1 chapter 11: s corporations. 2 s corporations (1 of 2) n should an s election be made? n s...
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Chapter 11:S Corporations
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S CORPORATIONSS CORPORATIONS(1 of 2)(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 CORPORATIONSS CORPORATIONS(2 of 2)(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 ElectionShould an S ElectionBe Made Be Made (1 of 4)(1 of 4)
Advantages of S corp– No corporate level taxation
» Income taxed directly to shareholders
– S corp losses can be used to offset s/h’s other income– All items retain character in s/h’s 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 ElectionShould an S ElectionBe Made Be Made (2 of 4)(2 of 4)
Advantages of S corp (continued)– Allowed to split S corp income between
family members (with restrictions)– S corp earnings not subject to SE tax
Disadvantages of S corp– Earnings retained by C corp taxed at rates
generally lower than s/h’s marginal tax rates
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Should an S ElectionShould an S ElectionBe Made Be Made (3 of 4)(3 of 4)
Disadvantages of S corp (continued)– 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– No dividends-received deduction– No special allocations allowed
» Income allocated based on ownership
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Should an S ElectionShould an S ElectionBe Made Be Made (4 of 4)(4 of 4)
Disadvantages of S corp (continued)– S corp liabilities do not increase loss limits
»Except for s/h loan to S corp
– 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 S Corporation RequirementsRequirements (1 of 2) (1 of 2)
Shareholder requirements– No more than 75 shareholders– Individuals, estates or certain types of trusts– U.S. citizens or resident aliens– Tax-exempt public charity or private
foundation may be a shareholder as of 1998
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S Corporation S Corporation RequirementsRequirements (2 of 2) (2 of 2)
Corporation-related requirements– Domestic corporation
– Must not be an “ineligible” corporation
– Only one class of stock
– May be a Qualified Subchapter S Subsidiary (QSSS)
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S Corporation ElectionS Corporation Election
Form 2553 must be filed no later than 15th day of third month for year election is to be effective– A new corporation’s tax year begins on first
day it acquires assets, has shareholders or begins business
All shareholder must consent to election
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Termination of S ElectionTermination of S Election(1 of 2)(1 of 2)
S election terminated when – Corporation either voluntarily revokes the
election (owners of more than 50% of the corporation’s stock must agree) or
– Corporation ceases to meet small business corporation (S corp) requirements
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Termination of S ElectionTermination of S Election(2 of 2)(2 of 2)
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
Inadvertent termination can be undone New S corp election cannot be made for 5 tax
years after termination
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Tax YearTax Year(1 of 2)(1 of 2)
Permitted tax years– A year ending on December 31, or
– Any fiscal year where a business purpose has been established including a natural business year
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Tax YearTax Year(2 of 2)(2 of 2)
Other tax years may be elected– Ownership year - same year as
shareholders owning 50% of stock
– Facts and circumstances year
– Sec. 444 year - deferral period of 3 months or less with advance payments
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Ordinary Income/Loss & Ordinary Income/Loss & Separately Stated ItemsSeparately Stated Items (1 of 3) (1 of 3)
Income is divided between ordinary and separately stated items
Separately stated items same as for partnerships plus passive activities and portfolio activities– Refer to Form 1120S Schedule K in
Appendix B for a complete listing
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Ordinary Income/Loss & Ordinary Income/Loss & Separately Stated ItemsSeparately Stated Items (2 of 3) (2 of 3)
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 or NOL carrybacks
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Ordinary Income/Loss & Ordinary Income/Loss & Separately Stated ItemsSeparately Stated Items (3 of 3) (3 of 3)
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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Special S Corporation Special S Corporation TaxesTaxes
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 E&P
Excess net passive income taxed at 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% 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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LIFO Recapture Tax(2 of 2)
LIFO recapture amount included in taxable income of corp’s final C corp tax year– Additional tax can be paid in four
annual installments See example C11-14
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Shareholder AllocationsShareholder Allocations
S/hs report pro rata share of ordinary income & separately stated items– 1. Divide item by # of days in tax year– 2. Divide daily amount by # of shares o/s– 3. Total daily allocations for a share– 4. Multiply amount per share times # of shares held
by owner– See Example C11-16
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Loss LimitationsLoss Limitations
Ordinary & separately stated loss amounts “passed” through to s/h
S/h’s deduction limited to adjusted basis in stock plus adjusted basis of debt owed directly by corp to s/h
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Additional LimitationsAdditional Limitations
§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
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Family S CorporationsFamily S Corporations
Donee or purchaser of stock in S corp not considered a s/h unless– Such stock acquired in bona fide
transaction AND
– Donee or purchaser is the real owner of stock
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Basis AdjustmentsBasis Adjustments(1 of 2)(1 of 2)
Initial investment+ Additional contributions+ Share of income/separate items- Distrib’s 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 AdjustmentsBasis Adjustments(2 of 2)(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 S Corporation DistributionsDistributions (1 of 2) (1 of 2)
Distributions for S Corp w/o AE&P – 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– Corporation recognizes gain on distribution
of appreciated property
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S Corporation S Corporation DistributionsDistributions (2 of 2) (2 of 2)
Distributions for S Corp w/ AE&P – Distributions based on tiers of earnings
»Distributions from AAA are tax-free»Distributions from AE&P 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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Other S Corp RulesOther S Corp Rules(1 of 2)(1 of 2)
Alternative minimum tax– No S corp AMT
»AMT items pass through to s/h
Related party transactions– §267 related party rules apply between s/h and S
corp– §267 applies to S corp and another entity if >50%
owned by persons
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Other S Corp RulesOther S Corp Rules(2 of 2)(2 of 2)
Fringe benefits paid to s/h-employee– For 2% (or more) s/h, S corp treated
like a partnership»Benefits tax-free to C corp s/h-employees
are taxable to S corp s/h-employees
