Tax

As you consider the process of shutting down your S corporation, it is crucial to understand the federal income tax implications that come with it. Here, I outline the tax basics for the corporation and its shareholders under two common scenarios: stock sale and asset sale with liquidation.

Scenario 1: Stock Sale

One way to shut down an S corporation is to sell all your company stock. The gain from selling S corporation stock generates a capital gain. Long-term capital gain tax rates apply if you held the shares for more than a year. The maximum federal rate for long-term capital gains is 20 percent, but this rate affects only high-income individuals.

If you are a passive investor, you may also owe the 3.8 percent Net Investment Income Tax (NIIT) on the gain. But if you actively participate in the business, you are exempt from the NIIT. Additionally, state income tax may apply to the gain from selling your shares.

Scenario 2: Asset Sale and Liquidation

A more common way to shut down an S corporation involves selling all its assets, paying off liabilities, and distributing the remaining cash to shareholders. Here’s how the tax implications unfold.

Taxable gains and losses. The S corporation recognizes taxable gains and losses from selling its assets. These gains and losses are passed to shareholders and reported on their personal tax returns. You will receive a Schedule K-1 showing your share of the gains and losses to report on your Form 1040.

Long-term gains and ordinary income. Gains from assets held for more than a year are typically taxed as Section 1231 gains at long-term capital gains rates. But gains attributable to certain depreciation deductions are taxed at higher ordinary income rates, up to 37 percent. Real estate depreciation gains attributable to straight-line depreciation can be taxed up to 25 percent.

NIIT considerations. Passive investors may owe the 3.8 percent NIIT on passed-through gains, while active participants are exempt.

Liquidating Distributions. The cash distributed in liquidation that exceeds the tax basis of your shares results in a capital gain, taxed as a long-term capital gain if held for more than a year. If the cash is less than the basis, it results in a capital loss.

Tax-Saving Strategy for Asset Sales

Your number one strategy for tax savings is to allocate more of the sale price to assets generating lower-taxed gains (e.g., land, buildings) and less to those generating higher-taxed ordinary income (e.g., receivables, heavily depreciated assets).

Compliance and Reporting

Report asset sales and allocations on IRS Form 8594 (Asset Acquisition Statement Under Section 1060).

File the final federal income tax return using Form 1120-S, including final shareholder Schedule K-1.

If you want to discuss shutting down your S corporation, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 2, 2024

I understand that you are considering offering your timeshare to your employees as an incentive for achieving specific revenue goals and are interested in how you can create a business tax-deductible treatment for the timeshare. Below, I outline two potential methods to help you achieve the desired tax deductions for your timeshare.

Method 1: Deductible Entertainment Facility

One option is to qualify your timeshare as a tax-deductible employee entertainment facility. This approach provides a significant tax-free advantage to your employees, as using such a facility is a tax-free fringe benefit. Here’s how.

Primary use by employees generally. Your timeshare must primarily benefit your employees generally. The “employees generally” group excludes 10-percent-or-more owners and highly compensated employees (those earning over $155,000 in 2024). 

Use ratio. The “employees generally” group must use the timeshare more frequently than the owners and highly compensated employees.

Non-discriminatory use. The timeshare should be made available to all employees generally on a first-come, first-served basis. Avoid any form of discrimination in access to the timeshare.

Proof of use. Maintain a guest log or similar documentation to record employee use.

Method 2: Timeshare as Compensation

Alternatively, you can treat the use of the timeshare as “compensation” to your employees. This method allows more flexibility, including the ability to discriminate among employees if desired. Here’s how it works.

Taxable compensation. You include the fair market value of the timeshare stay (and any additional perks) in the employee’s W-2 taxable income.

Deductible costs. You may deduct the costs incurred in providing the benefit, such as depreciation, Section 179 expensing for furniture and appliances, lease payments (if applicable), and operating expenses.

Business Tax Deduction

Regardless of the method chosen, you need to follow specific steps to ensure you have the deduction correct on your business tax return.

Proprietorship (Form 1040, Schedule C). If you own the timeshare personally, deduct timeshare expenses directly on Schedule C. 

Corporation. If you operate as a corporation, submit an expense report for reimbursement to ensure that the corporation receives the deduction and that you avoid taxable income.

If you want to discuss your timeshare, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• July 29, 2024

Were you self-employed during 2021? If so, there is a good chance that you could have qualified for COVID-19 sick and family leave credits worth as much as $32,220.

If you’re like many self-employed individuals or partners, you probably never heard about these tax credits. Unlike employee retention credit for employers, the special temporary credits for the self-employed received relatively little publicity. Many tax professionals were unaware of them. As a result, many self-employed individuals and partners never applied for them.

You qualified for the credits if you could not work or telework for various COVID-related reasons—for example, if you suffered from COVID-19; were under quarantine; underwent COVID testing; or looked after a friend, roommate, or family member impacted by the virus.

There are four separate credits:

1. Credit for Sick Leave—January 1, 2021, through March 31, 2021
2. Credit for Family Leave—January 1, 2021, through March 31, 2021
3. Credit for Sick Leave—April 1, 2021, through September 30, 2021
4. Credit for Family Leave—April 1, 2021, through September 30, 2021

The COVID-related sick leave credit was for up to 10 days from January 1, 2021, through March 31, 2021, plus an additional 10 days from April 1, 2021, through September 30, 2021. The maximum credit was $511 ($200 per day if you cared for others).

The COVID-related family leave credit was capped at $200 per day. Up to 50 days of credits were available from January 1, 2021, through March 31, 2021, plus an additional 60 days from April 1, 2021, through September 30, 2021. From January 1, 2021, through March 31, 2021, the credit was available only if you needed to care for a child whose school was closed or whose caregiver was unavailable because of COVID. From April 1, 2021, through September 30, 2021, lawmakers greatly expanded eligibility to include caring for roommates, friends, and relatives.

You were supposed to claim the credits on your 2021 tax return. But if you overlooked the credits, don’t worry. You can still claim them by amending your 2021 tax return. You need to file a completed 2021 IRS Form 7202, Credits for Sick Leave and Family Leave for Certain Self-Employed Individuals, along with Form 1040-X.

To determine your eligible sick and family leave days, you’ll likely have to consult your calendar for 2021, emails, vaccination or other medical records, school records, or other records showing the days you could not work for COVID-related reasons. 

You don’t need to file any documentation with your amended return. Just keep it with your tax records. 

You must file your amended return within three years (including extensions). The deadline is April 18, 2025, or if you filed for an extension, up to October 15, 2025. But why wait? Amend your 2021 tax return today, and you’ll get your money as soon as possible.

If you have questions about the credits, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• July 22, 2024