S Corporations

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S Corporations
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S Corporations

• Election - Form 2553
• corporate election with shareholders consent
• filing with IRS
• timeliness of election
• 75 day retroactive period
• prospective election
• necessary shareholder signatures

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S Corporations

• Termination of election - revocation
• 75 day retroactive effect
• prospective
• to start of next year
• to prospective date
• majority of shares must vote to revoke
• Termination by loss of eligibility
• effective date of termination
• Termination due to ENPI for three years
• effective date of termination

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S Corporations - Eligibility

• Corporation requirements
• domestic corporation
• insurance companies and certain banks are not
  eligible
• 75 shareholder limitation
• husband and wife are one even if they own shares
  separately
• one class of stock
• may split voting rights from dividend and
  liquidation rights
• safe harbor debt requirements
• calendar year

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S Corporations - Eligibility

• Shareholder requirements
• individuals or estates of individuals
• individuals must be US citizens or resident
  aliens
• certain trusts allowed - pass through trust
  taxation
• grantor trusts, QSSTs, ESBT, testamentary trusts
  -2year limit, voting trusts
• charitable organizations, pension trusts (not
  IRAs) and ESOPs

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S Corporations - Operations

• Organization expenses - 60 month amortization
• Fringe benefits for greater than 2 shareholder
• Shareholder may earn compensation, if reasonable
  in amount
• Distributive share is not self-employment income
• payroll taxes and social security benefit
  implications
• No deduction for charitable contributions
• No guaranteed payments as in K

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S Corporations - OperationsAllocation of
Distributive Share

• Computation of distributive share is comparable
  to partnership
• Allocation of shareholders distributive share
• per share/per day
• interim closing of the books method
• a shareholders interest is terminated
• disposition of more than 20 of interest within
  30 days
• more than 50 of the shares are sold in the year

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S Corporation - Shareholders Outside Basis

• Original basis computed according to the rules of
  C corporations ie 351
• corporate liabilities do not effect shareholder
  basis in stock
• debt basis on debt owed to shareholder
• Effect of operations on basis
• increases basis from share of income and gain
• decreases basis from share of deduction, losses
  and credits
• changes in corporate liabilities have no effect
  on shareholder basis
• Distributions of money and property reduce basis

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S Corporation - Shareholders Outside Basis

• Shareholders outside basis can not be reduced
  below zero
• post distributive share items first
• excess losses or deductions are suspended and
  carried over until there is basis
• post distributions second
• excess distributions are treated as capital gain

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S Corporations - Shareholders Basis in Debt

• Debt - must be owed to the shareholder
• losses and deductions may be recognized to the
  extent a shareholder has basis in debt owed from
  the corporation
• reduce basis in debt after stock basis is reduced
  to zero
• payments on debt principal may result in capital
  gain
• restore debt basis before restoring stock basis

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S Corporations-Transactions with Shareholders

• Transactions with shareholders are generally
  recognized
• subject to related party loss rule of 267

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Distributions from S Corporations

• Earnings and profits - from prior C operations
• if no e and p
• then, distributions are treated as a return of
  capital and reduce shareholders basis
• excess distributions are capital gain
• if a corporation has e and p, then, it must keep
  an Accumulated Adjustments Account as part of its
  equity section in balance sheet.
• AAA tracks S corporate operation taxable amounts
  and includes all items of taxable income, gain,
  deduction, loss and credit that is part of
  shareholders distributive share. AAA is reduced
  by money or property distributions.

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Distributions from S Corporations

• Distributions from e and p are taxable dividends
• Distributions from AAA are return of capital and
  reduce shareholders outside basis
• Most S corporations also keep an Other
  Adjustments Account - OAA that is used to
  reconcile the K-1 amounts with the AAA. Into OAA
  go items that are distributed but not taxable
  i.e. tax exempt interest and expenses
  attributable to tax exempt interest. The OAA
  account is not required by statute but a product
  of double entry accounting.
• Distributions are made in reverse chronological
  order

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Distributions of Property

• Property distributions from S corporations are
  treated like those from C corporations
• the property is deemed sold
• gain or loss is a separately stated item and
  taxable to shareholders
• a shareholder receiving the property has a basis
  equal to the fair market value (deemed sale
  price) of the property

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Distributions from S Corporation

• No distinction made between liquidating and
  current distributions

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Corporate Taxes Imposed on S Corporations

• Excess Passive Income Tax -ENPI
• corporation must have e and p
• passive income exceeds 25 of gross receipts
• 35 rate
• 3 years of this and S status is revoked
• special election possible to distribute e and p

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Corporate Taxes Imposed on S Corporations

• Built in gains tax of 1374
• must have e and p
• taxes the recognition of gains built in to
  balance sheet at the time an election to S status
  is made
• 10 year term
• 35 rate

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Disposition of Stock in S Corporation

• Stock of an S corporation is generally a capital
  asset and, therefore, its sale results in capital
  gain or loss