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jgordosea
jgordosea, Enrolled Agent
Category: Tax
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Experience:  I've prepared all types of taxes since 1987.
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Passive or Nonpassive on Tax Return

Resolved Question:

I am using H&R Blox TaxCut Premium. In the Federal area under income I am answering the questions on the Schedule K-1 S-Corp. It asks if it is a Passive or Nonpassive Trade or Business (what does it mean by materially participated?) He is a full time employee with a salary, and owner. Next - They do not deal in Rental Real Estate they are an Automation and Instrumentation Company, It asks if passive or nonpassive? Last: AFter filling in all the boxes that have information on the K-1 it says: something about the distribution being greater than the basis in your shares. It says this is not common. I don't understand figuring the basis in shares. His share is 33.333333%? do I need to put this as capital gains on Schedule D???? Thank you for your help.
Submitted: 6 years ago.
Category: Tax
Expert:  Lev replied 6 years ago.

Passive or Nonpassive Trade or Business considerations would be needed in determination if there is any limitation for loss offset.

This explanations and examples - while related to Dealership type of business - may provide some lights on the IRS interpretation - http://www.irs.gov/businesses/corporations/article/0,,id=137740,00.html

The basis that shareholder has in the corporation is his/her contribution (either money or property). On the schedule would be reported if shares were sold. If capital gains distribution is automatically reinvested, the reinvested amount is added to the basis.

Lev, Tax Advisor
Category: Tax
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Experience: Taxes, Immigration, Labor Relations
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Customer: replied 6 years ago.
OK, This is not a dealership type of business so does that mean passive?

The capital gains distribution is automatically reinvested, When the reinvested amount is added to the basis does this mean I put it on capital gains in Schedule D or does it mean I just enter it in the section where it asks to fill in all the boxes on the form 1120S in the TaxCut program and not worry about the Schedule D???
Expert:  jgordosea replied 6 years ago.

Greetings,

It sounds as if there is material participation and the activity is not by definition passive like residential rental real estate.

You can use the same decision tree that the IRS uses in an audit. If the answer to any one of the questions below is yes, losses are excepted from the passive loss limitations because he does materially participate. That means it is nonpassive and yes materially participates so losses are generally fully deductible.

  • Did the taxpayer work more than 500 hours in the activity during the year?
  • Did TP perform substantially all the work in the activity?
  • Did TP work more than 100 hours and more than anyone else (including non-owners)?
  • Did the taxpayer work more than 100 hours, but less than 500, in two or more businesses and the sum of all the hours in these businesses is more than 500?
  • Did the taxpayer materially participate in the activity for any five of the last ten years?
  • If the activity is a personal service activity, did the taxpayer materially participate for any three prior years?
  • Under all the facts and circumstances, did the taxpayer work on a regular, continuous and substantial basis in the activity? This test is not available if anyone was paid compensation in connection with management of the activity.

If answer to all the above tests is no, the taxpayer does not materially participate. The loss is passive and not deductible except against passive income.

I hope this helps for deciding material participation..

jgordosea, Enrolled Agent
Category: Tax
Satisfied Customers: 3093
Experience: I've prepared all types of taxes since 1987.
jgordosea and 3 other Tax Specialists are ready to help you
Customer: replied 6 years ago.
That is clear now. Please clarify this and I will be good.

The capital gains distribution is automatically reinvested, (I add it to the basis). when the reinvested amount is added to the basis does this mean I put it on capital gains in Schedule D or does it mean I just enter it in the section where it asks to fill in all the boxes on the form 1120S in the TaxCut program and not worry about the Schedule D???
Customer: replied 6 years ago.
The capital gains distribution is automatically reinvested, (I add it to the basis). when the reinvested amount is added to the basis does this mean I put it on capital gains in Schedule D or does it mean I just enter it in the section where it asks to fill in all the boxes on the form 1120S in the TaxCut program and not worry about the Schedule D???
Expert:  jgordosea replied 6 years ago.

Hello again,

Distributions and basis is another topic entirely than material participation and passive activity.

There are not a capital gains distributions from an S corporation. Capital gain distributions are given from mutual funds that sell part of the portfolio during the year.

You can get distributions from an S corporation; but these are generally distributions of the profit of the S corporation or return of the contributions that the shareholder made to the corporation.

In the tax software you need to be sure that you enter all of the contributions of cash and property that were made (and all of the prior year income that was reported as taxable) as part of the basis of the shareholder. Some software has a separate section to enter these contributions and prior earnings that were taxable. Often it will refer to the shareholder basis.

If you distribute more than you have previously invested in the S corporation and more than you have previously reported as income from the S corporation you will have a capital gain. That capital gain does go on Schedule D.

Make sure that the amount of distributions this year are more than the contributions and prior earnings that were subject to tax and if that makes sense then you will have an entry on Schedule D; but as you mentioned this is not the usual case.

I hope this helps for determining if there is a capital gain that exceeds the contributions and prior taxable earnings.

Best wishes.

Customer: replied 6 years ago.
2007 is the first year in business. The share was 33.333333%.
There was no contribution besides working for three months without pay and no prior taxable earnings. Expenses for those 3 months were reimbursed. But not the pay for 3 months to any of the shareholders.
So I guess this would be a capital gain?
Say if you think yea (capital gain) or nay (not a capital gain) and I'll be happy with the final answer.
Expert:  jgordosea replied 6 years ago.

Where did the money to run the corporation come from?

Are you saying he only worked and did not contribute money?

Are you counting the reimbursements as distributions?

Can the distributions that are more than the earnings for this year be considerd a loan from the corporation to him (the shareholder) ? Would he pay them back in the future (or have less of a distribution of future profits)?

Have you considered using a tax pracititoner to get the first return done properly as an investment in not having to correct it later?

Thanks for the information.

 

Customer: replied 6 years ago.
Where? Out of each partners pockets and each working free for three months.

The money they contributed for expenses were reimbursed when the first invoice was paid by customers.

No the reimbursements are not counted as distributsions. They all received W-2s just like the other employees who were hired.

An accountent did the S-Corps Filed return to the IRS Center in Ogden, UT.

I'm thinking this will be put on Schedule D in capital gains because the other partner had an official tax person do their taxes.

I don't think he will pay them back in the future.

I'm not sure where to start to figure the basis.

Thanks
Expert:  jgordosea replied 6 years ago.

If there was indeed reimbursement for all monies paid for expenses and also amounts were paid (over and above the wages); then those amounts will be distributions that could be capital gain to the extent that the distribution is more than the shareholder's part of the earnings for the year.

For example, if there was 150K of earnings and 60K was distributed to each 1/3 owner there would be 10K of capital gain reported by the shareholder. Earnings of 150K/3 was 50K and 60K - 50K = 10K of gain due to the excess of money paid over the share of the earnings.

At Shareholder's Basis in S Corporation is an example of a worksheet to compute basis for the tax year.

I hope this helps to clarify for you.

jgordosea, Enrolled Agent
Category: Tax
Satisfied Customers: 3093
Experience: I've prepared all types of taxes since 1987.
jgordosea and 3 other Tax Specialists are ready to help you

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jgordosea
jgordosea
Enrolled Agent
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I've prepared all types of taxes since 1987.