Ch 11 Part 2 Flashcards
Passive income test 3 things
Applies annually
Terminates S election if more that 25% of corps gross receipts
Are passive investment income for 3 consecutive years
And corporation has Subchapter C E&P at end of each 3
consecutive years
6 common events that terminate S election status
1 exceeding 100 shareholder limit
2 having ineligible shareholder own stock
3 creating second class of stock
4 attaining a prohibited tax status
5 Selecting an improper tax year
6 failing passive income test 3 consecutive years
Passive investment income
Includes royalties, rents, dividends, interest, annuities and
Capital gains on stocks
Subchapter C E&P
Subchapter C E&P includes only earnings accrued in tax years
Where S election was not in effect
S termination year
Terminating event occurring at some time other than first
Day of tax year creates an S termination year
S termination year divided into S short year and C short year
S short year
Begins on first day of tax year and ends on day preceding
termination date
C short year
Begins on termination date and continues through last day of corporation’s tax year
Returns preparation for S short year and C short year
Prepared on separate returns
S corp can use either of 2 rules to allocate the termination year’s income between S short year and C short year
1 general rule: allocates ordinary income/loss and separately Stated items between S short year and C short year based on # days in year
2 special election: corp can use normal accounting rules
To allocate, with consent of all shareholders of corporation
Inadvertent termination
Corporation can remain S corp with IRS approval
And necessary adjustments made to meet requirements
Of being an S corp
New election following termination
Corp must wait 5 years to make another S election after
termination unless it receives permission from IRS
Under regulation 1.1362-5 what 2 situations warrant an early reelection of an S corp?
1 more than 50% stock owned by persons who didn’t own
Stock on termination date
2 when event causing termination was not within control of
Corp or the SHs having substantial interest in corp and not
Part of plan to terminate election
Termination of an S election can potentially increase…
Corporate and shareholder taxes
What 4 steps can shareholders take to prevent untimely termination of an S election
1 monitor all transfers of S corp stock
2 establish procedures for S corp to purchase stock of deceased
Shareholders to avoid the stock being acquired by ineligible SHs
3 establish restrictions on transferability of S corp stock by having
SHs enter into stock purchase agreement
4 monitor passive income earned by S corp
Stock purchase agreement
Provides stock can’t be transferred without prior consent of
All shareholders
And if necessary consent can’t be obtained, corp will repurchase
Stock at specified price
Taxable year of S corp (sec 1378)
1 tax year ending December 31
2 any fiscal year for which corporation establishes business
Purpose
Section 1378 specifically notes that income deferral for shareholders is…
Not a necessary business purpose
When is a natural business year considered to end, when business has nonpeak and peak business periods?
Soon after close of peak business period
Ownership tax year
Same tax year used by shareholders owning over 50% of corp’s
Outstanding stock
Adoption of ownership tax year Permitted for S corps
Section 444 permits an S corp to elect a…
Fiscal year other than a permitted year
Having a deferral period of 3 months or less
A Sec. 444 election is not required of an S corporation that…
Satisfies the business purpose exception
What must an S corporation do that has elected a fiscal year under sec. 444?
Make required payments
Which approximate deferral benefit for fiscal year
2 accounting method elections for S corp shareholders
1 deduction and recapture of mining exploration expenditures
2 credit for foreign income taxes
S corp: ordinary income or loss
Net of income other than separately stated items
S corporation separately state items
Same as partnership separately stated items
Calendar year (including certain 52-53 week years)
Permitted tax year unless an exception applies
When will IRS grant approval for ownership year?
Tax year requested is same as shareholders owning more than
50% of corp’s outstanding stock
Test must be met on first day of year for which approval is
Requested
When will IRS grant approval for natural business year?
25% or more gross receipts for each of 3 most recent 12-month
Periods are in last 2 months of requested tax year
When will IRS grant approval for facts and circumstances year?
Corp establishes business purposes using facts and
circumstances of situation other than ownership year or
Natural business year
Non permitted fiscal year
Sec. 444 election permits S corp to use otherwise nonpermitted
Tax year if deferral period is 3 months or less
And corp makes necessary required payments
What form does an S corp report it’s separately stated items?
Form 1120S Schedule K
The character of income, gain, deduction, loss or credit item
Does not change merely because item passes through to
Shareholders
Deductions that can’t be claimed by S corporations 3
1 dividends received deduction
2 US production activities deduction
3 same deductions disallowed to partnership
Same deductions disallowed to both partnership and S corp under sec. 703, 6 things
1 personal and dependency exemptions 2 itemized deductions for individuals 3 tax paid or accrued by foreign country or US possession 4 charitable contributions 5 oil and gas depletion 6 NOL carry backs and carry forwards
2 similarities S corps have with C corps
1 S corps can elect to amortize organizational expenditures
2 20% reduction in certain tax preference benefits if S corp
Was a C corp in proceeding 3 tax years
Carryovers and carry backs when corporation status changes
No carryovers or carry backs that originate in C corp tax year
Can carry to an S corp tax year other than carryovers used to
Offset built in gains
No carryovers/carry backs created in S corp tax year can
Carry to C corp tax year
What happens when losses from S corp tax year are greater than shareholder’s income for the year?
Can create NOL carryover or Carryback for shareholder
What 3 special taxes is the S corporation subject too
1 excess net passive income tax
2 built in gains tax
3 LIFO recapture tax
Excess net passive income (sec. 1375) tax, when does it apply?
Applies when S corp has passive investment income for tax
Year that exceeds 25% of gross receipts
And at close of tax year S corp has Subchapter C E&P
Excess net passive income equation
Excess net passive income =
(Net passive income)
x ([passive investment income - 25% gross receipts]/ passive investment income)
Excess net passive income tax is not a problem for…
A corporation that has always been an S corp
Excess net passive income tax calculation
Excess net passive income x 35% (corporate tax rate)
Built-in gains (sec. 1374) tax, what does it apply to? 3 things
Applies to any income or gain corp would have included in
Gross income while a C corporation
Only if the corp used the accrual method of accounting (built
In gain )
Applies over 10 year period beginning date S election took
Effect
Built in loses
Any deductions or loses corp would have deducted while a
C corp had corp used accrual method
And that corporation reports beginning on 10 year period
Of jan 1 S election is made
A recognized built in gain can’t exceed…
property’s FMV - adjusted Basis on first day of 10 year recognition
Period
A recognized built in loss can not exceed…
Exceeds of property’s adjusted basis over its FMV on first
Day of 10 year recognition period
The net recognized built in gain for tax year is limited to smaller of excess of 3 things
1 net unrealized built in gain
2 total net recognized built in gain for prior tax years beginning
In 10 year recognition period
3 S corp’s taxable income as if it were C corp, but no dividends
Received deduction or NOL deduction allowed
If the net if the recognized built in gains and losses exceeds the corporation’s taxable income and the corporation made an S election after March 30, 1988, the excess built in gain…
Carries over to the next tax year
Where it may be subject to built in gains tax in the carryover year
LIFO recapture tax
If C corp uses LIFO inventory method makes an S election
They are required to include LIFO recapture amount in
Gross income for last C corp tax year
LIFO recapture amount
(Excess of inventory’s basis for tax purposes under FIFO)/
Basis under LIFO at close of final C corp tax year
S corp’s inventory basis is increased by…
The LIFO recapture included in gross income
LIFO inventory recapture is paid in…
Installment payments
Income allocation procedures for S corp shareholder
Shareholders must report pro rata share of ordinary income/loss
And separately stated items for S corp tax year
Allocated on per day/per share method
Special allocations
Permitted for partnerships but not S corporations
Allocation of loss
Occurs on daily basis
