Ch 11 Part 3 Flashcards
Unlike the partnership taxation rules, a shareholder cannot increase his stock basis by…
A Ratable share of general S corporation liabilities
Shareholder loss limitation
Shareholder deduction for ordinary loss and separately stated
items is Limited to:
(Adjusted basis in S corp stock)
+ (indebtedness owed directly by S corp to shareholder)
What 4 adjustments does a shareholder make in determining their stock basis limitation for loses?
1 increase stock basis for any capital contributions during yr.
2 increase stock basis for ordinary income and separately
Stated income or gain items
3 decrease stock basis for distributions not included in
Shareholder’s income
4 decrease stock basis for non deductible, noncapital
expenditures
Sequencing basis reduction for distributions ahead of losses means that distributions…
Distributions Reduce deductibility of S corp loss and deduction
Passthroughs
But losses don’t affect treatment of S corp distributions
When is the adjusted basis of S corp stock generally determined?
Last day of the year
If disposed before that date, bases is determined immediately
Before disposition
Loss and deduction pass through items are allocated to each
share of stock and reduce…
Each share’s basis
Once losses and deductions have reduced stock basis to zero, they then…
Reduce the basis of any debt owed by S corp to shareholder
Any loss or deduction pass through not currently deductible…
Is suspended until shareholder regains basis in his stock or
Debt
The carry over period is unlimited
Unused losses when shareholder sells or transfers to family member
If shareholder sells, unused losses are lost and the new shareholder
Doesn’t get them
If S corp stock is transferred to another family member, the
Unused losses are still available for that family member
3 special shareholder loss and deduction limitations
1 at risk rules
2 passive activity limitation rules
3 hobby loss rules
At risk rules (sec. 465)
Shareholder can deduct a loss from particular S corp activity
Only to extent the shareholder is at risk in S corp’s activity at
Year end
Passive activity limitation rules
Losses and credits from passive activity offset income earned
From passive activities in same or subsequent tax year
S corp shareholder must personally meet the material participation
Standard
Passive activity limitation rules: Material participation standard
S corp’s material participation in an activity doesn’t allow
Passive investor to deduct S corp losses against his or
Her salary and other active income
Hobby loss rules
S corp losses are subject to sec. 183 hobby loss rules unless
They can demonstrate profitable activity
Post termination loss carryovers
Loss and deduction carryovers incurred in S corp tax years
Can carry over to shareholder level even though S election
Terminated
Post termination transition period
Only period when shareholders can deduct post termination
Loss carryovers
Starts on termination date and ends one year after
During the post termination transition period, the shareholder can deduct the loss carryovers…
Only up to his adjusted basis of stock
Uneducated losses are losses forever
What is the allocation process of losses and deduction of S corporations?
Losses and deductions are allocated based on # of shares of
stock owned by each shareholder on each day of tax year
Special allocations of losses and deductions are not permitted
Termination of the S election requires the tax year be divided into 2 parts. The corporation can elect (with shareholder’s consent) to allocate the loss or deduction according to…
When is this election also available too?
The corporations accounting methods
Also available when shareholder’s interest in S corp terminates
Losses and deductions pass through on a…
Per share basis
Losses and deductions are limited to…
The shareholder’s basis in debt and stock
Losses and deductions that are not deducted…
Carry over to tax year where shareholder regains stock and
Debt basis
What is the time period of the loss and deduction carryover
Unlimited time period
When do unused loss carryovers lapse?
If shareholder transfers stock to anyone other than spouse
Or former spouse in incident of divorce
What 3 special loss limitations are S corp shareholders subject too?
1 at risk rules
2 passive activity limitations
3 hobby loss rules
What separately stated loss and deduction item is subject to shareholder loss limitations?
Investment interest expense
What other separately stated items are subject to corporate limitations but not shareholder limitations?
50% no deductible portion of meals and entertainment
Section 1366 definition of family
Spouse, ancestors, lineal descendants and trusts created for
Such individuals
How often must S corp basis be adjusted?
Annually
Basis adjustments to shareholder’s stock equation
Initial investment (or basis at beginning of tax year)
+ additional capital contributions made during year
+ allocable share of ordinary income
+ allocable share of separately stated income and gain items
- distributions excluded from shareholder’s gross income
- (allocable share of any expense not deductible in determining ordinary income and not chargeable to capital account)
- allocable share of ordinary loss
- allocable share of separately state loss and deduction items
= adjusted basis for stock (but not less than 0)
Why is determination of stock basis in an S corp. important?
To determine gain or loss on sale of stock and determine amount
Of losses that can be deducted
And determine amount of distributions to shareholders that are
Nontaxable
What is the basis of stock purchased from another shareholder?
Cost basis
What is the basis for stock received as part of a corporate formation?
Substituted basis from assets transferred
What is the basis for stock acquired by gift?
Takes donor’s basis adjusted for gift taxes
Or FMV (if lower)
Basis of stock acquired from decedent’s death?
