S Corporation Taxation

AAA account is the S Corp version of what for C Corps?

Current earnings and profits

For an S Corp, distribution of loss property ______. a) results in a recognized loss and reduces AAA. b) results in NO recognized loss and does not reduce AAA. c) results in a recognized loss and reduces AAA. d) results in NO recognized loss and reduces AAA

D

M Corp (an S Corp) has one shareholder, M. M Corp distributes land and a building to M. The land had an adjusted basis of 10 and a FMV of 30, and the building had an adjusted basis of 70 and a FMV of 40. What was the gain recognized? What is M's basis in both of these items after the distribution?

Gain is 20 30-10 = 20 gain on the land. 40-70 = 30 loss on the building. An S corp does not recognize loss on a distribution. Therefore, the gain is just 20. The basis to M in both items is the FMV, i.e. 30 and 40.

Barnhardt Corporation, an S Corp, generates gross receipts of 264M (of which $110M is passive investment income). Expenditures directly related to the PII total $30M. What is the amount of Passive Investment Income Tax?

Gross excess PII = 110 - (264 x 25%) = 44 Net PII = 110-30 = 80 44 x Net PII / Gross PII = 44 x 80/110 = 32 = net excess PII 32 x 21% (maximum tax rate) = $6,720 Note this only applies if the S Corp has E&P from prior status as a C Corp.

John contributed a property with a FMV of 60, a basis of 20, and a liability of 30, to the S Corp he's a member of. What are the tax consequences?

He will recognize a gain equal to the excess of liability over basis, i.e. 10.

On Jan 1 of this year, John owned half of the 100 shares of ABC Corp, a calendar year S corporation. On Feb. 9th John sold all of his shares to Mike. This year (365 days) ABC reported ordinary income of $73,000, accruing ratably throughout the year, and capital loss of $3,650 occurring on April 1. The shareholders elected an interim close for John. What amount of nonseparately stated income should John report from ABC.

Just $4,000 (40 x 200 x 50%) He will not recognize any of the capital loss because it occurred after he sold out. If an interim close had not been elected, he would recognize a capital loss of $200 (40 x 100 x 50%).

An S corp incurred losses totaling $50,000. Its sole shareholder (who materially participates in the business and is at risk), had a stock basis of $30,000 and debt with a basis of $15,000. What are the tax consequences?

Loss is limited to $45,000. $5,000 is carried forward.

At year-end, ABC Corp, an S Corp, has the following account balances: AAA of $200, E&P of $100, and shareholder adjusted basis of $240. ABC makes a distribution of $360 to its sole shareholder. What are the tax consequences?

$200 applied to AAA (not income) $100 E&P is income, does not affect basis Capital gain of $20. There is $40 left of basis (240-200), but $60 of the distribution remaining, so you end up with a capital gain of $20.

For 2018, ABC Corp (an S corp) has taxable income of $100M, which includes a $40M LTCG that is also a recognized built in gain. What is the net long term capital gain that passes through to the shareholders?

$31,600 $40,000 x 21% (highest corporate rate) = $8,400 The tax is treated as a LTCL, therefore: $40,000 - $8,400 = $31,600

Zinnia Inc, a C Corporation, owns a single asset with a basis of $100M and a FMV of $500,000. Zinnia elects S Corp status. If the property is sold within five years of electing S Corp status, what built in gain tax does Zinnia have to pay, and what is the built in gain?

$316,000 Realized gain = $400M Tax due: 21% x $400,000 = $84,000 $400,000 - $84,000 = $316,000

Elijah owned 100% of an S Corp. His basis at the beginning of the year was 25M. The corp. earned income of 1,000 and had a capital loss of 3,000. At the end of the year it distributed 30,000 to Elijah. What amount of the distribution is taxable to Elijah?

$4,000 25 basis plus 1 OI = 26 30 - 26 = 4 gain. The 3M capital loss is carried forward until he has enough basis to deduct it. Remember the order of what's applied to basis. Contributions, income, distributions, and losses. Distributions are applied BEFORE losses, that's why it's not 25 + 1 - 3, resulting in a 23M basis and a 7M gain.

