Prohibition of Suspense Accounts
A corporation engaged in farming must use an accrual method to account for taxable income if gross receipts exceed $1 million. If gross receipts increase to above the $1 million threshold, the corporation is required to change its method of accounting if it is not using the accrual method.
For family corporations engaged in farming, gross receipts must exceed $25 million to be required to use the accrual method of accounting for tax purposes.
Under the previous law, if a family corporation engaged in the business of farming was forced to change its method of accounting, the corporation had to establish a suspense account. The initial balance equaled the lesser of (1) Code Sec 481 adjustment otherwise required for the year of change or (2) the Code Sec. 481 adjustment computed as if the change in method of accounting had occurred as of the beginning of the tax year preceding the year of change.
Under the new law, suspense accounts are prohibited. Thus, any family corporation required, because of the $25 million rule, to change to an accrual method of accounting for any tax year ending after June 8, 1997, must restore the Code Sec. 481 adjustment applicable to the change in gross income ratably over a 10-year period beginning with the year of change.
Basis Allocation Rules
For partnership distributions after August 5, 1997, the basis allocation rules for distributee partners has been modified.
A distributee partner’s basis adjustment is allocated among distributed assets first to unrealized receivables and inventory items in an amount equal to the partnership’s basis in each such property and remaining basis is allocated first to the extent of each distributed property’s adjusted basis to the partnership. Any remaining basis adjustment, if an increase, is allocated among properties with unrealized appreciation in proportion to their respective amounts of unrealized appreciation and then in proportion to their respective fair market values. If the remaining basis adjustments is a decrease, it is allocated among the properties with unrealized depreciation in proportion to their respective amounts of unrealized depreciation , and then in proportion to their respective adjusted bases, taking into account the adjustments already made.
EXAMPLE
A partnership distributes both its assets, A and B, in liquidation of a partner whose basis in its interest is $55. Neither asset consists of inventory or unrealized receivables. A has a basis to the partnership of $5 and a fair market value of $40. B has a basis to the partnership of $10 and a fair market value of $10. Basis is first allocated $5 to A and $10 to B (their adjusted bases to the partnership). The $40 basis increase (the partner’s $55 basis minus the partnership’s total basis in distributed assets of $15) is first allocated to A in the amount of $35, its unrealized appreciation, and the remaining basis adjustment of $5 is allocated according to the assets’ fair market value, i.e., $4 to A (for a total basis of $44 for A) and $1 to B (for a total basis of $11 for B).
This is a very complex provision of the new tax law. For more information on how this new law may affect you, contact your tax advisor or Ford Levy at Maxwell Shmerler & Co., CPAs.