Knowshon, sole owner of Moreno Inc., is contemplating electing S status for the
ID: 2472326 • Letter: K
Question
Knowshon, sole owner of Moreno Inc., is contemplating electing S status for the corporation. Provide recommendations related to Knowshon's election under the following alternative scenarios:
1. At the end of the current year, Moreno Inc. has a net operating loss of $800,000 carryover. Beginning next year, the company expects to return to profitability. Knowshon projects that Moreno will report profits of $400,000, $500,000, and $600,000 over the next three years. What suggestions do you have regarding the timing of the S election? Explain.
2. How would you answer part (a) if Moreno Inc. had been operating profitably for several years and thus had no net operating loss?
3. While several of Moreno Inc.'s assets have appreciated in value (to the tune of $2,000,000), the corporation has one property—some land in a newly identified flood zone—that has declined in value by $1,500,000. Knowshon plans on selling the loss property in the next year or two. Assume that Moreno does not have a net operating loss. What suggestions do you have for timing the sale of the flood zone property and why?
Explanation / Answer
Answer:1 Knowshon should delay making an S election until the beginning of year three when it has used up its NOL carryover as a C corporation. With a net operating loss carryover, Moreno's income won't be subject to taxation even though it is a C corporation. If Moreno becomes an S corporation before it uses its NOL carryover, the NOL will disappear without providing any tax benefit.
Answer:2 To shield Moreno's income from double taxation, Knowshon should make the election as soon as possible (unless there are other nontax reasons not to make the election). In this situation, the earliest effective date for the election will be January 1 of the year after the current year. Before making the election, Knowshon should consider all factors associated with the election - not just losses.
Answer:3 If Knowshon is planning on making the S election, it may make sense to wait until after the election becomes effective to sell the land. This way, Moreno can reduce its exposure to the built-in gains tax. However, Knowshon should also consider the tax savings the loss property will generate if Moreno sells the property as a C corporation. The point is that Knowshon should consider the tax savings from the loss property if it is sold as a C corporation or as an S corporation.
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