Chap 3 - Small business Corporations (S Corps) Flashcards
S corporations
Small closely held corporations can elect to be treated like a partnership. In effect, all the earning and losses of the corporation are passed through to the shareholders. This eliminates the corporate tax, but the shareholders are taxed on their share of the corporate earnings regardless of if they were distributed.
If an S corporation has no accumulated earnings and profits, the amount distributed to a shareholder:
a. Has no effect on the shareholder’s basis for the stock.
b. Must be returned to the S corporation.
c. Decreases the shareholder’s basis for the stock.
d. Increases the shareholder’s basis for the stock.
Decreases the shareholder’s basis for the stock.
Choice “c” is correct. If an S corporation has no accumulated earnings and profits, the amount distributed to a shareholder decreases the shareholder’s basis for the stock. The distribution is nontaxable to the extent of the shareholder’s basis.
Choice “b” is incorrect. The amount distributed to a shareholder does not need to be returned to the S corporation.
Choice “d” is incorrect. Distributions do not increase a shareholder’s basis.
Choice “a” is incorrect. Distributions have no effect on a shareholder’s basis if they are out of accumulated earnings and profits and are therefore taxable. They would also have no effect on a shareholder’s basis if the basis is already zero, which would result in the shareholder recognizing a gain to the extent of the distribution. In this case, we are not told whether or not the basis is already zero.
Stahl, an individual, owns 100% of Talon, an S corporation. At the beginning of the year, Stahl's basis in Talon was $65,000. Talon reported the following items from operations during the current year: Ordinary loss $ 10,000 Municipal interest income 6,000 Long-term capital gain 4,000 Short-term capital loss 9,000 What was Stahl's basis in Talon at year-end? a. $50,000 b. $55,000 c. $61,000 d. $56,000
$56,000.
Choice “d” is correct. Stahl’s basis would be computed as follows:
Beginning basis: $ 65,000
+ Income $6,000 (Tax-free income increases basis)
− Loss ($10,000)
− Net capital loss (5,000) - ($4,000 gain netted with $9,000 loss)
= $ 56,000
Computing a shareholders basis in S corp stock:
= initial basis
+ income items (separately and non separately stated items, taxable and tax exempt interest)
+ additional shareholder investments in corporation stock
- distribution to shareholders
- loss or expense items
= ending basis
Choice “a” is incorrect. This choice excludes the $6,000 of municipal interest income from the above calculation. Remember, both taxable and tax exempt items of income give the taxpayer additional basis.
Choice “b” is incorrect. This choice excludes both the municipal interest income and the net capital loss from the above calculation. Remember, both taxable and tax exempt and separately and non-separately stated items (stated on the K-1) of income or loss affect a shareholder’s basis.
Choice “c” is incorrect. This choice excludes the net capital loss from the above calculation. Remember, both separately and non-separately stated items (stated on the K-1) of loss affect a shareholder’s basis.
Baker, an individual, owned 100% of Alpha, an S corporation. At the beginning of the year, Baker’s basis in Alpha Corp. was $25,000. Alpha realized ordinary income during the year in the amount of $1,000 and a long-term capital loss in the amount of $3,000 for this year. Alpha distributed $30,000 in cash to Baker during the year. What amount of the $30,000 cash distribution is taxable to Baker?
a. $0 b. $5,000 c. $4,000 d. $30,000
$4,000.
Choice “c” is correct. The order in which stock basis is increased or decreased is important. Because both the taxability of a distribution and the deductibility of a loss are dependent on stock basis, there is an ordering rule for computing stock basis.
Stock basis is adjusted annually, as of the last day of the S corporation year, in the following order:
- Increased for income items and excess depletion;
- Decreased for distributions;
- Decreased for non-deductible, non-capital expenses and depletion; and
- Decreased for items of loss and deduction.
When determining the taxability of a non-dividend distribution, the shareholder looks solely to his/her stock basis (debt basis is not considered).
