After four years in operation, my company still has no profits due to depreciation. The company declares capital reduction or share distribution so the shareholders or members can make use of the distributed fund for their other investments. The distribution is within (i.e., below) the capital basis.
If it is a corporation, does any capital gain tax need to be paid either by the corporation or shareholders? If it is an LLC, does the member need to pay the capital gain tax?
Is it correct that if the corporation has paid-up capital of $500,000 and net loss for the past four years as $200,000, then the ending capital basis is $500,000 – $200,000 = $300,000? If so, is the maximum capital reduction of $300,000 allowed to be declared and distributed to the shareholders without paying any capital gain tax for both corporation and shareholders? If it is an LLC, is the above scenario also true for LLC members?
I do not have enough information to give you a detailed answer. However, while you are generally calculating the basis correctly in the aggregate, it needs to be looked at on an individual level. Until each individual’s contributions, results of operations, and withdrawals are known, a determination on taxation cannot be figured. All taxation will be done at the individual level.
What appears to be a more vital question is what type of structure should this entity use for its operations? The answer to that question depends on the makeup of the owners, the type of business, the expected results of operations, the type of assets (if any) held by the entity, and the goals and objectives of the owners.
I highly recommend that you seek in-person professional advice from someone who can walk through the key issues with you and develop a solution that works for your particular situation. There are a number of factors to consider, and doing it incorrectly can have serious financial consequences. The PICPA website has a valuable CPA Locator feature that can help you find a qualified professional in your area. Since you have been operating for four years, it would be best to have this conversation sooner rather than later.
For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.
Answered by: Eric S. MacCollum, CPA, is a principal with Hudak and Company in Lemoyne, Pa.