Chapter 11 s corporations
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Chapter 11: S Corporations. Chapter 11: S Corporations. S CORPORATIONS (1 of 2). Should an S election be made? S corporation requirements S corporation election Termination of S election Tax year Ordinary income/loss and separately stated items. S CORPORATIONS (2 of 2).

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Chapter 11: S Corporations

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Chapter 11:S Corporations

Chapter 11:

S Corporations


  • Should an S election be made?

  • S corporation requirements

  • S corporation election

  • Termination of S election

  • Tax year

  • Ordinary income/loss and separately stated items


  • Special S corporation taxes

  • Shareholder allocations

  • Loss limitations

  • Additional limitations

  • Family S corporations

  • Basis adjustments

  • S corporation distributions

Should an S ElectionBe Made (1 of 5)

  • Advantages of S corp

    • No corporate level taxation

      • Income taxed directly to shareholders

        • Benefit reduced because dividends are generally taxed to individuals at 15%

    • All items retain character in s/h’s hands

      • E.g., tax-exempt income earned by S corp is tax-exempt to s/h

      • Limitations are computed at s/h level

Should an S ElectionBe Made (2 of 5)

  • Advantages of S corp (continued)

    • S corp losses can be used to offset s/h’s other income

    • Allowed to split S corp income between family members (with restrictions)

    • S corp earnings not subject to SE tax

Should an S ElectionBe Made (3 of 5)

  • Disadvantages of S corp

    • Earnings retained by C corp taxed at rates generally lower than s/h’s marginal tax rates

    • S corp earnings taxed to s/h even if no distributions are made

    • S corps subject to excess net passive income tax & built-in gains tax

Should an S ElectionBe Made (4 of 5)

  • Disadvantages of S corp (continued)

    • No dividends-received deduction

    • No special allocations allowed

      • Income allocated based on ownership

    • S corp liabilities do not increase loss limits

      • Except for s/h loan to S corp

Should an S ElectionBe Made (5 of 5)

  • Disadvantages of S corp (continued)

    • S corps and s/hs subject to at-risk rules, passive activity limits, and hobby loss rules

    • S corp restricted in type & number of s/hs

    • S corps generally must use calendar year

S Corporation Requirements (1 of 2)

  • Shareholder requirements

    • No more than 75 shareholders

    • Individuals, estates, and certain types of trusts (including QSSTs)

      • QSSTs may be complex trusts

    • U.S. citizens or resident aliens

    • Tax-exempt public charity or private foundation may be a shareholder

S Corporation Requirements (2 of 2)

  • Corporation-related requirements

    • Domestic corporation

    • Must not be an “ineligible” corporation

    • Only one class of stock

    • May be a Qualified Subchapter S Subsidiary (QSSS)

      • QSSS is 100% owned by an S corp

      • Assets, liabilities, income deductions, etc. considered owned by S corp parent

S Corporation Election

  • Form 2553 must be filed no later than 15th day of third month for year election is to be effective

    • A new corporation’s tax year begins on first day it acquires assets, has shareholders or begins business

  • All shareholders must consent to election

Termination of S Election(1 of 3)

  • Voluntary S election termination

    • Owners of more than 50% of the corporation’s stock must agree

    • Revocation made w/in 1st 2-1/2 can be retroactive to beginning of year

      • Otherwise, election effective for 1st day of next taxable year

Termination of S Election(2 of 3)

  • Involuntary S election termination

    • Occurs when corporation ceases to meet S corporation requirements

  • If termination occurs during tax year

    • Portion of year prior to termination is a short S corp year and

    • Portion of year after termination is a short C corp year

Termination of S Election(3 of 3)

  • Inadvertent termination can be undone

  • New S corp election cannot be made for 5 tax years after termination

    • Unless inadvertent termination

Tax Year(1 of 2)

  • Permitted tax years

    • A year ending on December 31, or

    • Any fiscal year where a business purpose has been established including a natural business year

Tax Year(2 of 2)

  • Other tax years may be elected

    • Ownership year - same year as shareholders owning 50% of stock

    • Facts and circumstances year

    • §444 allows S corp to elect a fiscal year end of 9/30 or later w/o satisfying business purpose exception

      • Advance payments required to eliminate benefit of income deferral

Ordinary Income/Loss & Separately Stated Items (1 of 3)

  • Income is divided between ordinary and separately stated items

  • Separately stated items same as for partnerships, including passive activities and portfolio activities

    • Refer to Form 1120S Schedule K in Appendix B for a complete listing

Ordinary Income/Loss & Separately Stated Items (2 of 3)

  • S corps cannot deduct

    • Dividends-received deduction

    • Personal or dependency exemption

    • “Personal” itemized deductions

    • Taxes paid/accrued to foreign country

    • Charitable contributions

    • Oil & gas depletion or NOL carrybacks

Ordinary Income/Loss & Separately Stated Items (3 of 3)