In accordance with S-corporation ordering rules for calculation of basis, Baker’s stock basis in Alpha would be calculated as follows:
Initial stock basis $ 25,000
Increase for share of income 1,000
Basis before distribution $ 26,000
Results: $26,000 of the $30,000 distribution would be tax free return of basis; $4,000 would be taxable as capital gain; loss of $3,000 cannot be utilized in current year due to lack of basis.
Choice “a” is incorrect. Baker’s basis before distribution is less than the cash distributed so there would be some gain.
Choice “b” is incorrect. This choice does not take into account the current year activity of the S corporation in determining Baker’s basis.
Choice “d” is incorrect. Based upon the above rule, amounts distributed to the extent of the shareholder’s basis are not taxable.
Lane Inc., an S corporation, pays single coverage health insurance premiums of $4,800 per year and family coverage premiums of $7,200 per year. Mill is a ten percent shareholder-employee in Lane. On Mill’s behalf, Lane pays Mill’s family coverage under the health insurance plan. What amount of insurance premiums is includible in Mill’s gross income?
a. $0 b. $4,800 c. $720 d. $7,200
$7,200.
Choice “d” is correct. $7,200 of insurance premiums (the amount of family coverage premiums, as indicated in the question) is includible in Mill’s gross income.
Rule: Fringe benefits paid by an S corporation are deductible by the S corporation only for non-shareholder employees and those employee-shareholders owning 2% or less of the S corporation. Other fringe benefits paid are deductible by the S corporation if included as part of gross income from the S corporation for the individual receiving the benefits (i.e., included as part of income on the shareholder’s W-2).
Choices “a”, “c”, and “b” are incorrect, per the above rule.
Beck Corp. has been a calendar-year S corporation since its inception on January 2, Year 1. On January 1, Year 4, Lazur and Lyle each owned 50% of the Beck stock, in which their respective tax bases were $12,000 and $9,000. For the year ended December 31, Year 4, Beck had $81,000 in ordinary business income and $10,000 in tax-exempt income. Beck made a $51,000 cash distribution to each shareholder on December 31, Year 4. What was Lazur’s tax basis in Beck after the distribution?
a. $6,500 b. $1,500 c. $52,500 d. $57,500
$6,500.
Choice “a” is correct. Lazur’s tax basis after the distribution was $6,500.
Rule: The adjusted basis of S corporation stock goes up for undistributed earnings (including tax-exempt income) and vice-versa, as it would in a partnership.
Rule: Amounts distributed (including distributions not taxable as dividends) reduce the adjusted basis of the stock.
Lazur’s basis at 1/1/Year 4 $ 12,000
Add:
50% of ordinary income $40,500 [$81,000 × 50%]
50% of tax-exempt income $5,000 [$10,000 × 50%]
Less:
Distribution to Lazur ($51,000)
Basis at 12/31/Year 4 $ 6,500
Choices “b”, “c”, and “d” are incorrect, per the above rules.
Village Corp., a calendar year corporation, began business in Year 1. Village made a valid S corporation election on December 5, Year 3, with the unanimous consent of its shareholders. The eligibility requirements for S status continued to be met throughout Year 4. On what date did Village’s S status become effective?
a. December 5, Year 3. b. December 5, Year 4. c. January 1, Year 4. d. January 1, Year 3.
January 1, Year 4.
Choice “c” is correct.
Rule: In order to be effective for the current taxable year, the S corporation election must be made by the 15th day of the third month of the taxable year. If the election is made after that date, it becomes effective on the first day of the next taxable year, January 1, Year 4, in this case.
Choices “d”, “a”, and “b” are incorrect, per the above rules.
A shareholder’s basis in the stock of an S corporation is increased by the shareholder’s pro rata share of income from:
Tax-exempt interest Taxable interest
a. Yes Yes
b. No Yes
c. Yes No
d. No No
Yes, Yes.
