©2010 Pearson Education, Inc. Publishing as Prentice Hall
11-1
S CORPORATIONS
(1 of 2)
 Should
an S election be made?
 S corporation requirements
 Election of S corporation status
 S corporation operations
 Taxation of the Shareholder
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11-2
S CORPORATIONS
(2 of 2)
 Basis
adjustments
 S corporation distributions
 Other rules
 Tax planning considerations
 Compliance and procedural
considerations
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11-3
Should an S Election Be Made?
Advantages (1 of 3)
 No
corporate level taxation
Income
taxed directly to shareholders
Benefit
reduced because dividends are
generally taxed to individuals at 15%
(through 2009)
 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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11-4
Should an S Election Be Made?
Advantages (2 of 3)
S
corp losses can be used to offset
shareholders’ other income
 Allowed to split S corp income
between family members
With
S
restrictions
corp earnings not subject to SE tax
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11-5
Should an S Election Be Made?
Advantages (3 of 3)
S
corp not subject to personal holding
company or accumulated earnings
taxes
 LLCs and partnerships may make S
election
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11-6
Should an S Election Be Made?
Disadvantages (1 of 3)
 Earnings
retained by C corp taxed at
rates generally lower than
shareholders’ marginal tax rates
 S corp earnings taxed to shareholders
even if no distributions are made
 S corps subject to excess net passive
income tax & built-in gains tax
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11-7
Should an S Election Be Made?
Disadvantages (2 of 3)
 No
dividends-received deduction
 No special allocations allowed
Income
allocated based on ownership
S
corp liabilities do not increase loss
limits
Except
for shareholder loan to S corp
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11-8
Should an S Election Be Made?
Disadvantages (3 of 3)
S
corps and shareholders subject to atrisk rules, passive activity limits, and
hobby loss rules
 S corp restricted in type & number of
shareholders
 S corps generally must use calendar
year
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11-9
S Corporation Requirements
(1 of 3)
 Shareholder
No
requirements
more than 100 shareholders
Family
members count as one shareholder
 Include
common ancestor, spouses of
common ancestor or lineal descendents, and
estates of family members
Individuals,
estates, and certain types of
trusts (including QSSTs)
QSSTs
may be complex trusts
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11-10
S Corporation Requirements
(2 of 3)
 Shareholder
requirements (continued)
U.S.
citizens or resident aliens
Tax-exempt public charity or private
foundation may be a shareholder
 Corporation-related
Domestic
requirements
corporation
Or
unincorporated entity electing to be
treated as a corp under check-the-box Regs
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11-11
S Corporation Requirements
(3 of 3)
 Corporation-related
(continued)
requirements
Must
not be an “ineligible” corporation
Only one class of stock
May be a Qualified Subchapter S
Subsidiary (QSSS)
QSSS
is 100% owned by an S corp
Assets, liabilities, income deductions, etc.
considered owned by S corp parent
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11-12
Election of S Corporation Status
Taxes Applicable to S Corporations
S
election exempts corps from all
taxes imposed by IRC Chapter 1
except
§1374
built-in gains tax
§1375 excess net passive income tax
§1363(d) LIFO recapture tax
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11-13
Election of S Corporation Status
Making the 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
shareholders must consent to
election
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11-14
Election of S Corporation Status
Terminating the Election (1 of 3)
 Voluntary
S election termination
Owners
of more than 50% of the
corporation’s stock must agree
Revocation made w/in 1st 2-1/2 months
can be retroactive to beginning of year
Otherwise,
election effective for 1st day of
next taxable year
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11-15
Election of S Corporation Status
Terminating the Election (2 of 3)
 Involuntary
S election termination
Occurs
when corporation ceases to
meet S corporation requirements
 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
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11-16
Election of S Corporation Status
Terminating the Election (3 of 3)
 Inadvertent
termination can be
undone
 New S corp election cannot be made
for 5 tax years after termination
Unless
inadvertent termination
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11-17
S Corporation Operations
 Taxable
year
 Accounting method elections
 Ordinary income and separately
stated items
 U.S. production activities deduction
 Special S corporation taxes
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11-18
Taxable Year
(1 of 2)
 Permitted
A
tax years
year ending on December 31,
Including
a 52-53 week year, OR
Any
fiscal year where a business
purpose has been established including
a natural business year
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11-19
Taxable Year
(2 of 2)
 Other
tax years may be elected
Ownership
year - same year as
shareholders owning 50% of stock
Facts and circumstances year
§444 allows S corp to elect a fiscal year
end of 9/30 or later w/o satisfying
business purpose exception
Advance
payments required to eliminate
benefit of income deferral
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11-20
Ordinary Income/Loss &
Separately Stated Items (1 of 4)
 Income
is divided between ordinary
and separately stated items
 Separately stated items same as for
partnerships, including passive
activities and portfolio activities
Refer
to Form 1120S Schedule K in
Appendix B for a complete listing
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11-21
Ordinary Income/Loss &
Separately Stated Items (2 of 4)
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
NOL carryovers from C corp years
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11-22
Ordinary Income/Loss &
Separately Stated Items (3 of 4)
 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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11-23
Ordinary Income/Loss &
Separately Stated Items (4 of 4)
 U.S.
production activities deduction
Determined
at s/h level
50% salary limitation
Each
s/h is allocated a share of S corp’s
W-2 wages equal to lesser of
 S/h’s
allocable share of W-2 wages OR
 6% (in 2009) of the qualified production
activities income allocated to the s/h
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11-24
Special S Corporation Taxes
 Special
levies apply to S corps
Excess
net passive income tax
Built-in gains tax
LIFO recapture tax
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11-25
Excess Net Passive Income Tax
(1 of 2)
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
highest corporate tax rate (35%)
 See Example 11
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11-26
Excess Net Passive Income Tax
(2 of 2)
[Passive investment
income] – [25% of
gross receipts]
__________________
Passive investment
income
X
Net
passive =
income
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Excess
net
passive
income
11-27
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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11-28
Built-in Gains Tax
(2 of 2)
 Tax
is 35% (top corp rate) on net builtin 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 13
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11-29
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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11-30
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
S corp’s basis in inventory increased by
LIFO recapture amount
 See
example 14
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11-31
Taxation of the Shareholder