  • Net operating losses

    • NOLs created when a C corp cannot be carried back/forward to S corp years

    • NOLs created when an S corp cannot be carried back/forward to C corp years

Special S Corporation Taxes

  • Special levies apply to S corps

    • Excess net passive income tax

    • Built-in gains tax

    • LIFO recapture tax

Excess Net Passive IncomeTax

  • S corp has passive income in excess of 25% of S corp gross receipts and has C corp E&P

  • Excess net passive income taxed at highest corporate tax rate (35%)

  • See Example C11-11

Built-in Gains Tax(1 of 2)

  • Imposed on income/gain that would have been included in gross income while a C corp if corp had used accrual accounting

    • E.g., property with a FMV in excess of basis on day S election was made

Built-in Gains Tax(2 of 2)

  • Tax is 35% (top corp rate) on net built-in gains recognized during tax year

    • Built-in gains recognized less any built-in losses recognized

  • Built-in gains tax applies to dispositions during 10-year period after S election is made

  • See Example C11-13

LIFO Recapture Tax(1 of 2)

  • Applies to C corps using LIFO inventory method who make an S election

  • LIFO recapture amount is excess of inventory basis using FIFO over inventory basis using LIFO at close of final C corp tax year

LIFO Recapture Tax(2 of 2)

  • LIFO recapture amount included in taxable income of corp’s final C corp tax year

    • Additional tax can be paid in four annual installments

    • S corp’s basis in inventory increased by LIFO recapture amount

  • See example C11-14

Shareholder Allocations(1 of 2)

  • S/hs report pro rata share of ordinary income & separately stated items

    • Known as per day/per share method

  • See Example C11-16

Shareholder Allocations(2 of 2)

  • Divide item by # of days in tax year

    • Daily amount for each item

  • Divide daily amount by # of shares o/s

    • Daily amount per share for each item

  • Total daily allocations for a share

  • Multiply amount per share times # of shares held by owner

Loss Limitations

  • Ordinary & separately stated loss amounts “passed” through to s/h

  • S/h’s deduction limited to adjusted basis in stock plus adjusted basis of debt owed directly by corp to s/h

Additional Limitations(1 of 2)

  • §465 at-risk rules applied at s/h level

  • Passive activity rules

    • S/h must meet material participation std. to avoid passive activity limitation

  • §183 “hobby loss” rules apply at s/h level

Additional Limitations(2 of 2)

  • Post termination loss carryovers

    • Unused S corp losses due to basis limitations

    • Carried over up to 1 yr after termination

      • Depending on reason for termination

    • Unused loss carryovers after post termination period are lost

Family S Corporations

  • Donee or purchaser of stock in S corp not considered a s/h unless

    • Such stock acquired in bona fide transaction AND

    • Donee or purchaser is the real owner of stock

Basis Adjustments(1 of 2)

Initial investment

+ Additional contributions

+ Share of income/separate items

- Distrib’s excluded from s/h gross inc.

- Non-deductible expenses not chargeable to capital

- Share of losses/distributions

= Ending basis (but not below zero)

Basis Adjustments(2 of 2)

  • Basis adjustments to s/h debt

    • After stock basis reduced to zero, basis reduction applies to indebtedness based on relative adjusted basis for each loan

  • Loss/deduction not currently deductible is suspended until s/h has basis in debt or stock

S Corporation Distributions (1 of 4)

  • Distributions for S Corp w/o AE&P

    • Money distributions tax-free and reduce s/h basis, but not below zero

    • When s/h has a zero basis, distributions received treated as gain from sale of stock

S Corporation Distributions (2 of 4)

  • Distributions for S Corp w/o AE&P (continued)

    • Corporation recognizes gain on distribution of appreciated property

      • No loss reported when corp distributes property that has declined in value

S Corporation Distributions (3 of 4)

  • Distributions for S Corp w/ AE&P

    • Distributions based on tiers of earnings

      • Distributions from AAA are tax-free

      • Distributions from AE&P are taxable

      • Distributions that reduce basis in S corp stock are tax-free

      • Distributions over stock basis are taxable

    • See Table C11-1 and Example C11-27

S Corporation Distributions (4 of 4)

  • Distributions for S Corp w/ AE&P (continued)

    • S corp can elect to skip over AAA in determining source of distributions

      • May be advantageous for s/hs who want to recognize dividend income before 15% rate expires after 2008

Other S Corp Rules(1 of 2)

  • Alternative minimum tax

    • No S corp AMT

      • AMT items pass through to s/h

  • Related party transactions

    • §267 related party rules apply between s/h and S corp

    • §267 applies to S corp and another entity if >50% of both entities owned by same persons

Other S Corp Rules(2 of 2)

  • Fringe benefits paid to s/h-employee

    • For 2% (or more) s/h, S corp treated like a partnership

      • Many benefits tax-free to C corp s/h-employees are taxable to S corp s/h-employees

End of Chapter 11

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