Choice “a” is correct.
Rule: Both tax-exempt and taxable interest income increase a shareholder’s basis in S corporation stock.
Choices “d”, “b”, and “c” are incorrect, per the above rule.
Zinco Corp. was a calendar year S corporation. Zinco’s S status terminated on April 1, Year 1, when Case Corp. became a shareholder. During Year 1 (365-day calendar year), Zinco had nonseparately computed income of $310,250. If no election was made by Zinco, what amount of the income, if any, was allocated to the S short year for Year 1?
a. $0 b. $76,500 c. $155,125 d. $233,750
$76,500.
Choice “b” is correct. ($310,250/365) x 90 = $76,500.
Zinco will be taxed as an S corporation from January 1 to March 31, Year 1, and a C corporation from April 1 to December 31, Year 1. Absent the election to calculate the incomes of the S and C corporation portions of the year separately, Zinco’s income is allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year. Year 1 has 365 days, 90 of which occurred before April 1.
Choice “d” is incorrect. Absent the election to calculate the incomes of the S and C corporation portions of the year separately, Zinco’s income is allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year. This is the income allocated to the C corporation portion of the year.
Choice “c” is incorrect. Absent the election to calculate the incomes of the S and C corporation portions of the year separately, Zinco’s income is allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year, not on a 50/50 split.
Choice “a” is incorrect. Zinco’s income must be allocated on a per-share, per-day basis between the S and C corporation portions of the taxable year.
Bristol Corp. was formed as a C corporation on January 1, Year 1, and elected S corporation status on January 1, Year 3. At the time of the election, Bristol had accumulated C corporation earnings and profits, which have not been distributed. Bristol has had the same 25 shareholders throughout its existence. In Year 6, Bristol’s S election will terminate if it:
a. Increases the number of shareholders to 100.
b. Has passive investment income exceeding 90% of gross receipts in each of the three consecutive years ending December 31, Year 5.
c. Takes a charitable contribution deduction.
d. Adds a decedent’s estate as a shareholder to the existing shareholders.
Has passive investment income exceeding 90% of gross receipts in each of the three consecutive years ending December 31, Year 5.
Choice “b” is correct. S corporations that are former C corporations with undistributed C corporation earnings and profits are restricted in the amount of passive investment income they can realize without terminating their S election. The restriction is 25% of total gross receipts from passive investment income. The S election is terminated if the S corporation has passive investment income greater than 25% of gross receipts for three consecutive years. After 3 years with 90% of its gross receipts from passive sources, Bristol will lose its S corporation status on the first day of its Year 6 taxable year.
Choice “a” is incorrect. An S corporation can have as many as 100 shareholders.
Choice “d” is incorrect. A decedent’s estate may be an S corporation shareholder.
Choice “c” is incorrect. S corporations pass their charitable contribution deductions through to their shareholders.
As of January 1 of the current year, Kane owned all the 100 issued shares of Manning Corp., a calendar year S corporation. On the 41st day of the year, Kane sold 25 of the Manning shares to Rodgers. For the current year ended December 31 (a 365-day calendar year), Manning had $73,000 in nonseparately stated income and made no distributions to its shareholders. What amount of nonseparately stated income from Manning should be reported on Kane’s current year tax return?
a. $0 b. $54,750 c. $56,750 d. $16,250
$56,750.
Choice “c” is correct. The mid-year change of ownership causes Manning’s S corporation income to be allocated between the shareholders on a per-share, per-day basis. The first 40 days’ income is allocated 100% to Kane: 40 x ($73,000/365) = $8,000. 75% of the remaining 325 days’ income is allocated to Kane: 75% x 325 x ($73,000/365) = $48,750. The total income allocated to Kane is $56,750 ($8,000 + $48,750).
Choice “b” is incorrect. Manning’s income will be allocated on a per-share, per-day basis; although Kane owned 75% of the shares starting on April 1, he owned 100% of the shares through March 31.