Income allocation procedures
Loss and deduction pass-through to
shareholders
Family S corporations
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11-32
Income Allocations
(1 of 2)

Shareholders report pro rata share of
ordinary income & separately stated
items


Known as per day/per share method
See Example 16
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11-33
Income Allocations
(2 of 2)
1.
Divide item by # of days in tax year

2.
Divide daily amount by # of shares o/s

3.
4.
Daily amount for each item
Daily amount per share for each item
Total daily allocations for a share
Multiply amount per share times # of
shares held by owner
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11-34
Loss & Deduction Pass-through
to Shareholders
 Allocating
the loss
Per
share per day allocation same as for
income
 Shareholder
limitations
 Special shareholder loss and
deduction limitations
 Post-termination loss carryovers
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11-35
Shareholder Loss Limitations
(1 of 2)
 Ordinary
& separately stated loss
amounts “passed” through to
shareholders
 Shareholder’s deduction limited to
adjusted basis in stock plus adjusted
basis of debt owed directly by corp
to shareholder
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11-36
Shareholder Loss Limitations
(2 of 2)
Sequence for stock basis limitation

1.
2.
3.
4.
5.
Beginning basis
+ Capital contributions
+ Share of ordinary income and
separately stated items
- Distributions not included in s/h inc.
- Nondeductible, noncapital expenditures
Basis available to absorb S corp loss
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11-37
Special Shareholder Loss and
Deduction 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
 Suspended losses do not transfer
Unless
transfer to spouse incident to divorce
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11-38
Post-Termination Loss Carryovers
 Unused
S corp losses due to basis
limitations
 Carried over up to 1 yr after
termination
Depending
on reason for termination
 Unused
loss carryovers after post
termination period are lost
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11-39
Family S Corporations
 Donee
or purchaser of stock in S
corp not considered a shareholder
unless
Such
stock acquired in bona fide
transaction AND
Donee or purchaser is the real owner of
stock
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11-40
Basis Adjustments
(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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11-41
Basis Adjustments
(2 of 2)
 Basis
adjustments to shareholder 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
shareholder has basis in debt or stock
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11-42
S Corporation Distributions
Without AE&P (1 of 2)
 Money
distributions tax-free and
reduce shareholder basis, but not
below zero
 When shareholder has a zero basis,
distributions received treated as gain
from sale of stock
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11-43
S Corporation Distributions
Without AE&P (2 of 2)
 Corporation
recognizes gain on
distribution of appreciated property
No
loss reported when corp distributes
property that has declined in value
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11-44
S Corporation Distributions
With AE&P (1 of 3)
 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
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11-45
S Corporation Distributions
With AE&P (2 of 3)
+
+
-
Beginning AAA balance
Ordinary income
Separately stated inc/gain items
Ordinary loss
Separately stated loss deductions
Non-deductible expenses not
chargeable to capital account
Ending AAA balance
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11-46
S Corporation Distributions
With AE&P (3 of 3)
S
corp can elect to skip over AAA in
determining source of distributions
Could
be used to avoid excess net passive
income tax and termination of S election
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11-47
Other Rules
(1 of 2)
 Alternative
No
minimum tax
S corp AMT
AMT
 Related
items pass through to s/h
party transactions
related party rules apply between
s/h and S corp
§267 applies to S corp and another
entity if >50% of both entities owned
by same persons
11-48
§267
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Other Rules
(2 of 2)
 Fringe
benefits paid to shareholderemployee
For
2% (or more) shareholder, S corp
treated like a partnership
Many
benefits tax-free to C corp
shareholder-employees are taxable to S
corp shareholder-employees
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11-49
Tax Planning Considerations
(1 of 2)
 Election
to allocate income based on
the S corp’s accounting methods
Available
when S election terminates or
s/h terminates or substantially reduces
ownership
May use per-share-per-day method OR
Closing-of-the-books method
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11-50
Tax Planning Considerations
(2 of 2)
 Increasing
Consider
 Passive
benefits from S corp losses
basis-increasing transactions
income requirements
S
corp can earn unlimited passive
income if no AE&P from C corp years
If
AE&P exist, S corp can elect to have
distributions come from AE&P before AAA
to avoid excess net passive income tax
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11-51
Compliance and Procedural
Considerations
 Making
Form
 §444
2553
election
Attach
year
 Tax
the election
Form 8716 to Form 1120S for first
return filed using Form 1120S
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11-52
Comments or questions about PowerPoint Slides?
Contact Dr. Richard Newmark at
University of Northern Colorado’s
Kenneth W. Monfort College of Business
[email protected]
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