Ch 11 Part 1 Flashcards
How are S corporations treated for legal and tax purposes?
Treated as corporation for legal purposes
Treated as partnership for tax purposes
3 purposes for Congress’s creation of the S corporation
1 permit businesses to select particular form of business
organization without being influenced by tax considerations
2 provide aid to small businesses with taxation only on shareholder
Level
3 permit corps realizing losses to obtain tax benefit of offsetting
The losses against income at shareholder level
Advantage: S-corp. income is exempt from…
Corporate income tax
Advantage: S- corp’s losses
Pass through to its shareholders
Can be used to reduce taxes owed on other types of income
Advantage: undistributed income taxed to shareholder is…
Not taxed again when distributed unless distribution exceeds shareholder’s basis in his stock
Advantage: capital gains, dividends and tax exempt income
Are separately stated and retain their character when passed
Through to shareholders
Advantage: deductions, losses and tax credits
Separately stated
And retain character when passed through to shareholders
Advantage: splitting S corporation’s income
Possible among family members
Advantage: what 2 taxes are earnings that pass through to S-corp’s shareholders not subject too?
2) What other tax are S-corp’s not subject too?
Self-employment tax and accumulated earnings tax
2) personal holding company tax
Disadvantage: C corp. is treated as separate entity
C corp is treated as separate tax entity from its shareholders,
Thereby permitting its first $50k in income to be taxed at 15%
Disadvantage: earnings are taxed even if…
They aren’t distributed to S corp shareholders
Disadvantage: 2 taxes S corp’s are subject to that partnerships aren’t subject to?
1 Excess net passive income tax
2 built in gains tax
Disadvantage: dividends
Dividends received by S corp aren’t eligible for dividends
Received deduction
Disadvantages: special allocations
Not permitted for ordinary income or loss for S corp as they
Are in a partnership
Disadvantage: loss limitations
Smaller for S corp shareholder because treatment of liabilities
S corp shareholder’s can increase their loss limitations by
Basis if debt they loan to S corp, whereas partners can
Ratably share all partnership liabilities
Disadvantage: 3 rules S-corps are subject too that C - corps aren’t?
1 at risk
2 passive activity limitation
3 hobby loss rules
Disadvantage: shareholders
S corp restricted in number of shareholders it can have
C corps and partnerships aren’t
Disadvantage: tax year
Must use calendar year unless it can establish business purpose
Can’t use fiscal year
S election: revoked
Can be revoked or terminated any time with minimal effort
2 categories if S corporation requirements
1 shareholder related requirements
2 corporation related requirements
3 shareholder requirements that must be satisfied on each day of the tax year
1 corp must not have more than 100 shareholders
2 all shareholders must be individuals, estates, certain
tax-exempt organizations or certain kinds of trusts
3 none of the individual shareholders can be classified as
A nonresident alien
100 shareholder rule
Members of a family and their estates count as 1 shareholder,
Lineal descendants within 5 generations apart
Unmarried or non family individuals that own stock jointly
Are considered separate shareholders
Eligible shareholders
C corporations and partnerships can’t own S corp stock
Tax exempt organizations under sec. 501 can own S corp stock
7 types of trusts can own S corp stock
1 grantor trusts 2 voting trusts 3 testamentary trusts 4 qualified sub chapter S trusts 5 qualified retirement plan trusts 6 small business trusts 7 beneficiary controlled trusts
Small business trusts
Complex trusts primarily used for estate planning
Can own S corp stock
Alien individuals who are not US citizens
Can only own S corp stock if they are US residents or are
Married to US citizen of make election to be taxed as resident
Alien
S corp election terminates if alien purchased s corp stock
And does not reside in US without making appropriate election
3 corporate related requirements that must be satisfied each day of the tax year
1 corporation must be domestic corp. or unincorporated entity
That elects to be treated as corp under check the box rules
2 corp must not be an “ineligible” corporation
3 corp must have only 1 class of stock
2 ways corporations are ineligible to make an S election
1 Corporations that maintain special federal income tax status
Ex. Financial institutions and banks
2 corps that have elected the special Puerto Rico and
US possessions tax credit or special Domestic Intl. Sales
Cop. Tax deduction
What are S corps allowed to own?
