Eligibility for the S Election

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Eligibility for the S Election

• Chapter 1
• IRC 1361

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Requirements for S Corporation Status

• Domestic ____________
• No ineligible __________
• Maximum of ____ Shareholders
• One Class of __________
• Cannot be ineligible _________

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Requirements for S Corporation Status (Cont)

• Domestic Corporation
• No ineligible Shareholder
• Maximum of 100 (75 pre 2005) Shareholders
• One Class of Stock
• Cannot be ineligible Corporation

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Domestic Corporation Requirement

• SCTG 202
• De jure corporation
• Association
• Regulations 301.7701-5
• Limited liability companies?
• See PLR 9636007

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Domestic Corporation Requirement

• SCTG 202
• De jure corporation
• Association
• Regulations 301.7701-5
• Limited liability companies?
• See PLR 9636007

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Domestic Corporation (Cont)

• Unincorporated entities
• Includes SMLLC, LLC, any Partnership
• Must elect association status per Reg.
  301.7701-3
• Must also qualify as S corporation

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Eligible Shareholders

• SCTG 203
• Individuals
• Estates
• Certain Trusts (Caution)
• Exempt Charitable Pension

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Individuals

• SCTG 203.01
• Must be US _____ or ______
• Community interest?
• Include Estate or trust?

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Individuals (cont)

• Must be US Citizen or Resident
• Community interest holder may disqualify. (Ward)
• Excludes Estates and trusts.

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Estates

• SCTG 203.02
• Two types

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Estates (cont)

• Estates
• Bankruptcy
• Decedent
• Excludes trusts.
• No election or time limit

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Trusts

• SCTG 203.03
• Grantor trusts.
• Beneficiary controlled.
• Qualified Subchapter S trusts.
• Electing Small Business Trusts.
• Testamentary trusts.
• Voting trusts.

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Trusts (cont)

• SCTG 2.03C1 Grantor trusts.
• More rulings on grantor trusts
• Grantor charitable lead trust, eligible PLR
  199936031

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Trusts (cont)

• SCTG 203.03A Grantor trusts.
• Tax treatment
• Additional requirements
• Intentionally Defective

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Grantor Trusts (cont)

• Grantor Trust Defined
• Transparent entity
• Defined by grantor power
• No election or time limit
• Grantor must be US C/R for S corp. qualification

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Grantor Trusts (cont)

• 203.03Aa Tax Treatment of Grantor Trust
• Grantor treated as owner of all trust property
• Thus all income, etc. is taxed to grantor

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Grantor Trusts (cont)

• 203.03Ab Additional Requirements to be S
  Corp. S/h
• Grantor must be U.S. C/R

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Grantor Trusts (cont)

• 203.03Ac Intentionally defective
• Historically undesirable, since trust rates were
  same as mfs, and split income
• After 1993, steep graduations, so usually better
  tax as grantor trust

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Grantor Trusts (cont)

• 2.03C1c Intentionally defective (cont)
• Usually want no trust for income tax, but
  completed gift for transfer tax
• Power to substitute property

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Trusts (cont)

• SCTG 203.03B Beneficiary controlled
• Transparent entity
• Defined by bene. power
• Includes Crummey
• No election or time limit
• Bene. Must be US C/R for S corp. qualification

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Trusts (cont)

• More rulings on Crummey trusts
• Basic strategy
• Present interest for exclusion
• Price is treatment as B/c trust

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Trusts (cont)

• SCTG 203.03C Grantor trusts after death of
  grantor
• Qualifies per se for 2 years
• Must then find other qualification or divest

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Trusts (cont)

• SCTG 203.03D QSST
• 1361(d)
• How many CIBs?
• Who reports income from S corp?
• Who elects for trust?

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QSST (cont)

• CI Beneficiary
• No other person may benefit during life of CIB
• Election by beneficiary note timing
• Annual distributions

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QSST (cont)

• CI Beneficiary reports all income on own return
• Taxable income from S corp.
• CI Beneficiary elects QSST
• Self, parent, guardian

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New Developments 2004

• When trust disposes of all S corporation stock,
  beneficiary may use suspended at-risk, PAL

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Trusts (cont)

• SCTG 203.03E Testamentary trusts
• Draw up instructions for S qualification with will

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Trusts (cont)

• SCTG 203.03F ESBT
• Multiple beneficiaries
• Accumulate or distribute
• Trustee election
• Tax at trust level

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Electing Small Business Trusts (cont)

• One trust can be up to three entities
• ESBT ONLY S corporation stock
• Deemed grantor if power or lapse of power to
  withdraw (Crummey, 55)
• Stand-alone trust

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Electing Small Business Trusts (cont)

• Power of appointment
• Does not disqualify due to potential appointees
  (PCIB) until actually exercised.