John has a basis of 120M in ABC Corp, an S corp, and he is the only shareholder. ABC distributes 180M to John. ABC has E&P of $50M and $100M in the accumulated adjustments account. What is the amount and character of his income?

10M capital gain; $50M dividend income 180 - 120 = 60M total income The order of distributions is AAA, E&P, return of capital, and gain. Therefore reduce your AAA first. 120 - 100 = 20 = basis after applying AAA. 20 (remaining basis) - 30 (total return of capital) = 10M capital gain Notice that dividend income does not reduce your basis. It works like with a C corp. Notice that an S corp will only have E&P and dividends if it used to be a C corp.

An S Corp had an AAA balance at year end of $200. During the year, two distributions were made. The first distribution of $150 was made on 3/1 and the second distribution of $100 was made on 11/15. What are the tax consequences?

120 of the first distribution comes from AAA (150/250 x $200) and 80 from the second (100/250 x $200)

As of Jan 1 of this year, John, the sole owner of ABC Corp, owned 100 shares of ABC Corp, an S corp. On Feb 9 (the 40th day of the year), he sold 25 shares. ABC had $73,000 in nonseparately stated income and made no distributions to shareholders. What amount of income should John report from ABC?

200 x 40 = 8,000 200 x 75% x 325 = $48,750 8,000 + 48,750 = $56,750

ABC, a calendar year S corporation, had an ordinary loss of $36,500 this year. John owned 50% of ABC for the first 40 days of the year before selling the stock to an unrelated party. John's basis in the stock was $10M, and he was a full time employee of the corporation. What was his share of the loss?

40 x (36,500/365) x 50% = $2,000

Why is the distribution from AAA tax free?

Because earnings have already been taxed when they flowed through to the individual partner.

Why is tax exempt income not included in the AAA balance?

Because the AAA amount is for income already taxed but not yet distributed. Tax exempt income isn't taxed.

Cougar, Inc. is a calendar year S Corp. Cougar's Form 1120S shows nonseparately stated ordinary income of $80,000. Johnny owns 40% of the Cougar stock throughout the year. The following information is obtained from the corporate records: Tax exempt interest income: $3,000 Salary paid to Johnny: ($52,000) Charitable contributions: ($6,000) Dividends received from a non-U.S. corporation: $5,000 Short term capital loss: ($6,000) Depreciation recapture income: $11,000 Refund of prior state income taxes: $5,000 COGS: ($72,000) Long term capital loss: ($7,000) Administrative expenses: ($18,000) Long term capital gain: $14,000 Selling expenses: ($11,000) Johnny's beginning stock basis: $32,000 Johnny's additional stock purchases: $9,000 Beginning AAA: $32,000 Calculate Cougar's ending AAA balance.

Beginning balance: $32,000 plus Net ordinary income: $80,000 minus Charitable contributions: $6,000 plus Dividends received from a non-U.S. corporation: $5,000 minus Short term capital loss: $6,000 plus Refund of prior state income taxes: $5,000 minus Long term capital loss: $7,000 plus Long term capital gain: $14,000 Equals ending basis: $117,000

The AAA account represents cumulative total undistributed: a) separately stated items b) non-separately stated items c) separately and non-separately stated items d) none of the above

C

S Corp distributes land to its sole shareholder. The land has a value of $100 and an adjusted basis of $80 on the date of distribution. Which of the following is true? a) No gain is recognized. b) A gain of $20M is taxed to the S Corp c) A gain of $20M is taxed to the shareholder. d) Ordinary income of $20M is taxed to the S Corp.

C - The corporation recognizes the gain but the shareholder is the one who is taxed, as S corps are flowthrough entities.

ABC Co. (an S Corp) had $50M booked expense for meals for 2019. What effect does this have on their TI and the shareholders' basis?

