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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

Chapter 11:S Corporations

Chapter 11:

S Corporations

s corporations 1 of 2
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
S CORPORATIONS(2 of 2)
  • Special S corporation taxes
  • Shareholder allocations
  • Loss limitations
  • Additional limitations
  • Family S corporations
  • Basis adjustments
  • S corporation distributions
should an s election be made 1 of 5
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 election be made 2 of 5
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 election be made 3 of 5
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 election be made 4 of 5
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 election be made 5 of 5
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
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
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
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
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
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
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
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
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
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
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
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 S Corporation Taxes
  • Special levies apply to S corps
    • Excess net passive income tax
    • Built-in gains tax
    • LIFO recapture tax
excess net passive income 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
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
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
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 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
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
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
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
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
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
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
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(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
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
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
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
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
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
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
slide40
End of Chapter 11

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