S Corporations: A Review of the Fundamentals

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S Corporations A Review of the Fundamentals

• Dr. Hughlene A. Burton
• Assistant Professor
• University of North Carolina at Charlotte

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Background

• Enacted in 1958
• Substantive revisions in 1982
• Additional revisions in 1986 and 1987
• Last revisions in 1996

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Eligibility

• Corporate Requirements
• Shareholder Requirements

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Corporate Requirements

• Domestic Corporation
• Can be a member of an affiliated group
• Corporations not eligible
• Financial Institutions
• Insurance companies
• Corporations electing Section 936

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One-Class of Stock

• Identical rights to distributions and liquidation
  proceeds
• Distributions may vary in time
• Constructive distributions ignored

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One-Class of Stock

• Voting rights may differ
• Debt Obligations
• Substantially nonvested stock

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Shareholder Requirements

• Number
• Not more than 75
• Type
• Individual
• Estates
• Trusts
• QSST
• ESBT
• Tax-Exempt Organization

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Election

• Filed on Form 2553
• File before the 15th day of the 3rd month
• Late Filings
• Shareholders must consent

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Special Considerations

• LIFO Recapture
• Pension and Profit Sharing
• Contribution of Property

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Permitted Year

• Calendar
• Fiscal if there is a business year
• Code Section 448

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Revocation

• Shareholders that own gt 50 of the stock consent
• Year Effective
• Method

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Termination

• Number of shareholders
• Ineligible shareholder
• Second class of stock
• Excess Passive Income

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Effect of Termination

• No longer a pass through
• Both an S and a C return may be due
• Allocation of income
• Distributions

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Inadvertent Termination

• Termination may be ignored
• Must correct problem in a timely manner

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Reelection

• Cannot reelect for 5 years
• Special rule under 1996 Act
• Approval

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Effect of Election on Corporation

• Tax Liability
• Computation of Taxable Income
• Elections

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Effect of Election on Shareholders

• Allocation of items of income and deductions
• Pro Rata Share
• Interim closing of the books
• No special allocations
• Year of inclusion

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Stock Basis

• Basis Calculation
• Basis Adjustment Order
• All positive items
• Nondeductible, noncapital expenses
• Expenses and Losses
• Distributions

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Stock Basis

• Basis Computed at End of Year
• Basis Computed on a Share by Share Basis
• Inherited Stock Basis

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Basis in Debt

• Initial Basis
• Basis Reduced by Losses
• Restoration of Basis

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Loss Limitations

• Basis
• At-Risk
• Passive

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Distributions

• Effect on Current Taxable Income
• Earnings Profits
• Order of Distributions
• AAA
• PTI
• E P
• OAA

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Post-Termination

• Post-Termination Period
• Post-Termination Distributions
• Suspended Losses

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Excess Passive Losses

• Tax Imposed
• Gross Receipts Defined
• Passive Income Defined

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Computation of Tax

• Excess Passive Income Net Passive
• Income X (Passive Investment Income -
• 25 Gross Receipts) / Passive Investment
• Income
• Tax Excess Passive Income x 34

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Capital Gains Tax

• Applies to S corporations that elected S status
  before 1987
• Conditions for tax to apply
• Tax 34 x (Net Capital Gains - 25,000)

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Built-in Gains Tax (BIG)

• Applies to gains recognized in the recognition
  period
• Recognition Period - 10 years
• Unrealized BIG FMV of assets at conversion -
  Basis of assets at conversion

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Built-in Gains Tax (BIG)

• Tax Highest corporate rate X recognized BIG
• Gain reduced by BIG tax
• Transitional rules