11-1 ©2010 pearson education, inc. publishing as prentice hall
TRANSCRIPT
11-1©2010 Pearson Education, Inc. Publishing as Prentice Hall
11-2
S CORPORATIONSS CORPORATIONS(1 of 2)(1 of 2)
Should an S election be made?S corporation requirementsElection of S corporation statusS corporation operations Taxation of the Shareholder
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11-3
S CORPORATIONSS CORPORATIONS(2 of 2)(2 of 2)
Basis adjustmentsS corporation distributionsOther rulesTax planning considerationsCompliance and procedural
considerations
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11-4
Should an S Election Be Should an S Election Be Made?Made?
Advantages (1 of 3)Advantages (1 of 3)
No corporate level taxationIncome 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/hLimitations are computed at s/h level
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11-5
Should an S Election Be Should an S Election Be Made? Made?
Advantages (2 of 3)Advantages (2 of 3)
S corp losses can be used to offset shareholders’ other income
Allowed to split S corp income between family membersWith restrictions
S corp earnings not subject to SE tax
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11-6
Should an S Election Be Should an S Election Be Made? Made?
Advantages (3 of 3)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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11-7
Should an S Election Be Should an S Election Be Made? Made?
Disadvantages (1 of 3)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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11-8
Should an S Election Be Should an S Election Be Made? Made?
Disadvantages (2 of 3)Disadvantages (2 of 3)
No dividends-received deductionNo special allocations allowed
Income allocated based on ownershipS corp liabilities do not increase loss
limitsExcept for shareholder loan to S corp
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11-9
Should an S Election Be Should an S Election Be Made? Made?
Disadvantages (3 of 3)Disadvantages (3 of 3)
S corps and shareholders subject to at-risk 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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11-10
S Corporation S Corporation RequirementsRequirements
(1 of 3)(1 of 3)
Shareholder requirementsNo more than 100 shareholders
Family members count as one shareholderInclude 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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11-11
S Corporation S Corporation RequirementsRequirements
(2 of 3)(2 of 3)
Shareholder requirements (continued)U.S. citizens or resident aliensTax-exempt public charity or private
foundation may be a shareholderCorporation-related requirements
Domestic corporationOr unincorporated entity electing to be
treated as a corp under check-the-box Regs
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11-12
S Corporation S Corporation RequirementsRequirements
(3 of 3)(3 of 3)
Corporation-related requirements (continued)Must not be an “ineligible” corporationOnly one class of stockMay be a Qualified Subchapter S
Subsidiary (QSSS)QSSS is 100% owned by an S corpAssets, liabilities, income deductions, etc.
considered owned by S corp parent
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11-13
Election of S Corporation Election of S Corporation StatusStatus
Taxes Applicable to S CorporationsTaxes 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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11-14
Election of S Corporation Election of S Corporation Status Status
Making the ElectionMaking the Election
Form 2553 must be filed no later than 15th day of third month for year election is to be effectiveA 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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11-15
Election of S Corporation Election of S Corporation Status Status
Terminating the Election (1 of 3)Terminating the Election (1 of 3)
Voluntary S election terminationOwners of more than 50% of the
corporation’s stock must agreeRevocation made w/in 1st 2-1/2
months can be retroactive to beginning of yearOtherwise, election effective for 1st
day of next taxable year
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11-16
Election of S Corporation Election of S Corporation Status Status
Terminating the Election (2 of 3)Terminating the Election (2 of 3)
Involuntary S election terminationOccurs when corporation ceases to
meet S corporation requirementsIf 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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11-17
Election of S Corporation Election of S Corporation Status Status
Terminating the Election (3 of 3)Terminating the Election (3 of 3)
Inadvertent termination can be undone
New S corp election cannot be made for 5 tax years after terminationUnless inadvertent termination
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11-18
S Corporation OperationsS Corporation Operations
Taxable yearAccounting method electionsOrdinary income and separately
stated itemsU.S. production activities
deductionSpecial S corporation taxes
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11-19
Taxable Year(1 of 2)
Permitted tax yearsA year ending on December 31,
Including a 52-53 week year, ORAny fiscal year where a business
purpose has been established including a natural business year
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11-20
Taxable Year(2 of 2)
Other tax years may be electedOwnership year - same year as
shareholders owning 50% of stockFacts and circumstances year§444 allows S corp to elect a fiscal year
end of 9/30 or later w/o satisfying business purpose exceptionAdvance payments required to eliminate
benefit of income deferral
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11-21
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 activitiesRefer to Form 1120S Schedule K in
Appendix B for a complete listing
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11-22
Ordinary Income/Loss &Separately Stated Items (2 of
4)
S corps cannot deductDividends-received deductionPersonal or dependency exemption“Personal” itemized deductionsTaxes paid/accrued to foreign countryCharitable contributionsOil & gas depletion NOL carryovers from C corp years
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11-23
Ordinary Income/Loss &Separately Stated Items (3 of
4)
Net operating lossesNOLs 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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11-24
Ordinary Income/Loss &Separately Stated Items (4 of
4)
U.S. production activities deductionDetermined at s/h level50% 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 OR6% (in 2009) of the qualified production
activities income allocated to the s/h
