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What are the tax rules for a tax-free contribution of property to an S-Corp?
- The event is tax-free, just like forming a C-Corp, if it is a
- Contribution of property (assets or money) and not services
- Solely in exchange for stock, and
- After the transfer, the shareholder(s) have control of the corp through 80% stock ownership
What are the tax consequences of property contributions to an S-Corp in exchange for stock that do not result in 80% ownership?
The transfer is treated as a taxable sale with gain/(loss) recognized by the new shareholder.
What is the basis of property received from a transferor in a tax-free exchange for stock?
- The greater of
- ++ the adjusted basis, plus any gain recognized by the transferor OR
- ++ debt assumed by the S-Corp (transferor may recognize gain to prevent a negative basis)
What is the basis of property received from a transferor in a non-tax-free exchange for stock?
What are the requirements to qualify as an S-Corp?
- Must be a domestic corp.
- The S-Corp may own any portion of a C-Corp (even 100%), but must not file a consolidated return
- Shareholders can include: individuals, estates, trusts, qualified retirement plans, 501(c)(3) orgs, grantor, or voting trust
- Shareholders can NOT include: corporations, partnerships, and non-resident aliens.
- There may not be more than 100 shareholders, but family members may elect to be treated a one shareholder.
- There can only be one class of stock, even if differences in voting rights. Preferred stock is not permitted.
True / False: S-Corps pay tax at the corporate level.
- Generally False, Except
- Tax consequences are passed through to the shareholders, whether or not they receive a distribution from the S-Corp.
- LIFO Recapture Tax
- Built-in Gains Tax
- Tax on Passive Investment Income
What is the LIFO Recapture Tax imposed on an S-Corp?
When a company first operates as a C-Corp, and it uses LIFO for inventory tracking, and then elects to be treated as an S-Corp, the C-Corp must include in taxable income for the last C-Corp year the excess of inventory computed under FIFO over LIFO on a cumulative basis. The resulting tax is paid in 4 equal installments, the first of which is due with the final C-Corp return, and the remainder paid by the S-Corp.
Describe the Built-in Gains Tax imposed on an S-Corp: When is it imposed? How much is the tax?
- A C-Corp turns into an S-Corp and the basis of the assets is less than FMV
- The S-Corp later sells or distributes the asset for a gain.
- The S-Corp is taxed at 35% of the of the lesser of:
- ++ the built-in gain (FMV at date switched to S-Corp minus book value on same date) less any previously recognized gain OR
- ++ the taxable income of the S-Corp as if it were a C-Corp
Describe the exemptions that can be used to avoid the Built-In Gains Tax that could be imposed on an S-Corp?
- If the S-Corp was never a C-Corp (no built-in gain occurred in transfer because there was no transfer)
- The sale occurred 10 years after S-Corp election
- The asset’s appreciation occurred after S-Corp election
- The asset itself was acquired after S-Corp election
- The built-in gain was recognized in previous years
Describe the Passive Investment Income Tax imposed on an S-Corp: When is it imposed? How much is the tax?
- The tax is 35% on the lesser of
- ++ Net income OR
- ++ Excess passive investment income IF the following 2 conditions are met
- ++++ The S-Corp has accumulated earnings attributable to prior periods in which the entity was a C-Corp AND
- ++++ The passive investment income exceeds 25% of gross receipts
What items are considered passive income?
- But NOT gains on sales of securities
Ordinary income of an S-Corp is allocated to shareholders via a K-1 on which basis?
- Per-share owned, on a per-day basis
- This is important when shares have been sold part-way through the year.
How is the shareholder’s basis in an S-Corp determined? What is excluded?
- The adjusted basis in the stock
- Loans made by a shareholder directly to the S-Corp. A nonrecourse loan (the shareholder is not personally liable) increases basis, but not the at-risk amount. Loans made by the S-Corp with a bank do NOT increase basis.
- Not included: shareholder guarantees b/c guarantees are to a bank, but the loan is made by the S-Corp.
True / False: A shareholder takes out a loan from a bank. The shareholder then takes the loan money and makes a separate loan directly with the S-Corp. The shareholder's loan will add to his basis.
