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advantages of S Corp treatment
- - income is taxed only to its shareholders
- - losses pass through to its shareholders and is used to reduce taxes on other types of income.
- - undistributed income taxed to the shareholder is not taxed again when subsequently distributed unless it exceeds the basis for their stock
- - Capital gains, dividends, and tax exempt income, are separately stated and retain their character when passed through to the shareholders
- - Deductions, losses, and tax credits are separately stated and retain their character when passed through to the shareholders.
- - splitting the S Corps income among family is possible if they are reasonably compensated.
- -Earnings that pass to the shareholders are not subject to self-employment tax.
- - Not subject to the personal holding tax or accumulated earnings tax
Disadvantages of S Corp
- - S Corps earnings are taxed to the shareholders, even though they are not distributed.
- - subject to an excess net passive income tax, and a built-in gains tax.
- - Not eligible for the dividends-received deduction
- - allocation of ordinary income or loss and the separately stated items is based on the stock owned on each day of the tax year
- - Shareholders can increase their loss limitations by the basis of any debt they loan to the S Corp
- - subject to at-risk, passive activity limitations, and hobby loss rules.
- - must use calendar year unless they can establish a business purpose for a fiscal year
Shareholder related requirements to elect S Corp
- - corp must not have more than 100 shareholders
- - all shareholders must be individuals, estates, certain tax-exempt organizations, or certain kinds of trusts
- - none of the individual shareholders can be classified as a nonresident alien.
100- Shareholder Rule
- -members of a family (and their estates) count as one shareholder
- - Members of a family do not include members who are more than 6 generations removed from the youngest generation
- - two unmarried or nonfamily individuals who own stock together are each considered a separate shareholder
- - C corps and partnerships cannot own S Corp stock
- - a tax-exempt public charity or private foundation can hold stock and is considered one shareholder
- - 7 types of trusts can be shareholders (grantor, voting, testamentary, QSST's, qualified retirement plan, small business, and beneficiary-controlled)
-not US citizens can only own stock if they are U.S. residents or are married to a U.S. citizen or resident alien and make an election to be taxed as a resident alien
Corporation related requirements to elect S Corp
- - Corp must be a domestic corp or an unincorporated entity that elects to be treated as a corp under the check-the-box regulations
- - the corp must not be an "ineligible" corporation'
- - the corp must have only one class of stock
- -Corps that maintain a special federal income tax status (banks that use the reserve method to account for bad debts and insurance companies)
- - Corps that have elected the special Puerto Rico and U.S. possessions tax credit or that had elected the special Domestic International Sales Corp tax exemption
Qualified Subchapter S Subsidiary (QSub)
- a domestic corp that qualifies as an S corp, is 100% owned by an S corp, and for which the parent S corp elects to threat the subsidiary as a Qsub.
A corp is treated as having only one class of stock if ____
all of its oustanding shares of stock possess identical rights to distribution and liquidation proceeds and the corp has not issued any instument or obligation, entered into any arrangement, that is treated as a second class of stock.
not treated as a second class of stock
Sec 1361 Safe Harbor debt is not treated as a second class of stock if:
- -the debt must represent an unconditional promise to pay a certain sum of money on a specified date or on demand.
- - the interest rate and interest payment dates must not be contingent on profits or the borrowers discretion.
- - The debt must not be convertible directly or indirectly into stock
- - the creditor must be an individual, estate, or trust eligible to be an S corp shareholder, or a nonidividual creditor actively and regularly engaged in the business of lending money
S Corp election
-must be made the previous year or on or before the 15 day of the 3rd month wished to be an S corp
Consent of shareholders
each person who is a shareholder on the election date, or who previously owned stock during any portion of the year preceding the election date must consent to the election of S corp
Revocation of S election
- any person owning more than 50% on the day of revocation, must consent to the revocation
- - If the revocation is made within the first 2 1/2 months it takes effect on the first of that year
- - if its made after March 15, the revocation takes place January 1 of the next year
Events that terminate S election
- -exceeding the 100-shareholder limit
- - having an ineligible shareholder own some of the stock
- - creating a second class of stock
- - attaining a prohibited tax status
- - selecting an improper tax year
- - failing the passive investment income test for three consecutive years
Passive investment income test
- terminates election if more than 25% of the corp's gross receipts are passive investment income for each of the three consecutive tax years and the corp has Subchapter C earnings and profits at the end of each of the three consecutive tax years.
Passive investment income
royalties, rents, dividends, interest, annuities, and gains from the sale or exchange of stocks and securities.
