Disregarded LLC Converting To S Corp on Quickbooks

I have a client that is converting their disregarded LLC to an S Corporation. For tax purposes, I know it's a simple IRC 351 tax-free transaction. However, for bookkeeping purposes in QuickBooks, I'm trying to figure out the entries to use to keep it all in the same file. The client does not want to create two separate files in which we can easily transfer the net asset value of the LLC over to the LLC for S Corp stock. Since, they would like to keep the same client file, what entry could I use to transfer the net asset value over for S Corp stock. I can't just move the LLC capital accounts and rename them S Corp stock. I know I can close out the LL draw accounts to retained earnings and add distribution and payroll accounts, but not sure about the S Corp stock entry.

"I can't just move the LLC capital accounts and rename them S Corp stock."

Why not?

So, just move the draw accounts to retained earnings, deactivate those accounts and relabel the capital and additional paid in capital as S Corp stock? I don't know that would balance to the net asset value of the LLC in the 351 exchange. It would be easier to show the transaction as two separate client files, but I suppose this could work as a plug.

It would be easier to show the transaction as two separate client files, but I suppose this could work as a plug.

How would it be easier in two files? You'd have outstanding checks and all kinds of other items to account for when creating a second QB file. Seems like a situation to avoid, if possible.

I, generally, take the net member equity on the s-election effective date and call that capital stock on the tax return. In the books, I'll reclass this to a separate member equity account and collapse the partner capital accounts. With multiple owners, sometimes there are equalizing receivable/payable accounts to create. Since you just have one owner, it's a little easier in that respect.

If you want, you can set up a new client and copy the old files to the new S corp. books.

Play around with it if you are unsure, but the R/E will equal the capital accounts immediately before transfer.

The 351 basis will equal what you have after you do the JE described by Capt. The only way it won't is if you have gain on the 351 transfer (debt greater than basis in assets transferred)

What if LLC has $100,000 in equity, before conversion. Can this be split into $50,000 S-Corp stock and a $50,000 Note payable to the stockholder at conversion date? Or, should LLC member take a distribution from the LLC before conversion of $99,000 or so?

Phil Moody, I see absolutely no difference. OP is, I think, using "conversion" to mean that the LLC will check the box to be treated as an S corp. If an actual legal entity, a corporation, is being formed, then what goes into capital stock and paid in capital depends on par value, if any, and state law. In any case, nothing goes into retained earnings. As to a distribution before conversion, what would that accomplish? Are you going to start the S corp. with $1,000 of net worth, and if so, why? And can there even be a distribution (that means anything for tax purposes) from a disregarded entity?

Post #8 caused me to go back and re-read #6. I had not even noticed the question involved debt. I had assumed the question was simply capital stock or paid in capital. I agree with CaptCook's #8. What is gained by creating debt?

I generally try not to play the debt/equity game. Too many pitfalls regarding basis and ensuring debt is maintained as bona fide.

If you take back a note, it will be taxable under IRC 351(b)(1)(B). This would not be a transfer "soley in exchange for stock"

But installment method might be available. Since OP involves an S corporation, there seems to be no need to get involved with a note or security.

I believe the sole prop to S under IRC 351 is immediately taxed and installment method not available.

You may be right, but it's not how I think it works. Why can't transferor treat gain on boot as installment gain?

Just to be clear, I agree with this: If you take back a note, it will be taxable under IRC 351(b)(1)(B). This would not be a transfer "soley in exchange for stock"
but I disagree with this: I believe the sole prop to S under IRC 351 is immediately taxed and installment method not available. Which is why I said this: I believe the sole prop to S under IRC 351 is immediately taxed and installment method not available.

Hearing no response, I looked and found some writings on the subject. They are all post-1989, when the law was changed to eliminate "or securities" from section 351(a).

