Dividends from Corp

[cpabsd]

The corporation was newly formed and has a tax free transfer from LLC. They have always been cash basis but decided that it is time to swith to accrual basis due to some non tax issues. The have a small amount of receivables with large amount of payables at 12/31/08. This caused income to go down to $426,000. They are an S corp and distributed $473,000 to shareholders. I know this can be treated as dividend but am unsure of how to record on the books or on the tax return. Any suggestions? They do not want to record as loan to shareholder and that is not what it really was anyway.

Thanks.

[imjulier]

Change in accounting method requires IRS approval. Clearly they wanted to switch to accrual because it would lower income and save their cash which they distributed out to themselves instead of paying off creditors. I'd be asking a lot of questions rather than letting them tell you what to do. Just my 2 cents.

Julie

[cpabsd]

2008 was the first year for the S corp. In prior years they were a cash basis LLC. Since there was a new entity, they decided to use accrual basis. They are not really changing an accounting method since it is a new entity. My question has to do with how to show excess distribution on the tax return. Per my research, distributions in excess of stock basis is taxed as a capital gain. How is this shown on the tax return? Do I show an amount as negative in the other adjustment accounts line? I need something in order for the balance sheet to balance. Please help guide me. I have never encountered this before.

[OldJack]

You should also read 2008 Small Business Quickfinder Handbook, page C-4 regarding Section 351 exchange with property subject to liabilities. I don't know if this applies to your specific case but check out the examples.

>>Property Subject to Liabilities

In a Section 351 exchange, if a shareholder contributes property subject to liabilities, the shareholder's basis in the stock received is reduced by the amount of liability relief. If liabilities exceed the shareholder’s adjusted basis in the property, gain is recognized on the excess and the shareholder’s basis in the stock is zero. Exception: Under Section 357( c )(3), liability relief is not included in the computation if the payment of the liability "would give rise to a deduction."<<

I get the impression that maybe the S-corp has deducted the payables before actual payment. When payables are a part of a Code §351 they are not deducted by the S-corp until they are actually paid even though the S-corp is on the accrual basis. The same is true with receivables that are not recognized as income until actually collected.

Also page C-4:

>>Generally, a corporation's basis in property received under Section 351 is equal to the transferor's basis. However, Section 362(e) includes a carryover basis limitation to prevent (1) the importation of built-in losses into the U.S. by transferors who are not subject to U.S. tax and (2) the double deduction of a single economic loss by transferring built-in loss property to a corporation in a carryover basis transaction with the transferee deducting a loss on the sale of the property and the transferor deducting a loss on the sale of stock.<<