- If the S-Corp had made the loan with the bank, it would not add to the shareholder's basis, but making a loan with the shareholder does.
- The S-Corp must then pay the shareholder, and the shareholder then pays the bank.
How is the at-risk amount in an S-Corp determined?
- INCREASES TO AT-RISK AMOUNT
- Generally it is equal to the shareholder’s stock and direct-loans. A nonrecourse loan does NOT increase the at-risk amount. A recourse loan DOES increase the at-risk amount.
- Plus contributions of cash or other property to the S-Corp
- Plus the allocable share of income undistributed
- DECREASES TO AT-RISK AMOUNT
- Allocable share of losses
- Distributions of cash or other property
What amount of S-Corp loss may a shareholder deduct from personal taxes?
The lesser of the basis in the S-Corp, or the shareholder’s at-risk amount
When are fringe benefits deductible vs not deductible to the S-Corp?
- Deductible: for non-shareholder employees and those employee shareholders owning 2% or less of the S-Corp
- Not-Deductible: for employee shareholders owning >2% of the S-Corp unless the benefits are included in W-2 income
What is the Accumulated Adjustments Account used for? What is the balance at the inception of the S-Corp?
- The AAA tracks earnings and profits (retained earnings) of the S-Corp since inception, and then distributions paid to shareholders.
- The balance at S-Corp inception = $0 (b/c the S-Corp hasn’t earned any money)
What items increase the Accumulated Adjustments Account?
- Separately and non-separately stated income and gains EXCEPT
- tax-exempt income and certain life insurance proceeds
What items decrease the Accumulated Adjustments Account?
- Corporate distributions, but distributions cannot reduce the balance of the AAA below zero.
- Corporate expenses and losses. (A corp operating loss can reduce AAA below zero.)
An entity first operated as a C-Corp, and then elected to become an S-Corp. The C-Corp had a positive earnings and profits (E&P=retained earnings) balance. Distributions are now being made to shareholders by the S-Corp. In what order and from which accounts are distributions made?
- 1st: from the AAA balance until depleted (tax-free distribution to shareholders)
- 2nd: from the carryover C-Corp E&P until depleted (shareholders taxed as dividend income)
- 3rd: as return of capital until basis depleted
- 4th: as a capital gain distribution (long-term if held >1 yr, otherwise short-term)
Why are distributions to shareholders made from the Accumulated Adjustments Account tax-free?
Because the shareholders paid tax when the income was created and are receiving a distribution on an amount that was already taxed.
An S-Corp elects to liquidate. What are the tax implications to the S-Corp and its shareholders?
- The S-Corp must recognize gain/(loss) on the distribution of property as if it were sold at FMV. The gain/(loss) is passed as an adjustment to shareholder basis.
- Distributions to shareholders are treated as a sale of their stock (property received = stock sold) and gain/(loss) recognized
- ++ (Cash + FMV of property received) – liabilities assumed – stock basis = taxable gain/(loss)
- ++ The taxaable gain/(loss) may be considered a capital gain/(loss) to the shareholder
Other than a decision to voluntarily terminate the S-Corp, what other events could force the termination of an S-Corp?
- It does not meet the qualifications of an S-Corp, including
- ++ sale of stock to a C-Corp or foreign investor
- ++ the 3-strike rule: >25% of gross receipts come from passive income AND the S-Corp has C-Corp E&P at the end of each year, for 3 consecutive years
True / False: S-Corp debt increases shareholder basis
- Only loans directly from the shareholder to the S-Corp increase that shareholder’s basis. A nonrecourse direct loan will increase basis, but not at risk amount.
What is the order in which a shareholder’s basis in and distributions from an S-Corp are calculated?
-  Shareholder basis to date
-  Increase for income items or excess depletion
-  Decrease for distributions. If the basis is -0- STOP. No additional loss can be taken.
-  Decrease for non-deductible, non-capital expenses and depletion, and
-  Decrease for items of loss and deduction
An S-Corp has both voting and non-voting common stock. What mixture of types of stock, and percentage of stockholders is required to revoke the S-Corp status?
>50% of the shares held, regardless of whether voting or non-voting, and any combination of the two