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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