They can only deduct 50% (25M) for tax purposes but it reduces the shareholders' basis by 50M.

T or F: An S Corp can be a shareholder in another S Corp

True - However, it must be a Qualified Subchapter S Subsidiary) QSSS in that it is 100% owned by a parent S Corp. It is treated not separately but as part of the parent S Corp.

T or F: A distribution from an S corp to a shareholder of property will be calculated based on the FMV of the property.

True - The shareholder's basis in the property will then be the FMV. It makes sense because the FMV is the actual economic value of the property.

T or F: The S corporation shareholder does not increase tax basis for loans made by third parties to the S corporation, even though the shareholder often is a guarantor of that debt.

True. Partners, however, do get basis from third party loans for partnerships.

What is the one year post-termination period for an S Corp that becomes a C Corp and what is the reason for it?

When an S converts to a C, for one year, distributions of cash are taken from the AAA account until it is exhausted (distributions after the exhaustion of AAA will be treated as E&P, i.e. dividends, and will be taxed as dividend income). After the one year post-termination transition period, distributions are taken out of both AAA and E&P proportionally.

What creates debt basis in an S Corp?

When the shareholder loans his or her own funds to the S Corp (it works different from partnerships, where the partners take on a pro rata share of debt the partnership incurs). It's basically a business owner making an "equity" contribution in the form of an insider N/P.

For purposes of the exam, passive income includes what?

interest, dividends (except dividends from a subsidiary to the extent the subsidiary is conducting an active business or trade), royalties, and rents

What is considered "excessive" passive income?

Passive income greater than 25% of gross receipts. - Note this only applies if the corporation has E&P from prior status as a C Corp.

Cougar, Inc. is a calendar year S Corp. Cougar's Form 1120S shows nonseparately stated ordinary income of $80,000. Johnny owns 40% of the Cougar stock throughout the year. The following information is obtained from the corporate records: Tax exempt interest income: $3,000 Salary paid to Johnny: ($52,000) Charitable contributions: ($6,000) Dividends received from a non-U.S. corporation: $5,000 Short term capital loss: ($6,000) Depreciation recapture income: $11,000 Refund of prior state income taxes: $5,000 COGS: ($72,000) Long term capital loss: ($7,000) Administrative expenses: ($18,000) Long term capital gain: $14,000 Selling expenses: ($11,000) Johnny's beginning stock basis: $32,000 Johnny's additional stock purchases: $9,000 Beginning AAA: $32,000 What is Johnny's ending stock basis?

Tax exempt interest income: $3,000 x 40% = 1,200 Salary paid to Johnny: ($52,000) - n/a Charitable contributions: ($6,000) x 40% = ($2,400) Dividends received from a non-U.S. corporation: $5,000 x 40% = $2,000 Short term capital loss: ($6,000) x 40% = ($2,400) Depreciation recapture income: $11,000 - n/a Refund of prior state income taxes: $5,000 x 40% = $2,000 COGS: ($72,000) - n/a Long term capital loss: ($7,000) x 40% = ($2,800) Administrative expenses: ($18,000) - n/a Long term capital gain: $14,000 x 40% = $5,600 Selling expenses: ($11,000) - n/a 32,000 + 32,000 + 9,000 + 1,200 -2,400 + 2,000 - 2,400 + 2,000 - 2,800 + 5,600 = $76,200

ABC Inc, an S corporation for 10 years, distributes a tract of land held as an investment to Chang, its majority shareholder. The land was purchased for $82,000 many years ago and is worth $22,000. What are the tax consequences?

The corporation cannot recognize a loss on the distribution, and the AAA is not reduced (it is only reduced if they sell the property instead of distributing it). Chang will take a basis of $22,000.

What is the goal in calculating an S Corp's net unrealized built in gain?

The goal of the calculation is to ascertain the net tax consequences to the corporation of a hypothetical liquidating sale of its entire business and assets. It's to prevent the owners from avoiding double taxation (like they would have with a C corp).

