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Category: tax

Comparison of Subchapter K v. Subchapter S

Posted on July 25, 2022December 18, 2023 by g83js92js91
Categories: business, internal revenue code, IRS, Life and the Law, limited liability company, llc, small business, starting a business, subchapter K, subchapter S, tax, tax attorney, Tax Issues, Tax Law
Depositphotos 7352892 s

Both Subchapter K and S of the Internal Revenue Code (IRC) are pass-through tax structures in which the members of the entity are taxed for the entity’s income, gains, losses, and expenses on their individual tax returns. That is where the similarities end.

There are several differences discussed below that make Subchapter K seem more taxpayer friendly than Subchapter S. Much of the popularity of the LLC is attributable to the fact that LLCs offer limited liability to all investors combined with the more flexible partnership tax regime. In some situations, however, the goals of the business owners may be better achieved with an S corporation.

Subchapter S places very strict restrictions on the ownership and capital structure for S corporations.  S corporations are limited to 100 shareholders (although members of a “family,” broadly defined, are counted as one shareholder), and they may not have more than one class of stock.  Additionally, all shareholders much be individual U.S. citizens or residents and other corporations or partnerships cannot be shareholders of the company.  Anyone can be a member or partner of an entity taxed under Subchapter K.

Partnerships and LLCs taxed under Subchapter K may make special allocations of income and deduction items, while shareholders of an S corporation must include corporate income and loss on a pro rata share basis.  Thus, partners/members may agree to share certain income or deductions disproportionately, and the agreement will be respected for tax purposes if it reflects their economic business deal.  Additionally, in most cases, partnerships and LLCs taxed under Subchapter K, can distribute appreciated property in kind without immediate recognition of taxable gain.

In a business with only a few owners, an S corporation may be the entity of choice because the flexibility of Subchapter K is not needed.  S corporations are often used by owners that prefer to conduct their business as a state law corporation instead of a partnership or limited liability company because they are more comfortable with the corporate governance structure.  S corporations are also often used by service providers to minimize their exposure to employment taxes.  S corporations are not viable options in many situations – a business with foreign investors would not be able to make the S corporation election because foreign investors are not permissible S corporation shareholders.  Additionally, many institutional investors (e.g., tax-exempt pension funds and charitable organizations) are discouraged by the tax system from investing in any type of active business that is operated as a pass-through entity.  Venture capital funds, which provide a large source of capital for start-up companies, appear to be more comfortable using the familiar C corporation capitalized with several classes of stock, a structure not available in an S corporation.

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For a complete analysis of the tax implications of C Corporations, Partnerships, and S Corporations click here for the Joint Committee on Taxation’s publication entitled “Choice of Business Entity: Present Law and Data Relating to C Corporations, Partnerships, and S Corporations.”

Contact us regarding your business law matter. Click here

Posted in business, internal revenue code, IRS, Life and the Law, limited liability company, llc, small business, starting a business, subchapter K, subchapter S, tax, tax attorney, Tax Issues, Tax Law

Mortgage Loan Debt Forgiveness

Posted on March 24, 2015April 25, 2022 by g83js92js91
Categories: debt forgiveness, Deed in Lieu, foreclosure, Foreclosures & Mortgage Loan Relief, Kelly Brown, loan modification, mortgage loan debt, mortgage loan debt income, short sales, tax, Tax Issues

Is Canceled Mortgage Loan Debt Income that you are Taxed on?

As an attorney with specific tax law knowledge who also works with borrowers to avoid foreclosure and/or to otherwise resolve mortgage loan problems, I deal with short sales, deeds in lieu of foreclosure, loan modifications, and mortgage loan settlements on a regular basis. Borrowers are usually thrilled to be able to get rid of unwanted mortgage debt either through disposing of the property, as part of a discounted pay off which allows them to keep the property, or in the form of a principal reduction as part of a modification. However, the mortgage loan debt canceled as a result of these types of transactions can have negative future tax consequences for the borrower.

