20 S Corporations

Question 1

What forms are used to report S corporation income?

Answer 1

Report taxable income on Form 1120S.
Report separately stated items for each shareholder on schedule K-1.

Question 2

What items increase a stockholder’s basis in an S corporation?

Answer 2

Additional contributions
Share of income and exempt income

Question 3

What items decrease a stockholder’s basis in an S corporation?

Answer 3

Distributions from accumulated adjustments accounts
Share of nondeductible expenses and corporate loss

Question 4

List the four limits on S corporation shareholders for flow-through of losses.

Answer 4

1. Adjusted basis of stock
2. Adjusted basis of direct loans to corporation by the shareholder once stock basis exhausted
3. May only deduct losses to extent at risk
4. Passive loss limits

Question 5

What percentage of shareholders must agree to the S election?

Answer 5

100%; it must be unanimous.

Question 6

What circumstances may cause a termination of S corporation status?

Answer 6

Majority vote of all shares
Violation of an eligibility requirement
Violation on limit of passive investment income for three consecutive years

Question 7

List the characteristics of an S corporation.

Answer 7

Shareholders are not liable for debt.
Shares are freely transferred.
Shareholders can be employees.
Flow-through taxation.

Question 8

List the requirements for an S corporation status.

Answer 8

No more than 100 shareholders.
Nonresident aliens, partnerships, and most trusts cannot be shareholders.
Only one class of stock is outstanding (voting and nonvoting is OK).

Question 9

List the types of trusts that can be stockholders in a corporation.

Answer 9

Estates
Grantor trusts where grantor is alive
Testamentary trusts within two years after death
Special stock voting trusts (all beneficiaries are shareholders)
Qualified S trusts (all beneficiaries are shareholders)
Small business electing trusts
Exempt entities

Question 10

What corporations are ineligible for S corporation status?

Answer 10

Most subsidiaries
Financial institutions
Domestic international sales corporations (DISCs)
Foreign corporations

Question 11

What is the accumulated adjustments account?

Answer 11

An account maintained to keep track of undistributed income and loss items for which the shareholders have already been taxed so that distributions can be distinguished between those that are taxable to shareholders and those that are distributions of income that have already been taxed. Amounts received out of AAA are not taxable when distributed.

Question 12

What is a separately stated item?

Answer 12

Items that are reported separately on the tax return of an S corporation (1120S) because of their tax treatments, enabling shareholders to each recognize their proportionate share of each item and handle it properly on their tax returns. They include capital gains and losses, Section 1231 gains and losses, dividends and interest, passive activities, charitable contributions, Section 179 depreciation elections, and tax credits.

Question 13

Briefly describe an S corporation.

Answer 13

A closely held corporation that, upon meeting certain qualifications, elects to be treated as a pass-through entity for tax purposes such that its income is not taxable to the corporation, but each shareholder is taxed on a proportionate share on a Schedule K-1.

Question 14

True or False: All shareholders must be U.S. residents or citizens.

Answer 14

True. All shareholders must be U.S. residents or citizens; nonresident aliens are not eligible.

Question 15

True or False: An S corporation can have voting and nonvoting stock.

Answer 15

True. There can be only one class of stock (e.g. no preferred stock). Voting rights may differ. Thus, two classes of common stock – one voting and one nonvoting – does not violate the one class of stock requirement.

Question 16

When must an S election be made in order for it to be effective for the current tax year?

Answer 16

A unanimous election on Form 2553 must be made by the 15th day of the 3rd month of the tax year (March 15 for calendar corporations, 2 1/2 months) for it to be effective for the current year. Any election made after that cannot become effective until the start of the following tax year.

Question 17

When is a termination effective if the S corporation has passive investment income >25% of gross receipts for 3 consecutive years and accumulated E&P* from C corporation years?

Answer 17

The S corporation termination effective date is the first day of the fourth year.

Question 18

What is the OAA and what does it represent?

Answer 18

The OAA is for nontaxable income and related deductions. Tax-exempt income and related deductions do not affect the AAA. These items, along with tax-exempt life insurance proceeds and related nondeductible life insurance premiums paid, accumulate in the other adjustments account (OAA).

Question 19

True or False: Distributions can reduce AAA below zero.

Answer 19

False. Distributions cannot cause AAA to go below $0 or increase a negative balance.

Question 20

In regard to distributions from an S corporation to a shareholder, describe the bypass election.

Answer 20

Bypass Election: If a corporation with AEP makes the bypass election, AEP is deemed distributed first resulting in dividend income to shareholders.

Question 21

Chief Inc is an S corporation and has the following reported on its income statement. Calculate Chief’s ordinary business income.
Gross revenue from sales $100,000
Advertising $ 1,200
Salaries paid $ 32,000
Long-term capital gain $ 4,400

Answer 21

Gross revenue from sales $100,000
Advertising (1,200)
Salaries paid (32,000)
Ordinary business income $ 66,800
The long-term capital gain is a separately stated item.

Question 22

True or False: An S corporation shareholder’s basis can never be negative.

Answer 22

True. The shareholder’s basis may never fall below zero. Distributions from the corporation reduce basis as a nontaxable return of capital, but never below zero. However, if cash distributions exceed basis, then basis is reduced to zero and any excess distribution is taxed as capital gain (i.e. the stock is a capital asset).

Question 23

Provide the calculation for an S corporation shareholder’s outside basis.

Answer 23

Shareholder’s beginning basis in corporation
+ Additional contributions
+ Percentage share of corporation’s ordinary income and separately stated income, gains
− Distributions from corporation (ie, cash and property)
− Percentage share of corporation’s operating loss and separately stated deductions, losses
= Ending shareholder basis (basis cannot fall below zero)

Question 24

True or False: An S corporation shareholder can increase their outside basis in the S corporation by their share of corporate debt.

Answer 24

False. Because S corporation shareholders have liability protection like a C corporation, debts of the corporation do not impact the shareholder’s stock basis. However, direct loans made by the shareholder to the corporation will create debt basis, which may be used to deduct pass-through losses.