Chapter 11: S Corporations

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Chapter 11S Corporations
Chapter 11 S Corporations
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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

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S CORPORATIONS(2 of 2)

• Special S corporation taxes
• Shareholder allocations
• Loss limitations
• Additional limitations
• Family S corporations
• Basis adjustments
• S corporation distributions

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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 (through 2008)
• All items retain character in s/hs hands
• E.g., tax-exempt income earned by S corp is
  tax-exempt to s/h
• Limitations are computed at s/h level

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Should an S ElectionBe Made (2 of 5)

• Advantages of S corp (continued)
• S corp losses can be used to offset s/hs other
  income
• Allowed to split S corp income between family
  members (with restrictions)
• S corp earnings not subject to SE tax

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Should an S ElectionBe Made (3 of 5)

• Disadvantages of S corp
• Earnings retained by C corp taxed at rates
  generally lower than s/hs 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

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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

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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

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S Corporation Requirements (1 of 3)

• Shareholder requirements
• No more than 100 shareholders
• Husband and wife counted as one s/h
• May elect to include all members of a family as a
  single shareholder
• Individuals, estates, and certain types of trusts
  (including QSSTs)
• QSSTs may be complex trusts

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S Corporation Requirements (2 of 3)

• Shareholder requirements (continued)
• U.S. citizens or resident aliens
• Tax-exempt public charity or private foundation
  may be a shareholder
• Corporation-related requirements
• Domestic corporation
• Or unincorporated entity electing to be treated
  as a corp under check-the-box regs
• Must not be an ineligible corporation

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S Corporation Requirements (3 of 3)

• Corporation-related requirements (continued)
• 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

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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 corporations tax year begins on first day
  it acquires assets, has shareholders or begins
  business
• All shareholders must consent to election

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Termination of S Election(1 of 3)

• Voluntary S election termination
• Owners of more than 50 of the corporations
  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

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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

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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

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Tax Year(1 of 2)

• Permitted tax years
• A year ending on December 31,
• Including a 52-53 week year, OR
• Any fiscal year where a business purpose has been
  established including a natural business year

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Ordinary Income/Loss Separately Stated Items (1
of 4)

• 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 or pages C11-14 C11-15

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Ordinary Income/Loss Separately Stated Items (2
of 4)

• 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
• NOL carryovers from C corp years

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Ordinary Income/Loss Separately Stated Items (3
of 4)

• 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

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Ordinary Income/Loss Separately Stated Items (4
of 4)

• U.S. production activities deduction
• Determined at s/h level
• 50 salary limitation
• Each s/h is allocated a share of S corps W-2
  wages equal to lesser of
• S/hs allocable share of W-2 wages OR
• 6 of the qualified production activities income
  allocated to the s/h

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Special S Corporation Taxes

• Special levies apply to S corps
• Excess net passive income tax
• Built-in gains tax
• LIFO recapture tax

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Excess Net Passive IncomeTax

• S corp has passive income in excess of 25 of S
  corp gross receipts and has C corp EP
• Excess net passive income taxed at highest
  corporate tax rate (35)
• See Example C11-11

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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

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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

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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

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Loss Limitations(1 of 2)

• Ordinary separately stated loss amounts
  passed through to s/h
• S/hs deduction limited to adjusted basis in
  stock plus adjusted basis of debt owed directly
  by corp to s/h

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Loss Limitations(2 of 2)

• Sequence for stock basis limitation
• Beginning basis
• Capital contributions
• Share of ordinary income and separately stated
  items
• - Distributions not included in s/h inc.
• - Nondeductible, noncapital expenditures
  _
• Basis available to absorb S corp loss

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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
• Suspended losses do not transfer to new owner
  unless to spouse incident to divorce

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Basis Adjustments(1 of 2)

• Initial investment
• Additional contributions
• Share of income/separate items
• - Distribs excluded from s/h gross inc.
• - Non-deductible expenses not chargeable to
  capital
• - Share of losses/distributions
• Ending basis (but not below zero)

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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

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S Corporation Distributions (1 of 4)

• Distributions for S Corp w/o AEP
• 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

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S Corporation Distributions (2 of 4)

• Distributions for S Corp w/o AEP (continued)
• Corporation recognizes gain on distribution of
  appreciated property
• No loss reported when corp distributes property
  that has declined in value

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S Corporation Distributions (3 of 4)

• Distributions for S Corp w/ AEP
• Distributions based on tiers of earnings
• Distributions from AAA are tax-free
• Distributions from AEP 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

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S Corporation Distributions (4 of 4)

• Distributions for S Corp w/ AEP (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

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Other S Corp Rules(1 of 2)

• Alternative minimum tax
• No S corp AMT
• AMT items pass through to s/h

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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

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End of Chapter 11
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