Generally, canceled or reduced mortgage principal is treated as income by the IRS, which means the amount of forgiven/reduced debt would normally be taxable income to the borrower. However, the Federal Government enacted the Mortgage Forgiveness Debt Relief Act of 2007 (the “Act”) to exclude up to $2 million of forgiven debt on a taxpayer’s primary residence from taxable income. This type of forgiven debt is specifically referred to as “Qualified Principal Residence Indebtedness”. The Act has been extended several times, with the most recent extension occurring in January 2015 to retroactively cover 2014, meaning that certain mortgage debt which was canceled or forgiven in 2014 need not be included as income to the borrower. 

North Carolina and South Carolina have different approaches on these matters as far as state income taxes. In most recent years, North Carolina followed the Federal Government’s lead and enacted legislation to exclude Qualified Principal Residence Indebtedness from a taxpayer’s income for state tax purposes. The North Carolina state exclusion expired in 2013 (just like the Federal exclusion), but unlike the Federal Government, North Carolina has not yet extended the exclusion to cover 2014. Thus, as of the date of this writing, the exclusion currently applies to 2014 for purposes of South Carolina state income taxes but not for North Carolina state income taxes (but changes may be taking place within weeks).

The debate surrounding the debt forgiveness exclusion is a hot topic for North Carolina lawmakers. In February 2015, the North Carolina State Senate passed a bill that requires forgiven debt to be included as income. North Carolina’s initial failure to extend the exclusion and the effect on homeowners was recently discussed by McGrath & Spielberger attorney Jason McGrath when he was interviewed by the Charlotte Observer.

The bill was subsequently rewritten by the NC House of Representatives to exclude forgiven debt from income and then passed by the NC House in early March 2015. As it currently stands, a Conference Committee with members from both the Senate and the House was appointed late last week to hash out whether North Carolina will follow the lead of the IRS and allow certain forgiven mortgage loan debt to be excluded from state taxation from the borrower side for certain debt canceled in 2014. Governor McCrory, of course, can sign or refuse to sign whichever version of the bill is presented to him.

At this point, homeowners with Qualified Principal Residence Indebtedness from 2014 will be able to exclude the forgiven debt amount from Federal income tax but would have to include that amount for North Carolina state income tax purposes. Homeowners facing foreclosure and other difficult mortgage loan situations could be forced into deciding whether to keep the home or pay at least state income tax later as to any canceled mortgage loan debt.

In contrast, South Carolina closely resembles the Federal income tax laws with only a few modifications. South Carolina has simplified its tax scheme by deciding to follow the Federal government’s lead on tax laws with any differences expressly stated in the South Carolina statutes. In fact, § 12-6-40(c) of the South Carolina Code of Laws specifically states, “If Internal Revenue Code sections adopted by this State which expired or portions thereof expired on December 31, 2013, are extended, but otherwise not amended, by congressional enactment during 2014, these sections or portions thereof also are extended for South Carolina income tax purposes in the same manner that they are extended for Federal income tax purposes.” Qualified Principal Residence Indebtedness is not mentioned or excluded in the South Carolina Income Tax Act and thus, one can conclude that the retroactive extension of the Mortgage Forgiveness Debt Relief Act of 2007 by the Federal Government allows a borrower in South Carolina to exclude certain forgiven debt for South Carolina state income tax purposes.

In addition to the Qualified Principal Residence Indebtedness exclusion, borrowers, including those in both North Carolina and South Carolina may be able to exclude some or all of forgiven debt from Federal taxation under the IRS’ insolvency exemption. The insolvency exemption allows a taxpayer to exclude canceled or forgiven debt from income if the taxpayer is insolvent. A borrower is insolvent when the total of all the liabilities exceed the fair market value of all the assets immediately before the cancellation of the debt. However, a borrower can only exclude forgiven debt up to the amount he or she was insolvent. 

Whatever you do, just make sure you are fully aware of the potential consequences of your mortgage loan resolution; there’s nothing worse than a nasty tax surprise hitting you out of the blue. If you need advice regarding a tax situation, a distressed mortgage loan, or something similar, please don’t hesitate to contact us to speak to an attorney Charlotte NC and Mt Pleasant SC.

Posted in debt forgiveness, Deed in Lieu, foreclosure, Foreclosures & Mortgage Loan Relief, Kelly Brown, loan modification, mortgage loan debt, mortgage loan debt income, short sales, tax, Tax Issues

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