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