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UCF School of Accounting Tax 5015. S Corporations Chapter Twelve. Learning Objectives. Explain the requirements for being taxed under Subchapter S Calculate ordinary income or loss Calculate amount of any special S tax levies

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ucf school of accounting tax 5015

UCF School of AccountingTax 5015

S Corporations

Chapter Twelve

learning objectives
Learning Objectives
  • Explain the requirements for being taxed under Subchapter S
  • Calculate ordinary income or loss
  • Calculate amount of any special S tax levies
  • Calculate S/H allocable share of ordinary income/loss and separately stated items
  • Determine limitations on a S/H deduction of S corp losses
  • Calculate a S/H basis in S Corp Stock and Debt
  • Determine taxability of S Corp distributions to S/H
sub s requirements
Sub S Requirements
  • The shareholders -
    • must number no more than 75 (100 after 12/31/2004);
      • After 12/31/2004, family members treated as 1 shareholder
        • Members of family defined as: common ancestor, lineal descendants of common ancestor, and spouses of lineal descendants or common ancestor. Maximum of 6 generations.
    • must be individuals, estates, certain types of trusts, and certain types of tax-exempt organizations;
    • must be U.S. citizens or resident aliens.
sub s requirements1
Sub S Requirements
  • The corporation -
    • must be a domestic corporation;
      • Unincorporated entities that “check the box” to be treated as corporation are also eligible.
    • must not be an “ineligible” corporation;
      • Corporations that have special status can not be S corp (e.g. financial institutions, insurance companies)
      • Corporations that have elected special Puerto Rico and US possession tax credit or special Domestic International Sales Corp tax exemption
    • must have only one class of stock
      • This provision may get complicated for unincorporated “check the box” entities
the election
The Election
  • Form 2553 must be filed no later than the 15th day of the 3rd month for year election is to be effective.
  • Tax year begins on the first day on which it acquires assets, has shareholders or begins business.
  • Each shareholder of a new corp must consent.
  • S election exempts corp from all federal income taxes except:
    • built-in gains tax
    • excess net passive income tax
    • LIFO recapture tax
    • Recapture of previously claimed ITC
termination of the election
Termination of the Election
  • The election is terminated when:
    • the corporation either voluntarily revokes the election
      • Filed during first 2 1/2 months of taxable year
      • Consented to by a majority of shareholders
    • The corporation ceases to meet the small business corporation requirements:
      • exceeding 75 (100) shareholder limit
      • having an ineligible shareholder own stock
      • second class of stock
      • retaining a prohibited tax year
      • failing the passive investment income test for 3 consec. years
passive income test
Passive Income Test
  • IF S Corp’s Passive Income exceeds 25% of total gross receipts for 3 consecutive years; AND
  • S Corp has C Corp E&P;
  • THEN S Corp election terminated beginning of 4th year.
  • Passive Income: gains from sale of securities, royalties, rents, dividends, interest, and annuities.
s corp operations
S Corp. Operations
  • S Corp.’s make same accounting period and accounting method elections as C Corp’s.
  • Tax Year - usually calendar year
    • Although business purpose exception is allowed
  • Accounting Methods
    • Most elections made by S Corp
    • Exceptions: same as partnership’s - discharge of indebtedness, mining exploration expenditures, FTC
reporting of s corp income
Reporting of S Corp. Income
  • Ordinary Income or Loss
  • Separately stated items (same as partnership)
  • Special Rules
    • Amortization of organizational expenditures allowed
    • No Dividends Received Deduction
    • Accrued expenses owed to S. Corp S/H not deductible by S Corp until S/H reports income
    • S/H’s may be employees, however those owning more than 2% of stock are not eligible for tax-free fringe benefits
    • Generally, no Carryback or Carryover of losses or deductions between an S Corp and a C Corp
    • Sec 291 Recapture applies ONLY if S Corp had been C Corp in any of its three preceding tax years.
shareholder s allocations per day per share
Shareholder’s AllocationsPer Day/Per Share
  • Each shareholder is allocated a pro rata portion of ordinary income (loss) and all separately stated items
    • If stock holdings change during year, shareholder is allocated a pro rata share of each item for each day