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11-25
Special S Corporation Taxes
Special levies apply to S corpsExcess net passive income taxBuilt-in gains taxLIFO recapture tax
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11-26
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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11-27
Excess Net Passive Income Tax(2 of 2)
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[Passive investment
income] – [25% of gross receipts]__________________
Passive investment
income
Net passive income
X =
Excess net
passive income
11-28
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 accountingE.g., property with a FMV in excess
of basis on day S election was made
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11-29
Built-in Gains Tax(2 of 2)
Tax is 35% (top corp rate) on net built-in gains recognized during tax yearBuilt-in gains recognized less any built-in
losses recognizedBuilt-in gains tax applies to
dispositions during 10-year period after S election is made
See Example 13
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11-30
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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11-31
LIFO Recapture Tax(2 of 2)
LIFO recapture amount included in taxable income of corp’s final C corp tax yearAdditional tax can be paid in four
annual installmentsS corp’s basis in inventory increased
by LIFO recapture amountSee example 14
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11-32
Taxation of the Taxation of the ShareholderShareholder
Income allocation procedures Loss and deduction pass-through
to shareholders Family S corporations
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11-33
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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11-34
Income Allocations(2 of 2)
1. Divide item by # of days in tax year Daily amount for each item
2. Divide daily amount by # of shares o/s
Daily amount per share for each item
3. Total daily allocations for a share4. Multiply amount per share times #
of shares held by owner
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11-35
Loss & Deduction Pass-through
to Shareholders
Allocating the lossPer share per day allocation same
as for incomeShareholder limitationsSpecial shareholder loss and
deduction limitationsPost-termination loss carryovers
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11-36
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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11-37
Shareholder Loss Limitations(2 of 2)
Sequence for stock basis limitation 1. Beginning basis2. + Capital contributions3. + Share of ordinary income and
separately stated items4. - Distributions not included in s/h inc.5. - Nondeductible, noncapital
expenditures Basis available to absorb S corp loss
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11-38
Special Shareholder Loss and Deduction Limitations
§465 at-risk rules applied at s/h levelPassive activity rules
S/h must meet material participation std. to avoid passive activity limitation
§183 hobby loss rules apply at s/h levelSuspended losses do not transfer
Unless transfer to spouse incident to divorce
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11-39
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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11-40
Family S Corporations
Donee or purchaser of stock in S corp not considered a shareholder unlessSuch stock acquired in bona fide
transaction ANDDonee or purchaser is the real
owner of stock
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11-41
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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11-42
Basis AdjustmentsBasis Adjustments(2 of 2)(2 of 2)
Basis adjustments to shareholder debtAfter 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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11-43
S Corporation S Corporation DistributionsDistributions
Without AE&P (1 of 2)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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11-44
S Corporation S Corporation DistributionsDistributions
Without AE&P (2 of 2)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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11-45
S Corporation S Corporation DistributionsDistributions
With AE&P (1 of 3)With AE&P (1 of 3)
Distributions based on tiers of earningsDistributions from AAA are tax-freeDistributions from AE&P are taxableDistributions that reduce basis in S
corp stock are tax-freeDistributions over stock basis are
taxable
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11-46
S Corporation S Corporation DistributionsDistributions
With AE&P (2 of 3)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 accountEnding AAA balance
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11-47
S Corporation S Corporation DistributionsDistributions
With AE&P (3 of 3)With AE&P (3 of 3)
S corp can elect to skip over AAA in determining source of distributionsCould be used to avoid excess net
passive income tax and termination of S election
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11-48
Other RulesOther Rules(1 of 2)(1 of 2)
Alternative minimum taxNo S corp AMT
AMT items pass through to s/hRelated party transactions
§267 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
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11-49
Other RulesOther Rules(2 of 2)(2 of 2)
Fringe benefits paid to shareholder-employeeFor 2% (or more) shareholder, S
corp treated like a partnershipMany benefits tax-free to C corp
shareholder-employees are taxable to S corp shareholder-employees
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11-50
Tax Planning Tax Planning ConsiderationsConsiderations
(1 of 2)(1 of 2)
Election to allocate income based on the S corp’s accounting methodsAvailable when S election terminates or
s/h terminates or substantially reduces ownership
May use per-share-per-day method ORClosing-of-the-books method
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11-51
Tax Planning Tax Planning ConsiderationsConsiderations
(2 of 2)(2 of 2)
Increasing benefits from S corp lossesConsider basis-increasing transactions
Passive income requirementsS corp can earn unlimited passive
income if no AE&P from C corp yearsIf 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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11-52
Compliance and Compliance and Procedural Procedural
ConsiderationsConsiderations
Making the electionForm 2553
§444 electionAttach Form 8716 to Form 1120S for
first yearTax return filed using Form 1120S
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