Chapter 22: S Corporations
If the entity distributes property,
Gain must be recognized Loss is not recognized
At-risk Rules
Generally apply to S corp shareholders Amounts include: Cash and adj basis of prop contributed to corp Any amt borrowed for use in the activity for which the shareholder is personally liable Net FMV of personal assets tha secure nonrecourse borrowing
AAA bypass election
If E&P exists, the entity may elect to first distribute E&P before reducing AAA
Excess net passive income (ENPI)
If an S corp has accumulated E&P from C corp years,a tax is imposed on ____
Passive investment income limitation
If passive income > 25% of gross receipts for 3 consecutive taxable years, S election is terminated as of the beginning of the fourth year. Only applies if the S corp used to be a C corp (has C Corp E&P)
day
If stock holding change during the year, shareholder is allocated a pro rate share of each item for each ___ stock is owned
date disqualification
If the entity no longer qualifies as a S corp, the election is terminated on ____ occurs
Similar to partnership basis rules, First you increase basis by ____ Then decrease it by ___ and finally ___
Income items distributions losses
For the election to be effective for current year, the corporation must
Make election by 15th day of third month of current year, or file in previous year
Shareholder's basis cannot be negative
-Once basis is reduced to zero, any additional reductions decrease basis in loans made to S corp -any excess losses or deductions are suspended -Once basis of debt is reduced, it is increased by subsequent net increases from all positive and negative adjustments
Where Earnings and profits exist,
1. Tax-free to the extent of accum adj acct 2. Any PTI from pre-1983 tax yrs can be distributed tax-free 3.Remaining distribution is ordinary dividend to extent of AEP 4. Tax-free to extent of Other Adj Acct (tac exempt income) 5. Tax-free reduction in basis of stock 6. Excess treated as gain from the sale or exchange of stock (capital gain in most cases)
5
A new election normally cannot be made within __ years after termination of a prior election
Tax liability may still arise at the entity level for:
Built-in gains tax, or passive investment income penalty tax
how to calculate the amount of distribution to shareholder
Cash +FMV of any other property distributed
Subchapter S corporations taxation resembles partnership taxation because
Certain items are accumulated and passed through to shareholders Other items are "separately stated" and each item is passed through to shareholders
A S corporation is not subject to the following taxes:
Corporate income tax Accumulated earnings tax Personal holding company tax Corporate alternative minimum tax
one
Corporation may have only ___ class of stock
100
To qualify as a S corp, the corporation must have ____ or less shareholders and family members may be treated as one shareholder
15th day of third month
To revoke the election, revocation must be filed by _____ to be effective for entire year, otherwise it is effective for first day of following year or any other specified future date
Basis is decreased by :
distributions not reported as income by shareholders nondeductible expenses non-separately computed losses separately stated loss and deduction items
Ineligible corporations
include certain banks, insurance companies and foreign corporations
Passive investment income
includes royalties, rents, dividends, interest, annuities, and sales and exchanges of stocks and securities
Determination of initial basis is similar to that of basis of stock in C corp, It depends on
manner stock was acquired ex) gift, inheritance, purchase, exchange
S corporation status
obtained through an election by a qualifying corporation with the consent of its shareholders
Net passive income
passive income less directly related deductions
Subchapter S
provide many of the benefits of partnership taxation and gives the owners limited liability protection from creditors
Accumulated Adjustments Account (AAA)
represents cumulative total undistributed non-separately and separately stated items Mechanism to ensure that earnings of an S corp are taxed to shareholders only once
Examples or Separately Stated items
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
To elect under Subchapter S, a corporation must meet the following requirements:
Must be a domestic corporation Must not otherwise be "ineligible"
When computing Taxable income, S corp items are divided into
Non-separately stated income or loss Separately stated income, losses, deductions and credits that could affect tax liability of shareholders in a different manner
transferor
On the date of transfer, the ____ is considered to own the stock
Basis rules are similar to partnership rules except
Partner's basis in partnership interest includes direct investment plus a ratable share of partnership liabilities except for loans from a shareholder to the S corp, corporate borrowing does not affect shareholder's basis
Who cannot own S corp stock?