What is the accumulated adjustments account?

Represents cumulative total undistributed non-separately and separately stated items. Ensures earnings from an S corp are only taxed once. Basically, the earnings are passed through to the shareholders when they're incurred, regardless of whether or not they're distributed. What's not distributed is the AAA.

Which is reduced first, debt basis or stock basis?

Stock basis.

What is the definition of a "natural business year?"

A year in which 25% or more of the gross receipts occur in the last two months of the year (three consecutive years)

ABC Inc, an S corporation for 10 years, distributes a tract of land held as an investment to Chang, its majority shareholder. The land was purchased for $22,000 many years ago and is worth $82,000. What are the tax consequences?

ABC recognizes a gain of 60M, which increases the AAA by 60M. The gain is then passed through to all the shareholders. The AAA is then reduced by $82,000. Basis to Chang in the land is 82M.

The S corp equivalent of the E&P account is ____.

Accumulated adjustments account

Distributions of cash following the termination of an S corp status are treated how for tax purposes?

As a tax free recovery of stock basis. (only for one year after terminating S corp status)

Earnings and profits are _____ and the accumulated adjustment account is _____. a) after tax / before tax b) before tax / after tax c) after tax / after tax d) before tax / before tax

B

For S Corps, ____ can be negative. a) only stock basis b) only the AAA account c) both the stock basis and the AAA account d) neither the stock basis nor the AAA account

B

LIFO recapture for an S corp that used to be a C corp is required when ______ exceeds ______. a) LIFO inventory; FIFO inventory b) FIFO inventory; LIFO inventory

B

____ are subject to payroll taxes. a) partners b) shareholders of an S corp who work for the S corp c) both A and B d) neither A nor B

B

A voluntary termination of S corp status occurs through ____. a) unanimous consent b) majority vote

B Unanimous consent is required for election, not termination

Revoking a termination of S corporation status requires: a) majority approval b) unanimous approval c) neither - A termination is always final and can never be revoked

B - Because it's basically like your making the S corporation election, which of course requires unanimous approval

ABC Corp. filed a revocation of S Corp status to be effective 6/15/20. They filed the revocation on 3/2/20. When does ABC's S Corp status terminate?

6/15/20 - They have until March 15 to file for this to take effect.

An S Corp distributes property with an inside basis of $75M and a FMV of $100M. The corporation _____. a) recognizes a gain of $25M b) recognizes no gain

A

An S Corporation can recognize a loss on _____. a) only the sale of loss property b) only the distribution of loss property c) on both the sale and distribution of loss property d) on neither the sale nor distribution of loss property

A

T or F: The S Corp is an entity type recognized on ___. a) the federal level only b) the state level only c) the federal and state level

A

What is a qualified Subchapter S subsidiary?

A corporation that meets all the requirements for Subchapter S and is owned 100% by a parent S corporation.

T of F: Shares that vary in only voting rights are counted as two different classes of stock.

False

T or F: Distributions from the AAA account are taxable.

False

T or F: For an S Corp, distributions of stock from E&P will reduce stockholder basis.

False

T or F: Tax exempt income increases the AAA account.

False

T or F: The AAA account includes tax exempt income.

False

T or F: AAA can never be below zero.

False - It can go below zero, but only from losses, not from distributions.

T or F: A shareholder's basis in an S Corp is reduced by dividend income (from E&P carried over from when they were a C Corp).

False - It is not reduced as this is taxable income

T or F: A built in gains tax is not imposed imposed on a corporation that has always been an S electing corporation.

True

T or F: A built in gains tax is not imposed on a corporation that has always been an S electing corporation.

True

T or F: An S Corp cannot file a consolidated return with an affiliated C Corp.

True

T or F: An S corporation can offset built-in gains with NOLs or unexpired capital losses from C corporation years.

True

T or F: Built in gain or loss property does not have any special implications for the contributing shareholder.

True

T or F: Built in gain subject to built in gains tax is limited to the S Corp's taxable income for that year.

