring to "file the check the box ?

 

I plan to shut down S corporation and move assets to LLC

 

Hmm, this termination of the S corp and transfer to the LLC will trigger gain recognition from the distribution of the real estate at FMV.

[michaelmars]

Thanks to all who responded. Based on my research so far, looks like if S corporation has passive income for three consecutive years or 25% or more of corporation's income is passive income, S election automatically terminates therefore so I have decided to float new LLC and move those assets to this newly floated LLC filing Schedule E. The reason for this move is after three years when S election terminates corporation needs to file 1120, net rental income will be taxable at corporate level

 

Thanks Richcpaman I am going to follow your advise. Oh by the way what box are you referring to "file the check the box ?

 

I plan to shut down S corporation and move assets to LLC

please tell where you found this?

[mircpa]

Look at this

26 U.S. Code § 1362 - Election; revocation; termination

(3) Where passive investment income exceeds 25 percent of gross receipts for 3 consecutive taxable years and corporation has accumulated earnings and profits (A) Termination

(i) In general An election under subsection (a) shall be terminated whenever the corporation—

(I) has accumulated earnings and profits at the close of each of 3 consecutive taxable years, and

(II) has gross receipts for each of such taxable years more than 25 percent of which are passive investment income.

 

Wikipedia

If more than 25% of a S-corporation's gross receipts consists of passive income for three consecutive years when the corporation has accumulated earnings and profits, the S corporation will automatically lose its subchapter S status and revert to being a regular C corporation.[1]

 

[jklcpa]

please tell where you found this?

 

Reference is §1362(d)(3)(A)(i). Here's a link to that section:

http://www.law.cornell.edu/uscode/text/26/1362

[jklcpa]

Mircpa, take a look at this Feb 2014 article from Bloomberg BNA about the IRS waiving the termination to see if this might help you:

 

http://www.bna.com/irs-waives-termination-n17179882518/

Edited October 28, 2014 by jklcpa
added source

[Randall]

Doesn't apply to the current topic, but another reminder NOT to put real estate in a corporation.

[Richcpaman]

Mir:

 

The form number is 8832, Entity Classification form.  If the entity has existed for more than 5 years, it may be able to become a disregarded entity...  Read the directions, and make your decision. 

 

If you float a new LLC, if there is no debt on the property, then the move from Inc. to LLC may not cost much.   The transfer costs at the courthouse, mainly.  But if there is debt, then you need a whole new loan. 

 

There is reasons that we do not put real estate in S-Corps.  This is one of them.  Not easy to move. 

 

Rich

[michaelmars]

IF THEY are supplying rental services, managing the property, etc then it isn't considered passive for this situation.

[mircpa]

Michaelmars

Rental activity is passive activity regardless of anything unless taxpayer is real estate professional, besides all this presently this corporation owns  ONLY commercial rental properties deriving rental income. Taxpayer gets decent amount  W2 from other business I cannot take position of material participation, this argument will be kicked out should his case be audited.

 

Jklcpa

The case you cited is for an S corporation that lost election subsequent to 3 years passive income reporting, in my client's case I want to take premptive step avoiding termination in future. I hope same set of rules should apply. Looks like this is fairly new case, do you think I should take advance ruling from IRS so that S election does not automatically gets revoked in future after 3 years ?

 

Richcpaman

Right now my main concern is Bank, these rental properties do have debt I dont know how bank would react if they see property being transferred from a corporation for LLC. I understand your concern not to keep property under corporation but keep in mind this corporation recently flipped properties under 1031 exchange. Hopefully as advised by Jklcpa I think there should be some way out waiving termination of S election.

 

Again I am very much thankful to all who shared their thoughts.

[jklcpa]

Mircpa, not only will you have a problem moving the real estate out of the corporation without triggering gain as I'd already mentioned, you also will trigger gain recognition because of the related party rules that will negate any benefit derived from the 1031 exchange if you move the property from the S corp to another related entity within 2 years of the exchange date if the same owner of the current S corp also owns more than 50% of the new entity. That would include other S corps, C corps, partnerships, LLCs, etc.