S Short year
begins on the first day of the year and ends of the day preceding the termination date
C short year
begins on the day of termination and continues through the last day of the corps tax year
New election following termination
a corp that revokes its S election must wait 5 years before it can elect S corp again
Natural business year
when a business has nonpeak and peak periods of business, the natural business year is considered to end at, or soon after, the close of the peak business period.
Ownership tax year
the same tax year used by shareholders owning more than 50% of the corp's outstanding stock
Separately stated items
- Net ST and LT capital gains and losses
- Sec 1231 gains and losses
- Unrecaptured Sec 1250 gains
- Sec 179 expense
- Charitable contibutions
- Dividends and interest income
- Taxes paid or accrued to foreign country
- Tax-exempt interest
- Investment income and expenses
Deductions that cannot be claimed
- - dividends-recieved deduction
- - us production deduction
- - charitable contributions, oil and gas, NOL carrybacks and carryfowards)
Excess net passive income tax
applies when an S corp has passive investment income for the tax year that exceeds 25% of its gross receipts and, at the close of the tax year, the S corp has Subchapter E and P.
Excess net passive income calculation
Net passive income x (passive income - 25% of gross receipts including passive income) / (passive investment income)
The excess net passive income is then multiplied by 35%
Built in gains tax
applies to any income or gain the corp would have included in gross income while a C corp, had the corp used the accrual method of accounting and that the corp reports during the ten-year period begining on the date of S election
any deductions or losses the corp would have deducted while a c corp has the corp used the accrual method of accounting and that the corp reports during the ten-year periood begining on the date the S election took effect.
Built-in gains include
the differences between FMVs and adjusted bases of assets held at the time the S election takes effect.
Sec 1374 tax determination
- 1. Determine the corps net recognized built-in gain for the tax year
- 2. Reduce the net recognized built-in gain from step 1 by any NOL or capital loss carryovers from prior C corp tax years
- 3. Compute a tentative tax by multiplying the amount determined in step 2 by 35%
- 4. Reduce the tax determined in Step 3 by the general business credit and minimum tax credits carryovers from any prior C corp tax years
Net recognized built in gains tax limitation
- the smaller of:
- - the excess of (1) the net unrealized built-in gain over (2) the total net recognized built-in gain for prior years begining in the ten-year period
- - the S corps taxable income as if it were a C corp but with no dividends-received deduction or NOL deduction allowed
the excess of the inventory's basis under FIFO over its basis under LIFO at the close of the final C corp tax year.
Shareholder loss limitations
limited to the sume of the adjusted basis for their S corp stock plus the adjusted basis of any idebtedness owed directly by the s corp to the shareholder
Determining the stock basis limitation for losses
- - increase stock basis for any capital contributions during the year
- - increase stock basis for ordinary income and separately stated income or gain items
- - decrease basis for distributions not included in the shareholders income
- - decrease basis for nondeductible, noncapital expenditures
Loss deduction carryover in transfers of stock
carryover loss does not transfer to the new shareholder unless the transfer is made to a spouse or former spouse
a shareholder can deduct a loss from an S corp activity only to the extent the shareholder is at risk in the S corps activity at year end
Passive activity limitation rules
losses and credits from a passive activity offset income earned from that passive activity or other passive activities in the same or subsequent tax year. An S corp shareholder must personally meet the material participation standard for an activity to avoid the passive activity limitation.
Hobby loss rules
limit deductions to the activity's gross income unless the S corp can establish that it is engaged in the activity for profit
a court decision that becomes final, a closing agreement entered into, a final disposition of a refund claim by the IRS, or an agreement between the corp and the IRS that the corp failed to qualify as an S corp
Basis adjustment to S corp Stock
- Begin with initial investment
- Plus: additional capital contributions made during the year
- - allocable share of ordinary income
- - allocable share of separately stated income and gain items
- - distributions excluded from the shareholders gross income
- - allocable share of any expense not deductible in determining ordinary income and not chargeable to the capital acct
- - Allocable share of ordinary loss
- - allocable share of separately stated loss and deduction items
- AAA balance at the beginning of the year
- - ordinary income
- - separately stated income and gain items
- - Distributions made from AAA
- - Ordinary loss
- - separately stated loss and deduction items
- - expenses not deductible in determining ordinary income and not chargeable to the capital account
Transactions involving related parties
deny a payor a deduction for an expense paid to a related payee when a mismatching of the expense and income items occurs because of differences in account methods