From the Texas Bar -

3. Securities
Before Congress amended Section 351(a) in 1989,
an exchange of property for the transferee corporation’s securities could be accomplished tax- free.15 Since 1989, however, securities are treated as boot, and thus, a transferor will recognize gain equal to the fair market value of any securities received in a Section 351 exchange, unless the installment method is available under Section 453.

http://www.texasbarcle.com/materials/ev ... 479_01.pdf

From the American Bar, objecting to 2009 proposed regs. that are still proposed only: http://www.americanbar.org/content/dam/ ... eckdam.pdf (See comments under "Cherry Picking".

From an outline whose source I can no longer figure out:

CERTAIN TYPES OF PROPERTY:
SECURITIES, NOTES, INDEBTEDNESS:
INSTALLMENT METHOD- Since pmts on boot will be received over time, SH may take advantage of installment reporting under §453.
Note- Anytime you have debt being issued to SH by corp, think installment method.
Shareholder’s Gain: SH receives boot gain as pmts received where at least 1 pmt is received after close of taxable yr in which disposition occurs, T defers tax on gain and spreads recognition over period of installment obligation. Reg 1.453-1(f)(3)

From another such outline:

Boot
Recognize gain to the extent of boot received
Allocate according to relative FMV of properties contributed
Installment sale – recognize gain upon receipt of payment

And yet another, from a Professor Kurtz:

(3) Installment Sales Accounting - §453 - installment method of accounting may apply to defer G when boot prop. (e.g., corp. note) is received
(a) Applies if non-inventory prop is transferred and there is at least one payment to be received after the current taxable year (i.e., through debt instruments) - §453(b)
(b) New amendment to the law in 2000…. Accrual method taxpayers can’t use the installment method (§453)
(c) Installment method:
(i) Allocate the A/B of the prop to the stock up to the FMV of the stock
(ii) If A/B in the prop. exceeds the FMV of the stock, the excess basis is allocated to the note for installment treatment.
(iii) Installment treatment:
(A) First, determine the gross profit on the note = FMV of the note – excess basis
(B) Then, determine the gross profit ratio on the note = gross profit / FMV of the note (or selling price)
(C) Every time a payment of principal is made, the amount of payment is multiplied by the gross profit ratio and that amount is taxable as a G to the s/h.
(D) For each payment that creates a G to the s/h, the corp. must increase it’s A/B in the prop. by the amount of that G.
(4) If multiple assets are transferred in exchange for stock that comes with boot, the boot is allocated to each of the assets based upon FMV and the G on each asset is determined separately. (Rev. Rul. 68-55)
(5) The character of the G depends on the type of prop. given up.

Len: sorry for being lax about not getting back to you. You provide so much to this forum, I feel the least I can do is respond timely. This article has good history, as well as informative.

Example 4 in this Tax Advisor article states that if there is no bona-fide business purpose for the corp. to assume this loan, it is boot and taxable in year of exchange. If I remember right, we had this discussion on TA with Ckenefick also?

https://www.cpa2biz.com/Content/media/P ... change.jsp

My earlier reference to "cherry picking" in the ABA letter leads to a detailed discussion of the issues in a 351 transfer for stock and notes. It is worth reading. The Tax Adviser article example has to do with assumption of debt by the corporation, not what is happening here. A different way might be to sell some assets to the corporation for an installment note and then separately transfer other assets solely for stock. Yes, I know they need to be substantively separate.

But given that we are dealing with an S corporation here, one that was never a C corporation, I think the whole issue is moot. What advantage is to be gained from splitting the transaction into stock and debt? I can think of disadvantages, as alluded to by CaptCook above.

Where is this note coming from? After the exchange or before? I say before. The corp. is assuming a personal loan.

I think this statement in the Tax Advisor article speaks volumes:

In Example 4, it would certainly appear that there is no bona fide business reason for F to assume the personal loan. B’s retention of the $100,000 loan proceeds, coupled with F’s assumption of that liability, may be viewed as the economic equivalent of F borrowing the $100,000, then passing it to B as boot in the Sec. 351 transaction. This is the reason Sec. 357(b) was enacted