FMV date of death or alternative valuation date (if elected)
What is the basis adjustment when corporation makes initial S election?
No basis adjustment is made
Basis of S corp stock inherited firm deceased shareholder?
FMV - corporate income that would have been income in
Respect of decendent
Ordinary income and separately stated income and gain items, what is there effect on shareholder’s basis? Does it matter if they are tax exempt?
Increase shareholder’s basis whether taxable or tax exempt
Ordinary income and separately state gain items first restore the basis of what?
First restore the basis of debt the corporation owes the S corp
Shareholder
Then it restore’s shareholder’s stock basis
When does repayment of shareholder indebtedness result in gain recognition?
When repayment amount exceeds debt’s adjusted basis
Character of repayment of indebtedness: if debt is secured by note, if not?
If debt is secured by note, gain is capital in character
If debt is unsecured, repayment is ordinary income
Corporations that have no E&P: treatment of distributions
2-tier rule applies: distributions are initially nontaxable and reduce
Shareholders stock basis (not below 0)
If distribution exceeds shareholder’s stock basis, shareholder
treats excess as capital gain from sale or exchange of stock
Can distributions that exceed stock basis be tax free to the extent of shareholder loans?
No, although amount of deductible losses can be increased
By amount of shareholder loans, nontaxable limitations are
Strictly limited to stock basis
Distributions never reduce debt basis
If an S corporation distributes appreciated property to its shareholders, what are the tax consequences? 3 things
1 S-corp recognizes gain if it sold the property, taxed at corporate
Level as part of S corp’s built in gains or excess net passive
Income
2 shareholders basis reduced by FMV of distribution, and
shareholder is never taxed on shareholder level
3 Losses not recognized
Accumulated adjustments account (AAA)
Account required for S corporations that have E&P from previous
C corp election
Account represents cumulative income and loss recognized
In S corp
If AAA account is positive and sufficient basis exists in stock, then distributions are…
Non taxable and reduce stock basis
Year end AAA balance equation
AAA balance at beginning of year
+ ordinary income
+ separately state gain items (except tax exempt income)
- distributions made from AAA
- ordinary loss
- separately stated loss and deduction items (except tax exempt)
- (expenses not deductible in determining ordinary income
And not chargeable to capital account)
= year end AAA (accu. Adjustments acct.) balance
Source of money or property distributions made by S Corporations have accumulated E&P: classification - Accumulated adjustments account
What’s the Tier and treatment of the distribution from this account?
Tier 1
Nontaxable generally
Source of money or property distributions made by S Corporations have accumulated E&P: classification - Accumulated E&P
What’s the Tier and treatment of the distribution from this account?
Tier 2
Taxable (dividend)
Source of money or property distributions made by S Corporations have accumulated E&P: classification - Basis of S corporation stock
What’s the Tier and treatment of the distribution from this account?
Tier 3
Nontaxable generally
Source of money or property distributions made by S Corporations have accumulated E&P: classification - Excess over stock basis
What’s the Tier and treatment of the distribution from this account?
Tier 4
Taxable (capital gain)
5 differences exist between positive and negative adjustments required for AAA (accumulated adjusted account)
1 distributions not included in gross income reduce stock basis
Before negative adjustments, otherwise distributions reduce AAA
After negative adjustments
2 when net negative adjustment occurs it reduces AAA after
Distribution
3 tax exempt income doesn’t increase AAA but increases basis
In S corp stock
4 nondeductible expenses reduce stock basis and AAA (unless
Produce tax exempt income)
5 AAA can be negative but S corp stock basis can’t
Allocation of AAA balance to individual distributions, when does it occur?
Occurs at year end after taking into account current year income
And loss items
In general AAA balance is allocated ratably to individual distributions within a tax year based on…
Amount of money or FMV of noncash property
Other Adjustments Account (OAA) when do corporations maintain it?
Maiif they have accumulated E&P at end of year
Other Adjustments Account (OAA), what increases 1 and decreases 2 this account?
Increases: tax exempt income earned
Decreases: distribution out of OAA and federal taxes paid by
S corp attributable to C corp tax years
Property distributions (other than money) made by S corporation with accumulated E&P: tax consequences, how do they affect AAA?
Trigger gain recognition
FMV of noncash property distributed reduces AAA
Distribution ordering election, define, what are the benefits of this in an example?
S corp can elect to change the distribution order of E&P and AAA
Ex. Can elect to skip over AAA, by distributing straight from
C corp E&P can avoid excess net passive income tax and
Subchapter S termination
Post termination transition period distributions
Nontaxable distributions of money made during S corp’s
Post termination transition period
Can be made to shareholders who owned S corp stock on
Termination date, come from AAA balance then from E&P
Any distributions made from current or accumulated E&P and noncash distributions during post termination period are…
Taxable
What happens to the AAA balance when the post termination period ends?
It disappears
Profits earned during S election during post termination period: tax consequences on distribtutions
Can’t be distributed tax free from AAA
can be distributed tax free to extent shareholder’s stock basis
Once corp distributes all its E&P
