Charles Blair, DDS
John McGill, MBA, CPA, JD
After operating as a C corporation for several years, it has been six years since I made a Subchapter S election. I understand that 10 years must pass before all gains and losses pass directly to my 1040 without any corporate-level tax involved. In 1996, I sold stock, which I held for 10 years in the name of the PC, and made a $100,005.03 profit. My accountant, on the 1120S Schedule D, which is capital gains and losses, calculated that the PC owed $18,623.32 in corporate tax because I did not have the required 10 years. The difference between the profit and the tax ($81,381.71) was transferred to my personal 1040 under Schedule D Line 13, which is net long-term gains from S corporations, and I had to pay long-term capital-gains tax on this amount.
My accountant told me that instead of paying $28,000, I had to pay a combined capital-gains tax of approximately $42, 000. I thought that if the PC paid the capital-gains tax and the money remained in the PC, I would not have to pay any additional personal capital gains tax.
With the advent of the S corporation came the built-in gains tax imposed under IRC Section 1374. Upon the conversion of a C corporation to an S corporation, the corporation must take a snapshot of its balance sheet on the date of conversion and determine the amount by which the fair-market value of its assets exceed the adjusted bases of such assets.
If, during the 10-year period following the conversion, any such assets are sold at a gain, the gain is taxed at the highest applicable corporate tax rate - except to the extent the gain is offset by any recognized built-in losses that existed as of the date of conversion. The purpose of the built-in gains tax is to prevent a C corporation from converting to S status, selling appreciated assets, and making distributions to the shareholders without paying the double tax otherwise imposed on C corporations.
You were required to pay capital-gains tax immediately in this situation because all items of income and deduction flow through to your personal returns annually.
I have read many articles that discuss parents each gifting children $10,000 per year without paying a gift tax. I understand that this is after-tax money that parents give children. Is there a tax consequence for children receiving the money- specifically, if the child is age 30 and will use the money to attend law school?
There is no tax consequence to the child receiving the money. If any gift tax is payable, it is payable by the donor, not the donee. Also, under Code Section 2503(e), payments for tuition made directly to an educational organization on behalf of an individual are not considered gifts. Accordingly, if you pay your child`s tuition directly, the amounts paid do not count against the $10,000 annual exclusion amount that you could otherwise give the child free of the gift tax. In addition, gifts are not considered as taxable income to the donee.
I used my own money to purchase a dental practice by transferring the funds into my S corporation account and then writing a corporate check to the seller. If the corporation repays $2,000 a month to me for the loan, isn`t the $2,000 loan repayment deductible as an expense to my corporation? Is the repayment amount that I receive from the corporation subject to federal income tax?
The loan repayments would not be considered taxable income to you nor a deductible item for the corporation to the extent that they represent repayment of the principal of the loan. The interest portion of the payments would be deductible by the corporation and taxable as ordinary income to you.
Dr. Blair is a nationally known consultant and lecturer. McGill is a tax attorney and MBA. They are the editors of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes and protect assets. The newsletter ($149 a year) and consulting information are available from Blair/McGill and Company, 4601 Charlotte Park Drive, Suite 230, Charlotte, NC 28217 or call (704) 523-5882.