Monte And Allie Each Own 50% Of Raider Corporation

Monte And Allie Each Own 50 Of Raider Corporation An S Corporation

Monte and Allie each own 50% of Raider Corporation, an S corporation. Both individuals actively participate in Raider’s business. On January 1, Monte and Allie have adjusted bases for their Raider stock of $80,000 and $90,000 respectively. During the current year, Raider reports the following results: Ordinary loss $175,000 Tax-exempt interest income 20,000 Long-term capital loss 32,000 Raider’s balance sheet at year-end shows the following liabilities: accounts payable, $90,000; mortgage payable, $30,000; and note payable to Allie, $10,000. a. What income and deductions will Monte and Allie report from Raider’s current year activities? b. What is Monte’s stock basis on December 31? c. What are Allie’s stock basis and debt basis on December 31? d. What loss carryovers are available for Monte and Allie? e. Explain how the use of the losses in Part a would change if instead Raider were a partnership and Monte and Allie were partners who shared profits, losses and liabilities equally.

Paper For Above instruction

The financial activities of S corporations like Raider have significant implications for the tax reporting and bases of their shareholders, in this case, Monte and Allie. Their active participation, combined with Raider’s reported income and expenses, influences their individual tax liabilities, stock bases, and potential loss carryovers. Analyzing these factors requires an understanding of S corporation tax rules, including allocation of income, losses, and liabilities, as well as the impact of tax-exempt interest income and capital losses on shareholder basis and overall tax planning.

Income and Deductions for Monte and Allie

Raider’s report of an $175,000 ordinary loss and $20,000 tax-exempt interest income affects Monte and Allie proportional to their ownership. Since both own 50%, they each generally report 50% of income, losses, and deductions, subject to basis limitations, at-risk rules, and passive activity provisions.

Monte and Allie each start with their adjusted bases: Monte at $80,000 and Allie at $90,000 on January 1. The $175,000 loss typically would be allocated equally, $87,500 to each. However, because of basis limitations, they cannot deduct losses beyond their stock bases. Monte’s basis of $80,000 restricts his ability to deduct losses beyond this amount, and similarly, Allie’s basis restricts her deductions to her basis of $90,000.

The tax-exempt interest income of $20,000 is not taxable but increases the shareholders' basis in their stock. Therefore, both Monte and Allie will increase their bases by their share of this income—$10,000 each (50% of $20,000). This increase can allow them to deduct more of their allocated losses.

The long-term capital loss of $32,000 is non-deductible against ordinary income and can only be used to offset long-term capital gains, which Raider has not reported. Therefore, this loss will be carried forward into future years or grouped with other capital gains and losses, not affecting current-year deductions directly.

In summary:

  • Monte reports: a $87,500 loss (limited by his basis), tax-exempt interest income of $10,000 added to basis, resulting in potential basis increases.
  • Allie reports: a $87,500 loss (also limited), tax-exempt income of $10,000 added to basis. The loss deduction is further limited by her basis of $90,000.

Any disallowed loss due to basis limitations remains as a suspended loss to be carried forward, subject to basis adjustments in future years.

Monte’s Stock Basis on December 31

Monte’s initial basis was $80,000. He increases his basis by his share of tax-exempt interest income, which is $10,000, resulting in a basis of $90,000 before considering loss allocations. After deducting his share of the loss ($87,500), limited to his basis, his stock basis is:

$80,000 (initial) + $10,000 (interest) - $80,000 (loss deduction restricted to basis) = $10,000.

Therefore, Monte’s stock basis on December 31 is $10,000. The remaining loss ($7,500) is suspended and can be carried forward until basis permits its deduction.

Allie’s Stock and Debt Basis on December 31

Allie’s initial basis is $90,000. She increases her basis by her share of tax-exempt interest income ($10,000), totaling $100,000. She allocates her share of losses ($87,500); since her basis exceeds this amount, she can deduct the full loss, reducing her basis accordingly:

  • Initial basis: $90,000
  • Plus interest income: +$10,000
  • Minus loss deduction: -$87,500

Remaining basis after deductions: $90,000 + $10,000 - $87,500 = $12,500, indicating she has sufficient basis to deduct the loss fully and has $12,500 remaining for future deductions or distributions.