True

T or F: Distributions from AAA reduce stock basis.

True

T or F: For S Corps, each beneficiary of a shareholding trust is counted as a separate shareholder.

True

T or F: For S corporations, it is assumed that all distributions take place at the end of the year after adjusting for income or subtracting deductions to adjust the basis.

True

T or F: For an S Corp, basis should be reduced by nondeductible expenses and increased by non-taxable income.

True

T or F: For an S Corp, exempt income increases basis.

True

T or F: Fringe benefits to a 2% or more shareholder-employee of an S Corp will be included in the shareholder's W-2.

True

T or F: Section 1202 treatment (qualified small business stock) is not available for S Corps.

True

T or F: Shareholders of an S Corp can recognize gains on distributions of both cash and property.

True

T or F: The excess passive investment income tax will not apply to an S corp that has always been an S corp.

True

T or F: For an S Corp, capital gains and losses are a separately stated item.

True - An exception is built in gains from when it was formerly a C Corp.

T or F: AAA can never be negative.

False - it can be, but only from losses, not from distributions

For an S Corp to 25,000 rental income (normally passive) can be deducted against non-passive income if ___.

the shareholder actively participates in the rental activity and owns at least 10% of the value of the S Corp's stock.

What is the other adjustments account?

tracks tax-exempt income earned by the corporation

ABC uses the LIFO method of accounting for its inventory and elected S Corp status effective 1/1/20. Assume that at the end of 2019, the basis of the inventory under the LIFO method was 90M, and under the FIFO method, the basis would have been 100M. Regular taxable income was 40M. What amount of LIFO recapture tax will ABC have due by 4/15/20?

$525 100 - 90 = 10 10 x 21% = 2,100 2,100 / 4 = $525

Whindy Corporation, an S corporation, reports a recognized built in gain of $80,000 and a recognized built in loss of $10,000 this year. Whindy holds an $8,000 unexpired NOL carryforward from a C corporation year. Whindy's ordinary income for the year is $65,000. Calculate any built in gains tax.

$57M Lower of 65M and 70M is $65M. $65M - $8M = $57M From Tax Adviser: "To prevent the tax from becoming significantly more onerous than the tax that would have been imposed on a C corporation, it is not imposed on an amount greater than the taxable income that would have been reported by the taxpayer had it remained a C corporation. For any tax year in which the net RBIG of an S corporation exceeds its taxable income computed in this manner, the excess is carried over and is treated as RBIG in the subsequent year." Notice how the answer is 57M, not 65M. This is because, as explained above, you have to calculate taxable income based on how it WOULD HAVE BEEN calculated as a C Corp. Obviously the $8M reduces taxable income.

Short, a calendar year S Corp, distributes $1,300 of cash to its only shareholder, Otis, on Dec. 31. Otis's basis in his stock is $1,400. Short's AAA balance is $500 and short holds $750 AEP before the distribution. What is Otis's basis in the stock after the distribution?

$850 AAA distribution: 1,400 - 500 = $900 Dividends: 900 - 0 (dividends are taxable and therefore won't reduce basis) = 900 Return of capital: 900 - 50 = $850

What is the order of items that distributions are applied to?

-AAA (return of capital) -AEP (if applicable) -Reduction in stock basis -Capital gain

Mike owns 100% of the shares of M Corp (an S Corp). M Corp distributes land and a building to Mike. FMV of land: $30,000 FMV of building $40,000 AB of land: $10,000 AB of building: $70,000 1) What is the gain/loss recognized by the corporation? 2) What is Mike's basis in the property?

1) 20M gain, due to gain from land. The $30M loss is not counted as an S Corp does not recognize a loss on the distribution of property. 2) FMV = $70M

What are the four ways that loss deductions are limited for an S corp?

1) Adjusted basis of stock 2) Adjusted basis of loans made to the company 3) At-risk amount 4) passive loss limits (when applicable)

Distributions of property should be applied to the shareholder basis in what order?