Partnerships,Corps, LLPs, most LLCs and most IRAs
If the corp is involved in rental activities or shareholders do not materially participate,
Passive losses and credits flow through to shareholders Shareholder's stock basis is reduced even if passive losses are not currently deductible
Computing taxable income is determined in a manner similar to partnerships except,
S corp amortizes org 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 (DRD)
voting rights
S corp can have stock with differences in _____ but not in distribution or liquidation rights
Any domestic corporation that is not an ineligible corp can be qualified Subchapter S Subsidiary (QSSS) if:
S corp owns 100% of its stock, and Elects to treat the subsidiary as a QSSS
corporations
S corporations are still ___ for legal purposes
When deciding to elect S Corp Status, the following factors should be considered
Shareholders marginal tax rates vs C corp rates If NOLs are anticipated If currently C Corp,any NOL carryovers from prior yrs cant be used during S corp yrs Whether the S status is recognized for state and local tax purposes
Treatment of Losses
Step 1: Allocate total loss to the shareholder on a daily basis, based upon stock ownership Step 2: If shareholder's loss exceeds stock basis, apply any excess to adjusted basis of indebtedness to the shareholder Step 3: Where loss >debt basis, excess is suspended and carried over to future tax years Step 4: In future tax yrs, any net increase in basis adj restores debt basis first, up to its original amt Step 5: Once debt basis is restored, remaining net increase is used to increase stock basis Step 6: Suspended loss from a previous yr now reduces stock basis first and debt basis second Step 7: If S election terminates, any loss carryover remaining at the end of the post-termination transition period is lost forever
Computation of Built-in Gains Tax
Step 1: Select the smaller of built-in gains or taxable income Step 2: Deduct unexpired NOLs and capital losses from C corporation tax years Step 3: Multiply the tax base from Step 2 by the top corporate tax rate Step 4: Deduct bus credit carryforwards and AMT credit carryovers from a C corp tax yr from the amt obtained in step 3 Step 5: The corporation pays any tax resulting from step 4
Stockholders basis is increased by
Stock purchases Capital contributions Non-separately computed income Separately stated income items Depletion in excess of basis
the highest corporate tax rate for the year
Tax rate applied to passive investment income is ___
accumulated E&P
Taxation of distribution depends on whether the S corp has ___ from C corp years
5 year waiting period is waived if:
There is a > 50% change in ownership after first year for which termination is applicable Event causing termination was not reasonably within control of the S corp or its majority shareholders
How to calculate Excess net passive income
(Passive investment income > 25% of gross receipts / Passive invest. income for the year) x (net passive invest income for the year)
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 property (capital gain)
The S election is lost in any of the following ways:
1. Shareholders owning a majority of shares voluntarily revoke the election 2. New shareholders owning > 50% of entity refuses to consent to election 3. Election no longer qualifies as S corp 4.The corp does not meet the passive investment income limitation
Passive loss rules
A S corp is not directly subject to the ____
reporting
A S corporation is a ____ entity, rather than a tax-paying entity
Cash
Distributions of ____ during a one-year period following S election termination receives special treatment
pro rata
Each shareholder is allocated a ___ portion of non-separately stated income (loss) and all separately stated items
Subchapter C
Entity is subject to _____ rules for a transaction unless Subchapter S provides alternate rules
To become an S corp, must make a valid election that is
Filed timely All shareholders must consent to the election
Distributions of property- Gain
____ is allocated to shareholders and increases shareholders basis in stock in the entity, before considering the effect of the distribution
Distributions of cash during a one-year period following S election termination are treated as
a tax-free recovery of stock basis to the extent it does not exceed AAA account. the corp should not distribute property during this postelection termination period
Excess net passive income
cannot exceed corp taxable income before considering any NOL or other special deductions