Can own stock of C corp without limitation on percentage of
Voting power or value held
An S corp that owns the stock of a C corp, can’t participate in…
Filing a consolidated return
Qualified Subchapter S Subsidiary (QSub) 4 things
1Domestic corporation that qualifies as an S corp,
2 is 100% owned By an S corp
3 where the parent elects to treat the subsidiary As a QSub
4 assets, liabilities, income, deductions, losses of QSub are
Treated as those if S corp parent and reported on parent’s
Tax return
A second class of stock is not created if the only difference between the 2 classes of stock is…
Voting rights
The determination of whether all outstanding shares of stock confer identical rights to distribution and liquidation proceeds is based on 6 things
1 corporate charter 2 articles of incorporation 3 bylaws 4 applicable state law 5 binding agreements relating to distribution 6 liquidation proceeds
Determine whether outstanding shares confer identical rights, what is not included? 3 things
1 time of death, divorce, disability or termination of employment
2 distributions made on basis of shareholder’s varying stock
Interests during year
3 distributions that differ in timing
Debt instruments, corporate obligations and deferred compensation arrangements generally are…
Not treated as second class of stock
2 safe harbors for characterizing corporate obligations as debt (instead of as second class of stock)
1 unwritten advances from shareholder that don’t exceed $10k
During tax year are treated as debt between 2 parties
2 obligations that are considered equity under general tax laws
But are owned solely by shareholders in same proportion as
Corp’s outstanding stock
4 requirements for straight debt instruments to meet to not be treated as second class of stock if issued when S election is in effect
1 debt must represent an unconditional promise to pay certain
Sum of money on specified date or on demand
2 interest rate and interest payment dates must not be contingent
On profits, or the borrowers discretion
3 debt must not be convertible into stock
4 creditor must be individual, estate or trust eligible to be S corp
Shareholder
The S corp election exempts a corporation from all taxes imposed by Ch 1 of the IRC except for 3 taxes
1 sec 1374 built in gains tax
2 sec 1375 excess net passive income tax
3 sec. 1363 LIFO recapture tax
What 4 common taxes does the S election exempt the corporation from?
1 regular income tax
2 accumulated earnings tax
3 personal holding company tax
4 corporate alternative minimum tax
In what 3 ways does an S election affect shareholders?
1 shareholders report pro rata share of S corp’s ordinary income
Or loss as well as separately stated items
2 shareholders treat most distributions as nontaxable recovery
Of their stock investments
3 shareholders’ stock bases are adjusted for shareholders’
Ratable share of ordinary income or loss and separately stated
Items
The S election can only be made by…
Small business corporations
When must an S election be made?
Before the 15th day of the 3rd month in the tax year wanted for
S election
Can be made later if IRS determines there was reasonable cause
To make the election
Consent of shareholders
Each person who is a shareholder on election date must
Consent to election
Any shareholder who previously owned stock at the beginning
Of the tax year before the election date must also consent to
The election even when they no longer hold stock
Revocation of election
Shareholders owning more than one half the corps stock
On day corp makes revocation must consent to revocation
Revocation made within 2.5 months of tax year is effective
For first of that tax year, anything after 2.5 months applies to
Next year
S Corp requirements: shareholder related 3
1 corp may have no more than 100 SH, family members and
estates Count as 1 SH
2 all SHs must be individuals, estates, certain kinds of trusts,
Tax exempt organizations
3 all individual shareholders must be US citizens or resident
Aliens
S Corp requirements: corporate related 3
1 corp must be domestic or unincorporated entity
2 corp must not be an ineligible corp
3 corp must have only one class of stock issued and outstanding
Differences in voting rights are ignored
An unincorporated entity that makes an S election is automatically treated as…
Having elected to be taxed as a domestic corp under check the
Box regulations
Ineligible corporation
Bank, other financial institution, insurance company or
Foreign corporation
Making the S election: timing
Corp can make S election any time during tax year before 15th
Day of 3rd month of tax year for that tax year to be effective
Late elections effective next year unless corp obtains IRS relief
For reasonable cause
Making the S election: approval
Each shareholder who owns stock on date corp makes election
must consent to election
If corp makes election after beginning of tax year, each person
Who was a shareholder during portion of the tax year proceeding
Election must consent to election
