UCF School of Accounting Tax 5015

1
UCF School of AccountingTax 5015

• S Corporations
• Chapter Twelve

2
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

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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.

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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

5
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

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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

7
Passive Income Test

• IF S Corps Passive Income exceeds 25 of total
  gross receipts for 3 consecutive years AND
  
• S Corp has C Corp EP
• THEN S Corp election terminated beginning of 4th
  year.
  
• Passive Income gains from sale of securities,
  royalties, rents, dividends, interest, and
  annuities.

8
S Corp. Operations

• S Corp.s make same accounting period and
  accounting method elections as C Corps.
  
• Tax Year - usually calendar year
• Although business purpose exception is allowed
• Accounting Methods
• Most elections made by S Corp
• Exceptions same as partnerships - discharge of
  indebtedness, mining exploration expenditures,
  FTC
  

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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/Hs 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.
  

10
Shareholders 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

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Loss Limitations

• Both ordinary and separately stated loss amounts
  are passed through to the shareholders.
  
• The shareholders deduction is limited to
• s/hs 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

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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 EP)
• 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
  

13
S Corp Distributionsno C Corp EP 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

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S Corp DistributionsS Corps with C Corp EP

• Cash Distribution
• AAA (Tax Free up to S/Hs Basis in Stock)
• PTI (Tax Free up to S/Hs Basis in Stock)
• Accumulated E P (Taxable)
• Other Adjustments Account (Tax-Free up to S/Hs
  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

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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).

16
OAA Account

• Other Adjustments Account (OAA) maintained only
  by corps having accumulated EP at year end
  
• Computed as follows
• Beginning of year OAA Balance
• PlusTax 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

17
Excess Net Passive Income Tax

• If S Corps 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

18
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/Hs from sale of assets