1) Cash 2) Inventory and A/R 3) other property

What is the order of distributions for an S corp?

1) Tax-free AAA (these are nontaxable) 2) E&P (dividend) 3) tax free return of capital - reduce stock basis 4) capital gain

1) An S corp incurred a loss of $20,000 for 2017. Its sole shareholder (who materially participates in the business and is at risk) had a stock basis of $10,000 and debt with a basis of $15,000. What are the tax consequences? 2) Assume that for 2018, the same S corp had ordinary income of $10,000 and made a $4,000 cash distribution to its shareholder during the year. What is the shareholder's stock basis and debt basis after this?

1) The pass through of the $20,000 loss would first reduce stock basis to zero, and then reduce debt basis to $5,000. 2) $4,000 stock basis, and $11,000 debt basis. Debt basis is only later increased with net undistributed income. $4,000 is distributed income. Here's how it works: The distributed income is treated as an increase in stock basis, bringing up the stock basis from $0 to $4,000. The basis is then reduced the same amount, bringing it back down to zero. The remaining balance is applied to the debt basis.

What are the four scenarios in which an S Corp will pay taxes?

1) built in gains 2) excess passive investment income 3) LIFO recapture 4) General business credit recapture

What is the order in which the stock basis in an S corporation is adjusted?

1) increased for contributions 2) increased for all income items 3) decreased for distributions that are excluded from gross income 4) decreased for nondeductible, noncapital items 5) decreased for deductible expenses and losses

What is the order of distributions from an S corp?

1) tax free from AAA 2) E&P 3) stock basis 4) capital gain

A(n) _____ may have ownership in a(n) _____. a) S corp; C corp b) C corp; S corp c) neither d) both

A - This should be kind of intuitive. It's weird to think of an S Corp making distributions to a C Corp, but it's not weird to think of a C Corp paying dividends to an S Corp.

T or F: Payroll tax penalties are included in the other adjustments accounts.

False - Only nontaxable income and nondeductible expenses that went toward generating that nontaxable income are included in the OAA. Payroll tax penalties do not contribute to the generation of nontaxable income.

T of F: For S Corps, shareholders only recognize gain on distributions when cash distributed exceeds their basis.

False - They recognize gains when the value of distributions (cash or property) exceeds adjusted basis of stock.

T or F: S Corp's must pay the personal holding company tax.

False - only C Corps

An S Corp can recognize gain or loss on a distribution of property.

False - only a gain. They can recognize a gain or loss on the SALE of property.

T or F: The control club rules do not apply to contributions to an S Corp.

False - they're the same as C Corp.

T or F: S corporations can deduct charitable donations when calculating their taxable income.

False - this is a separately stated item. It is treated differently for different taxpayers. They're reported on the taxpayers' individual returns. They can't use that amount to reduce the amount of S corp income or loss they are paying taxes on. Instead, they are recorded as individual charitable deductions.

T or F: A shareholder of an S Corp only recognizes gain on distributions of cash that exceed the shareholder's basis.

False - this is true for partnerships, not corporations. Shareholders of corporations can recognize gains on distributions of property other than cash.

T or F: The distributive share of earnings for an S Corp are subject to self-employment taxes.

False - true for partnerships, not S Corps.

T or F: For an S corporation, built-in gains resulting from converting from a C corporation to an S corporation are taxed as a separately stated item.

False.

T or F: The owners of an S Corp are considered to be self-employed.

False.

T or F: In the distribution of loss property, only the S Corp can recognize the loss.

False. Neither the shareholder nor the S Corp recognizes a loss on the distribution of loss property. The shareholder receives a step down in basis (equal to FMV) and no loss is recognized. Thus, distributions of property should be avoided. Instead, sell the property at the loss and distribute the cash.

What is the time limit that a built in gain tax can be imposed?

Five years

For an S Corp, the amount of distribution to shareholder is equal to:

cash plus the FMV of any other property distributed