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Trusts (cont)

• SCTG 203.03F Electing Small Business Trusts
• Charitable beneficiary, remote contingency did
  not endanger the trusts ESBT status.
• authority to add new beneficiaries as they were
  born was ok

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Trusts (Cont)

• SCTG 203.03G Voting Trust
• Rarely used
• Sometimes part of buy-sell arrangement

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Trusts (Cont)

• SCTG 203.03H Testamentary Trust
• Qualifies per se for 2 years
• Must then find other qualification or divest

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Charitable Organizations and Pension Trusts

• SCTG 203.04
• Does not include IRAs
• UBTI
• ESOP special rules

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Charitable Organizations and Pension Trusts (Cont)

• UBTI on all income from S corp.
• Includes dividend and interest
• Includes gain from sale of stock

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ESOPs

• SCTG 203.05
• Permitted as of 1/1/98
• Restricted as of 3/14/01

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ESOPs (Cont)

• 1 ESOPs in General
• Qualified defined contribution plan
• Invests primarily in employer securities
• Pays participants in stock or cash at retirement

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ESOPs (Cont)

• No current taxation to Trust or participants
• Nondiscrimination Rules

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ESOPs (Cont)

• 2001 Changes
• Identify disqualified persons in ESOP
• Own gt 10 directly
• Own gt 20 using family attribution of 318

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ESOPs (Cont)

• If disqualified persons own gt 50
• Taxed as if current distribution
• Penalty of 10 on participant if age lt 59 ½
  years
• Penalty of 50 on corporation

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ESOPs (Cont)

• Effective date of 2001 change
• If S election in effect and ESOP owns on 3/14/01,
  after 2004
• Otherwise after 3/14/01

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ESOPs (Cont)

• Fiduciary of ESOP signs the Form 2553

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Nominal and Beneficial Shareholders

• SCTG 203.06
• Nominal need not qualify
• Must act like nominal
• Bene. Must qualify and act

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Ineligible Shareholders

• SCTG 203.07
• Any other than above
• Thus , corp., ps, many trusts, LLCs, etc. are all
  disqualified

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Limit on Number of Shareholders

• SCTG 2.04
• Limited to 100 shareholders
• Family attribution after 2004
• Not same as consent rule, where each co-owner
  must sign separately

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Number of Shareholders (Cont)

• Husband, wife, estates, all years
• No election required

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New Developments 2004

• Family attribution after 2004
• No details as of 1/2005
• Up to 6 generations from common ancestors
• One family member must elect
• Inadvertent termination relief (?)

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One Class of Stock

• SCTG 205
• Look to charter, state law
• Shareholder side agreements

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Class of Stock

• Problem areas
• Issued or authorized?
• Identical distributions?
• Options, etc?
• Debt?

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General Rules for Issued Stock

• SCTG 205.01
• EXAMPLE 2 - 15

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Voting Rights

• SCTG 205.02
• Nonvoting allowed

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Voting Rights (cont.)

• Nonvoting shares may be issued to key employees,
  no 2nd class

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Distributions

• SCTG 205.03
• Generally, equal rights
• Varying interest rule
• EXAMPLE 2 - 17
• EXAMPLE 2 - 19

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Distributions (cont.)

• SCTG 205.03A Disproportionate distributions
• Inadvertently makes disproportionate
  distributions, but makes remedial distributions,
  no 2nd class

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Redemptions

• SCTG 205.03C
• 302 tests
• FMV safe harbor

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Transfers of Shares

• SCTG 205.04
• Restrictions
• PLR 9011055
• EXAMPLE 2 - 23
• Brown case

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Stock and Equity-Flavored Compensation

• SCTG 205.05
• Options
• Phantom Stock
• SARs

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Stock Options Issued to Employees

• SCTG 205.05B
• Generally not 2d class
• (Certainty and purpose)

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Options Issued to Nonemployees

• SCTG 205.05E
• (Certainty and purpose)

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Debt Reclassified as Equity

• SCTG 205.06
• Historic problem

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Debt /Equity

• Portage Plastics
• Straight Debt Safe harbor
• Shareholder loans

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Debt /Equity (cont.)

• No cases after Georgia Cold Storage

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Debt /Equity (cont.)

• SCTG 2.05F2 Straight-debt safe harbor.
• Holder must be an individual U.S. citizen or
  resident, an estate or one of the permitted
  trusts
• No charity or pension

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Affiliated Groups

• SCTG 206
• Problem pre-1997

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Other Associations

• SCTG 207
• Brother/sister C and/or S Corp
• Member of p-ship or LLC
• Owner of QSub
• All ok

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Other Ineligible Corporations

• SCTG 208

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Banks and Bank Holding Companies

• SCTG 209
• Several elected
• Some unique problems