  • No special allocations are allowed
  • No pre-contribution gain rules apply
loss limitations
Loss Limitations
  • Both ordinary and separately stated loss amounts are “passed” through to the shareholders.
  • The shareholder’s deduction is limited to:
    • s/h’s adjusted basis in the stock
    • plus the adjusted basis of debt owed by the corporation to the shareholder.
  • Additional Limitations:
    • The Sec. 465 at-risk rules are applied at the shareholder level.
    • Passive activity rules apply. The shareholder must personally meet the material participation standard to avoid the passive activity limitation.
    • The Sec. 183 “hobby loss” rules apply
basis adjustments
Basis Adjustments
  • Stock
    • Initial investment (or basis at beginning of year)
    • Plus:
      • Additional contributions
      • Share of ordinary and sep.stated income and gains
    • Minus (in order):
      • S Corp Distributions (not out of C Corp E&P)
      • Non-deductible expenses not chargeable to capital
      • Share of ordinary and separately stated losses
    • Equals: Adjusted Basis of S Corp stock
  • Debt
    • decrease for losses if stock basis reduced to zero
    • increase for ord inc and/or sep. stated. gains up to original basis
s corp distributions no c corp e p present
S Corp Distributions:no C Corp E&P present
  • Consequences to Shareholder
    • Reduce Basis in Stock
    • Distributions in Excess of Basis are Capital Gain
    • S/H takes FMV basis in distributed property
  • Consequences to S Corp
    • Must recognize gain on distribution of appreciated property
    • Can not recognize losses
s corp distributions s corps with c corp e p
S Corp Distributions:S Corps with C Corp E&P
  • Cash Distribution:
    • AAA (Tax Free up to S/H’s Basis in Stock)
    • PTI (Tax Free up to S/H’s Basis in Stock)
    • Accumulated E & P (Taxable)
    • Other Adjustments Account (Tax-Free up to S/H’s Basis in Stock)
    • Basis of Stock (Tax Free)
    • Capital Gain on Sale of Stock Once Basis Reduced to Zero
  • Property Distribution: same rules as for cash distributions except:
    • Gain recognized by S Corp on distribution of appreciated property
    • Shareholder takes a FMV basis in distributed property
aaa account
AAA Account
  • Accumulated Adjustments Account: represents cumulative income/loss recognized in post-1982 S Corp years.
  • Computed as follows:
    • Beginning of Year AAA Balance
    • Plus:
      • ordinary income
      • separately stated income items (not tax-exempts)
    • Minus (IN ORDER):
      • expenses that are not deductible in determining ord. Income
      • Ordinary loss
      • separately stated deduction and loss items (not tax-exempt)
      • distributions made during year from AAA
    • Equals: End of Year AAA Balance
  • Note: if net adjustments (not including distributions) is negative, then distributions are deducted first (before any other adjustments).
oaa account
OAA Account
  • Other Adjustments Account (OAA) maintained only by corps having accumulated E&P at year end
  • Computed as follows:
    • Beginning of year OAA Balance
    • Plus:Tax Exempt Income Received
    • Minus:
      • Expenses incurred in earning tax-exempt interest
      • Distributions from OAA
      • Federal taxes paid by S Corp that are attributable to C Corp tax years
    • Equals: End of year OAA Balance
excess net passive income tax
Excess Net Passive Income Tax
  • If S Corp’s Passive Investment Income exceeds 25% of its gross receipts AND
  • it has C Corp E & P at close of tax year
  • THEN S Corp pays tax on excess net passive income at 35%
  • Recall that Passive income was defined previously as: gains from sale of securities, royalties, rents, dividends, interest, and annuities
  • Net Passive Income = Total passive income less deductions directly connected
  • Excess Net Passive Income =
    • Net Passive Income x [(Passive Investment Income - 25% of gross receipts)]/Passive Investment Income
  • Income passed through to shareholders is reduced by the amount of the tax
built in gains tax
Built-in Gains Tax
  • C Corp Converting to an S Corp incurs corporate level tax on any built-in gains when asset disposed of at a gain within 10 years of conversion.
  • Tax applies to any asset disposition (e.g. accounts receivable, inventory, real estate, etc).
  • Tax levied at 35% on the lesser of:
    • Built-in gains recognized for tax year
    • Taxable income (computed as if C corp, ignoring DRD and NOL)
    • Net unrealized Built-in gains at conversion less total recognized built-in gain for prior tax years
  • Tax not levied if asset acquired after 1st day of S status
  • Built-in Gains Tax reduces amount of regular gain pass through to S Corp S/H’s from sale of assets