[Lee B]

Nineteen years ago, my clients sold a deli and a small meat processing plant, business plus real property.

 

The buyer's attorney set up a S Corporation and put the real property into the S Corporation.

 

Afterwords, the buyers decided to keep me as their accountant.

 

The real property is still in the S Corporation.

 

No audits yet, however the owners are now trying to sell the business.

 

So the sale will finally bring this to an end.

  

[jklcpa]

Mircpa, does this S corp actually have accumulated E&P?  That would only come about if the company was formerly a C corp or may have "inherited" the accum E&P in an earlier tax-free reorganization with another C corp that did have the accum E & P.

 

If your S corp doesn't have accumulated E & P on its books, you will not have the technical termination of the S status. It also wouldn't be subject to the passive investment income tax either.

 

I have several more links that may help you -

 

"Taking the 'Sting' Out of S Corporations' Earnings and Profits" from the Journal of Accountancy, Jan 2011 - the article talks about the tax traps of excess passive income in the S corp and possible solutions including how to structure distributions to pay out the accum E & P, or how to make an election to pay out accum E & P before AAA

http://www.journalofaccountancy.com/Issues/2011/Jan/20103334.htm

 

"Determining the Taxability of S Corporation Distributions: Part II" from The Tax Advisor, Feb 1, 2014 - more in depth about the taxation of distributions from S corps with accum E & P, more examples. This article also includes a link back to the Part I of the article from the month before.

http://www.aicpa.org/publications/taxadviser/2014/february/pages/nitti_feb2014.aspx

 

"S Corporations and Rental Income" from the NY State Society of CPAs CPA Journal Online, from 2006, includes a discussion of PLR 200339042 where the IRS ruled that the rental income received into an S corp from commercial real estate wasn't passive because of significant management services provided by the S corp. The article includes a list of those services that were provided. 

http://www.nysscpa.org/cpajournal/2006/1006/essentials/p44.htm

[michaelmars]

"S Corporations and Rental Income" from the NY State Society of CPAs CPA Journal Online, from 2006, includes a discussion of PLR 200339042 where the IRS ruled that the rental income received into an S corp from commercial real estate wasn't passive because of significant management services provided by the S corp. The article includes a list of those services that were provided. 

 

that's what I was getting at, and if you google it you will find case law and a lot more which states that the rental income isn't passive in regards to S corps.

[mircpa]

Jklcpa

This corporation is an S corporation ever since. It was never a C corporation therefore there is no A&E. Why do you think it will not have technical termination ? My uderstanding if an S corporation has passive income for 3 years it terminates. As per PLR 200527013 if corporation's rental income is only income it  derives I think it is income pursuant to conduct of active trade and business

 

"In PLR 200527013, the IRS described how an S corporation that owned rental farmland would avoid these tax penalties. Based on several factors, the IRS determined that the business activities amounted to the conduct of an active trade or business and, therefore, the rents would not be classified as passive investment income. The same analysis has also been applied to an S corporation that owns a rental building. In PLR 200339042, the IRS concluded that rental income from commercial buildings was not passive investment income.

 

Therefore I think owner needs to paid payroll showing officers compensation and show rental income as ordinary business income. So I need to move assets from 8825 and link to 1120S ? Because after 1031 exchange when replacement property was bought I included under 8825

[jklcpa]

Jklcpa

This corporation is an S corporation ever since. It was never a C corporation therefore there is no A&E. Why do you think it will not have technical termination ? My uderstanding if an S corporation has passive income for 3 years it terminates.

 

No, in order to lose S status under the rule we are discussing, it has to have the excess passive income for 3 consecutive years AND ALSO must have accumulated E & P on the books. You stated that yourself earlier in this topic in bold in your post #12.  If this entity has always been an S corp and you say it doesn't have accumulated E & P, it won't lose S status.

 

If it doesn't have accum E & P, not only will it NOT lose the S status under 1362(d)(3), it also won't be subject to the "sting" tax on its net passive investment income either.

 

The first article that I linked to specifically discusses how S corps can distribute accum E & P to get it off the books so that it can avoid these 2 things occurring.