Chapter 12 - S Corporations

how is S corporation status is obtained

-S corporation status is obtained through an election by a qualifying corporation with the consent of its shareholders -To make a valid election, it must be: - Filed timely - All shareholders must consent to the election

After terminated, when can a new s election be made

A new S election normally cannot be made within 5 years after termination of a prior election - Five year waiting period is waived if: • There is a > 50% change in ownership after first year termination is applicable • Event causing termination was not reasonably within control of the S corp or its majority shareholders

Taxation resembles which organizational form

partnership taxation - Certain items (primarily business income and certain expenses) are accumulated and passed through to shareholders - Other items are "separately stated" and each item is passed through to shareholders

Computation of Taxable Income

• Determined in a manner similar to partnerships except - S corp. amortizes organizational costs under the C corp. rules - S corp. must recognize gains (but not losses) on distributions of appreciated property to shareholders - Certain other special C corp. provisions do not extend to S corps. • e.g., Dividends received deduction

Following factors should be considered When to Elect S Corp Status:

• Following factors should be considered: - If shareholders have high marginal tax rates vs C corp rates - If NOLs are anticipated - If currently C corp, any NOL carryovers from prior years can't be used during S corp years • Still reduces 20 year carryover period - Character of anticipated flow-through items - State and local tax laws - A variety of other factors

Where Earnings and Profits exist

- 1. Tax-free to the extent of accumulated adjustments account - 2. Distributions from AEP constitute dividend income. ** - 3. Tax-free to extent of Other Adjustments Account - 4. Tax-free reduction in basis of stock* - 5. Excess treated as gain from the sale or exchange of stock (capital gain in most cases)

S Corporation Distributions to shareholder

- Cash + FMV of any other property distributed, Taxation of distribution depends on whether the S corp has accumulated E&P from C corp years

An S corporation is not subject to the following taxes:

- Corporate income tax - Accumulated earnings tax - Personal holding company tax - Corporate alternative minimum tax

how is S corporation status is obtained To be effective for current year

- Make election by 15th day of third month of current tax year, or - File in previous year

S Corp Qualification Requirements

- Must be a domestic corporation - Must not otherwise be "ineligible" • Ineligible corporations include certain banks, insurance companies and foreign corporations • Any domestic corp. that is not an ineligible corp. can be a qualified Subchapter S Subsidiary (QSSS) - Corporation may have only one class of stock • Can have stock with differences in voting rights but not in distribution or liquidation rights • It is possible for debt to be reclassified as stock - Must have 100 or less shareholders

When computating Taxable Income, S corp items are divided into:

- Nonseparately stated income or loss - Separately stated income, losses, deductions and credits that could affect tax liability of shareholders in a different manner • Identical to separately stated items for partnerships

Accumulated Adjustments Account (AAA)

- Represents cumulative total undistributed nonseparately and separately stated items - Mechanism to ensure that earnings of an S corp are taxed to sharehol ders only once

Separately Stated Items for S Corps are:

- Tax-exempt income - Gains/losses from disposal of business property and capital assets - Charitable contributions - Income/loss from rental of real estate - Interest, dividend, or royalty income - Tax preference items

Where no Earnings and Profits exist

1. Nontaxable to the extent of adjusted basis in stock 2. Excess treated as gain from the sale or exchange of stock • Capital gain in most cases

Termination of Election

1. Shareholders owning a majority of shares voluntarily revoke the election 2. New shareholder owning > 50% of entity affirmatively refuses to consent to election 3. Entity no longer qualifies as S corp 4.The corp. does not meet the passive investment income limitation (passive income >25% of gross receipts for 3 years_

How long can an s election remain in force

An S election remains in force until revoked or lost, or terminated

Allocation of Income and Loss

Each shareholder is allocated a pro rata portion of nonseparately stated income (loss) and all separately stated items