S Corp Eligibility Requirements

1
S Corp Eligibility Requirements

• Eligible Corps no banks or insurance companies,
  affiliated group member only if Qualified
  Subchapter S Subsidiary 100 owned by S corp
  and election to disregard QSSS as tax entity.
• Shareholder number 100 max. Married couple
  count one. If fiduciary holds, look thru to
  beneficiaries. Families can elect to one six
  generations deep.
• Eligible shareholders No corps, partnerships,
  nonresident aliens, and ineligible trust.
  Estates, qualified pension trusts and some
  charitable trusts OK.
• One Class of Stock. Voting differences only
  allowed.

2
Trusts That Work With S Election

• Voting trusts
• Grantor trusts
• Testamentary trusts that were grantor trusts
  for 2 years following death of grantor.
• Testamentary trusts that receive S corp stock
  under will but only for 2 years following
  death.
• QSST - Qualified Subchapter S Trusts.
  Requires Only one beneficiary all income
  distributed annually to US citizen or resident
  Elect QSST status and treated as owner of S corp
  stock for tax purposes. QTIP Trust classic
  example.
• ESBT Electing Small Business Trust.
  Requires All beneficiaries qualified S corp
  shareholders all interests received by gift or
  bequest, not purchase trust S corp income taxed
  at highest individual marginal rates. Advantage
  allows multiple Bs and income sprinkling.

3
Straight Debt Huge Safe Harbor

• 1361(c)(5)
• Unconditional promise to pay on demand or at
  specified time.
• Interest rate and payments not contingent on
  profits or discretion.
• No convertibility
• Creditor actively and regularly engaged in
  lending money or is individual, estate or trust
  that would be eligible S corp shareholder.
• Note If safe harbor met, excess interest may
  still not be treated as interest for tax
  purposes.

4
Problem 888

• Z Corp 120 shares outstanding. 99 each own 1
  share and A B (brothers) own 21 shares as joint
  tenants. Family exception limits to 100
  shareholders. S Corp allowed.
• Same, except A B are married and own shares
  different ways. S allowed because spouses
  treated only as one shareholder no matter how
  owned per 1361(c)(1). Both spouses must file
  consents.
• Same as (b). Z Makes S election, B dies and
  leaves to friend Z. While in estate, S election
  good. When go to Z, have 101 and S terminates on
  that day and have S short year and C short year.

5
Problem 888

• Same as (a), but last 21 shares held by voting
  trust with 3 beneficiaries. Voting trust
  permissible shareholder, but count now is 102 -
  so no S election.
• Same as (a), but 21 shares owned by revocable
  living trust. Since grantor trust and only one
  person, count only 100 and S election permitted.
• QTIP trust may qualify as qualified subchapter S
  trust under 1361(d) if beneficiary makes
  election under 1361(d)(2).
• Z has 100 shareholders and forms partnership
  with two other corps, each with 100 shareholders.
  Partnership is only business. S election
  permitted per Rev. Rule 94-43. Rationale 100
  limit was for administrative simplicity, which is
  not adversely effected by partnership.

6
Problem 888

• Z has voting and non-voting common stock, which
  is only outstanding stock. Has authorized,
  unissued preferred stock. Z may make S election.
  Voting and nonvoting still considered one class
  per 1361(c)(4). Preferred would kill if issued,
  but no effect if it unissued.
• Same as (h), but agreement gives shareholders
  with large tax burden larger distributions. Two
  classes of stock per Reg. 1.1361-1(l)(2)(v). No
  S election.
• Bonds issued to shareholders proportionately at
  25-to-1 debt/ equity ratio with interest at prime
  plus 3. Clearly bonds may be equity, but not
  kill S if straight debt per 1361(c)(5)(A).
  Neither subordination nor high rate prevent
  straight debt, but excess interest may not be
  deductible as interest.

7
Problem 893

• Basic Facts Snowshoe Inc.
• - A owns 300 share voting common.
• - B, C D own 100 shares nonvoting common
• - Operations began October 3
• Who must consent to S? All shareholders,
  including nonvoting. 1362(a)(2). If B sold to
  G, both B G would need to consent because both
  shareholders during first year. If B refused,
  then election good for second year.
• If B partnership which transfer to
  individual, election not good for first year
  because B (ineligible shareholder) owned for part
  of first year. Election good for year 2.

8
Problem 893

• Basic Facts Snowshoe Inc.
• - A owns 300 share voting common.
• - B, C D own 100 shares nonvoting common
• - Operations began October 3
• When election required? By 15th day of third
  month. 1362(b)(1)(B). Begin Oct 3, so election
  due by Dec 17. New corp year begins when corp
  has shareholders, acquires assets or begins
  business, whichever is first.
• What taxable year allowed? Permitted year is
  calendar year or natural business year. 25 last
  two month gross reciepts test of Rev. Proc.
  87-32. Also, 444 election and 7519 deposit game
  allowed. Since ski resort, should meet 25 test.

9
Problem 893
Basic Facts Snowshoe Inc. - A owns 300 share
voting common. - B, C D own 100 shares
nonvoting common - Operations began October
3 (d) Who can revoke? Those owning more than
half all stock outstanding, including non-voting.
Reg. 1.1362-2(a). A would need one additional
shareholder. If revocation by 15th day of 3rd
month, effective on first day of year.
Otherwise, effective for next year.
1362(d)(1)(C). (e) C sells to nonresident alien?
S termination immediately. 1362(b)(1)(C).
Current year divided into short S year and short
C year. 1362(d)(2)(B) 1362(e).
10
Problem 893
Basic Facts Snowshoe Inc. - A owns 300 share
voting common. - B, C D own 100 shares
nonvoting common - Operations began October
3 (f) Only 5 shares to Olga and C had no
knowledge? 1362(f) permits cure for inadvertent
termination. Olgas sale would need to be
rescinded and C recognizes income otherwise
allocable to Olga. Inadvertent burden of proof
on corporation. Fact that corp had no knowledge
of sale tends to establish proof of
inadvertence. Reg. 1.1362-4(b) and -5.
11
Problem 893
Basic Facts Snowshoe Inc. - A owns 300 share
voting common. - B, C D own 100 shares
nonvoting common - Operations began October
3 (g) What if 45 gross receipts from rentals,
dividends and interest? No problem with S
election because no C corp earnings and profits
1362(d)(3) termination for 25 passive income not
apply. Before 82, there was 20 lid on passive
income for all S corps, but no more. Now passive
termination threat exists only if C corp E P,
which will never exist for corp that has always
been S corp.