17 - S Corporations
What qualifications are necessary for an electing small business trust to be eligible to hold stock in an S corporation?
All beneficiaries of the trust must be individuals, estates, or charitable organizations that are eligible to be S corporation shareholders, and the trust must not have an interest acquired by purchase. A specific election to be treated as an electing small business trust must be filed by the trustee. An electing trust is one that does not have as a beneficiary any person other than (1) an individual, (2) an estate, or (3) an organization eligible to accept charitable contributions under Sec. 170. Also, an electing small business trust cannot have any interest acquired by purchase, and a specific election to be treated as an electing trust must be filed by the trustee.
XYZ Corporation is a qualified S corporation. In 2013, its books and records reflected the following transactions: Business income: $500,000 Real estate rental loss: $(20,000) Interest income: $5,000 Salaries and wages: $(50,000) Depreciation (without Section 179 expense): $(40,000) Section 179 expense: $(10,000) Other business deductions: $(300,000) What is XYZ's ordinary income (loss) to be reported on its 2013 Form 1120S?
$110,000 S corporation items of income, deduction, and credit, which could alter the tax liability of shareholders if taken into account by them on their personal returns, are required to be stated (and are passed through) separately. The ordinary income reported on 2013 Form 1120S would equal the following: Business income: $500,000 Salaries expense: (50,000) Depreciation: (40,000) Other business deductions: (300,000) =Ordinary income: $110,000
An S corporation without prior C corporation earnings and profits must maintain the accumulated adjustments account in order to
1) Determine the tax effect of any cash distributions. 2) Determine the tax effect of distributions of property. 3) Determine the tax effect of possible future postmerger distributions. S corporations maintain records for each shareholder referred to as accumulated adjustment accounts (AAA), other adjustments accounts (OAA), and previously taxed income accounts (PTI accounts). These records, together with a shareholder's basis in his or her stock and any Subchapter C earnings and profits (E&P) in the corporation, are used to determine the manner in which shareholders must treat distributions from the S corporation for tax purposes.
S Corp facts:
An S corporation passes a pro rata share of its total income (loss) through to the individual shareholders except for items that require separate treatment by the shareholder. Royalty income, charitable contributions, and investment interest expense must be separately stated. Income from trade or business, however, is combined with other nonseparately stated income or loss. Only individuals and specified trusts and estates may be S corporation shareholders. Other entities, including partnerships and corporations, are ineligible. An S corporation must have only one class of stock. One class of stock means that the outstanding shares of the corporation must be identical as to the rights of the holders in the profits and in the assets of the corporation. Variation in voting rights of that one class of stock is permitted. The number of shareholders may not exceed 100. Related taxpayers and their estates are considered a single shareholder for this purpose. A nonresident alien (NRA) may not own any shares. Each shareholder must be either an individual, an estate (including estates of individuals in bankruptcy), or a qualified trust. Certain small business trusts and tax-exempt organizations can be shareholders. Partnerships, corporations, and nonresident aliens may not be shareholders. Additionally, Charitable Remainder Unitrusts and Charitable Remainder Annuity Trusts are not eligible to be shareholders. The corporation must be domestic and not an ineligible corporation. Ineligible corporations include financial institutions, such as banks (that use the reserve method of accounting) and insurance companies. In the event of a loss by an S corporation, the basis of the stock is reduced for the amount of the loss. The basis cannot be lowered below zero. After basis in the shareholder's S corporation stock has been reduced to zero, the shareholder's basis in debt of the S corporation to that shareholder is reduced (but not below zero) by his or her share of items of loss and deduction. A shareholder's share of loss and deduction items in excess of basis in the debt is not deductible. The excess is suspended and carried over indefinitely. It may be deducted in a subsequent tax year in which basis is restored to debt or to stock. An S corporation may owe tax if, at the end of the tax year, the corporation had accumulated earnings and profits and taxable income and if its passive investment income exceeds 25% of its gross receipts. an S corporation's status may be revoked by an election of the shareholders collectively holding more than half of the shares of a corporation.
On December 31, Year 1, Mr. Vear purchased 50% of S corporation Z's only class of stock outstanding for $100,000. Z is an electing S corporation. On November 30, Year 2, he purchased the other 50% of its stock for $100,000. For Year 2, Z Corporation had an ordinary loss of $255,500. How much of the loss can Mr. Vear deduct on his individual income tax return for Year 2?
An S corporation shareholder includes his/her pro rata share of loss from the S corporation [Sec. 1366(a)]. Sec. 1377(a) defines pro rata share as the taxpayer's share of loss determined on a per-day and then a per-share basis. The loss for the whole year was $255,500, which is $700 per day ($255,500 ÷ 365 days). Therefore, Vear's share is $138,600 [$127,750 + ($700 × 50% × 31 days)] because Vear owned 50% of the stock for the full year and the other 50% for 31 days.
ABC corporation commenced business on July 20, Year 1. What is the final date at which ABC could file an election for S corporation status and be recognized as valid for the Year 1 tax year?
October 3, Year 1. An eligible corporation must make the election for S corporation status. If the election is made within 2 months and 15 days of the beginning of the corporation's tax year, the election is effective from the first day of that tax year. Therefore, ABC corporation has 2 months and 15 days from July 20, Year 1, to file an election for S corporation status. If ABC files an election for S corporation status by October 3, Year 1, the election will be valid for the Year 1 tax year.
Which factor serve to determine whether an S corporation may be subject to the tax on excess net passive income?
Passive investment income is more than 25% of its gross receipts. Why? If an S corporation has more than 25% of its gross receipts as passive investment income, it may be subject to the tax on excess net passive income. The S corporation has been an S corporation from the date of its incorporation. Why? B/c if it has, it will not be subject to npi. The S corporation has Subchapter C earnings and profits at the end of the year.
