S Corporation Basis: If you're an S corporation shareholder you should plan to be able to utilize tax losses that pass through from the corporation to your personal return. To deduct losses you must have "basis" (investment) in the S corporation to support the loss. If the S corporation borrows money, it won't increase your basis (but in a partnership or LLC it would). So borrowing has to be carefully planned. In a recent case the taxpayer was entitled to increases his basis for a $6 million bank loan he took to fund S corporation transactions. The IRS argued that because the loan repayments were sourced from the corporation, the corporation and not the shareholder was the borrower. That would have undermined the taxpayer's deductions. The court, however, held for the taxpayer finding that the loan was really between the bank and the shareholder, and not between the bank and the S corporation. The IRS argument was refuted because the shareholder was listed as sole borrower on the loan and letter of credit. Further, the lender intended to treat the shareholder as the borrower. The taxpayer lost the arguments on other loan transactions. Thomas Gleason, et ux. v. Commissioner, (2006) TC Memo 2006-191. The moral is simple, have your tax adviser, not just corporate counsel, review all S corporation related borrowing and capital infusions in advance.
Selling a business to your heirs in an exchange for a private annuity has been a popular estate and retirement planning technique. You could freeze the value of your business, sell it to an heir active in the business, have an annuity for the rest of your life, report income as you received the annuity rather than immediately, and more. The IRS proposed new regulations Reg-141901-05 10/18/06 ruining the party by requiring you to recognize the gain immediately. These rules are only proposed, and they provide a slight window of opportunity. If you're contemplating such a sale, you'd better move quick.
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