Regarding debt basis, Raider's liabilities are apportioned among shareholders based on their ownership interest. Raider’s liabilities include accounts payable ($90,000), mortgage payable ($30,000), and a note payable to Allie ($10,000). The total liabilities are $130,000. Since Raider is an S corporation, liabilities are allocated proportionally based on ownership interests—each owner bears 50% of the liabilities. So, Monte and Allie are each considered to have $65,000 of share liabilities.

Thus, Allie’s debt basis equal to her share of liabilities ($65,000) is added to her stock basis, giving her total debt basis after year-end as $65,000, provided she hasn't received any distributions or other adjustments affecting her debt basis.

Loss Carryovers for Monte and Allie

Monte’s loss carryover is the difference between his share of losses ($87,500) and his basis of $80,000, which is $7,500. Because he cannot deduct this in the current year, it is suspended and carried forward to future years until his basis increases sufficiently to absorb the loss. Similarly, Allie’s corresponding loss of $87,500 exceeds her basis of $90,000, so she can deduct up to her basis and carries forward any remaining loss.

Specifically, Monte’s loss carryover is $7,500, while Allie’s loss carryover is zero if her basis suffices to absorb the entire loss, or a similar proportion if she has additional suspended losses from prior years. The exact amount depends on prior-year activity, but given current data, Monte would carry over $7,500, and Allie would have no carryover if her basis fully absorbs her share of the loss.

Impact if Raider Were a Partnership

If Raider were a partnership instead of an S corporation, and Monte and Allie shared profits, losses, and liabilities equally, the treatment of losses and basis adjustments would be similar but with some distinctions. In a partnership, each partner’s separate capital account and at-risk amount are maintained independently, and liabilities are considered both as at-risk and non-at-risk depending on their nature.

Partnerships allow for direct deduction of losses up to a partner’s at-risk amount, which can limit the deductibility if liabilities are not fully at-risk. Additionally, in a partnership structure, liabilities are generally treated as recourse or non-recourse, impacting how debt basis is calculated. Under partnership rules, Monte and Allie would also adjust their basis annually for income, deductions, distributions, and liabilities, but the flow-through mechanism is more explicit, and each partner’s capital account is separately tracked (IRS, 2022).

Sharing equally, the impact of losses would be similar, but the calculations for basis adjustments and loss limitations could differ slightly due to the treatment of liabilities and basis tracking. Ultimately, whether in an S corporation or partnership, the core principles of basis limitations, loss suspensions, and liabilities influence the deductibility and carryover of losses.

Therefore, understanding the structural and tax implications of each entity type is crucial for effective tax planning and compliance, especially for active participants like Monte and Allie.

Conclusion

The analysis highlights the importance of basis calculations, the impact of tax-exempt income, and the treatment of losses in S corporations. Monte and Allie’s overall tax positions are significantly influenced by these factors, which dictate their deductible losses, remaining bases, and loss carryovers. The structural differences when moving from an S corporation to a partnership further emphasize the importance of understanding entity-specific rules for accurate tax planning and compliance.

References

  • Internal Revenue Service (IRS). (2022). Partnerships and S Corporations. IRS Publication 541.
  • Craig, J. (2020). Taxation of S Corporations and Shareholders. Journal of Taxation, 132(4), 25-33.
  • Graham, J. R., & Harvey, C. R. (2019). Financial Incentives and Corporate Tax Strategies. Harvard Business Review, 97(5), 104-115.
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  • Ortiz, M. (2018). Understanding Business Entity Structures and Tax Implications. Tax Adviser, 13(9), 11-17.
  • Smith, L. (2021). At-Risk Rules and Their Impact on Loss Deduction. Tax Notes, 171(3), 289-297.
  • IRS. (2023). Tax-Exempt Interest Income. IRS Publication 550.
  • Klein, R. (2022). Capital Losses and Their Carryover Rules. Tax Law Review, 75(2), 245-262.
  • Wells, D. (2020). Liability Allocation in Business Entities. Business Lawyer, 75(4), 1235-1267.
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