Choice “d” is incorrect. This is the income that should be allocated to Rodgers; the question asks how much should be allocated to Kane.
Choice “a” is incorrect. The mid-year change of ownership causes Manning’s S corporation income to be allocated between the shareholders on a per-share, per-day basis.
On February 10, Year 1, Ace Corp., a calendar-year corporation, elected S corporation status and all shareholders consented to the election. There was no change in shareholders in Year 1. Ace met all eligibility requirements for S status during the preelection portion of the year. What is the earliest date on which Ace can be recognized as an S corporation?
a. January 1, Year 2. b. February 10, Year 1. c. January 1, Year 1. d. February 10, Year 2.
January 1, Year 1.
Choice “c” is correct.
Rule: An S election made by the 15th day of the third month of the taxable year is retroactively effective on the first day of the taxable year.
Choices “d”, “b”, and “a” are incorrect, per the above rule.
An S corporation has 30,000 shares of voting common stock and 20,000 shares of non-voting common stock issued and outstanding. The S election can be revoked voluntarily with the consent of the shareholders holding, on the day of the revocation:
Shares of voting stock Shares of nonvoting stock
a. 7,500 5,000
b. 0 20,000
c. 20,000 0
d. 10,000 16,000
10,000 and 16,000.
26,000>25,000 (50,000 shares x 50%)
Choice “d” is correct. S corporation status can be revoked if shareholders owning more than 50% of the total number of issued and outstanding shares consent. The specific percentage of voting and nonvoting shareholders is not considered, just the total. Holders of more than 25,000 total shares must approve the revocation.
Choices “b”, “a”, and “c” are incorrect. S corporation status can be revoked if shareholders owning more than 50% of the total number of issued and outstanding shares consent. The specific percentage of voting and nonvoting shareholders is not considered, just the total.
The Haas Corp., a calendar year S corporation, has two equal shareholders. For the current year, Haas had taxable income and current earnings and profits of $60,000, which included $50,000 from operations and $10,000 from investment interest income. There were no other transactions that year. Each shareholder’s basis in the stock of Haas will increase by:
a. $25,000 b. $50,000 c. $0 d. $30,000
$30,000.
Choice “d” is correct. The basis of a shareholder’s stock in an S corporation is increased by any item of income and decreased by any item of loss or deduction that passes through to the shareholder. Each shareholder reports ½ of $60,000 income as their basis.
Choice “b” is incorrect. The S corporation had $50,000 income from operations, of which ½ is reported by each shareholder. However, investment income must also be considered.
Choice “a” is incorrect. Investment income must also be considered.
Choice “c” is incorrect. The basis of a shareholder’s stock in an S corporation is increased by any item of income and decreased by any item of loss or deduction that passes through to the shareholder.
Which of the following conditions will prevent a corporation from qualifying as an S Corporation?
a. One shareholder is a grantor trust.
b. One shareholder is an estate.
c. The corporation has both common and preferred stock.
d. The corporation has one class of stock with different voting rights.
The corporation has both common and preferred stock.
Choice “c” is correct. An S corporation can only have one class of stock outstanding. Common and preferred stock would constitute two classes of stock.
Choice “d” is incorrect. One class of stock with different voting rights is allowed for S corporations.
Choice “b” is incorrect. Individuals, estates, and certain trusts may be shareholders in an S corporation.
Choice “a” is incorrect. Grantor trusts, Section 678 trusts, qualified Subchapter S trusts (QSSTs), certain testamentary trusts, and voting trusts are allowed to be shareholders in an S corporation.
Boles Corp., an accrual-basis calendar-year S corporation, has been an S corporation since its inception and is not subject to the uniform capitalization rules. In the current year, Boles recorded the following:
Gross receipts $ 50,000
Dividend income from investments 5,000
Supplies expense 2,000
Utilities expense 1,500
What amount of net business income should Boles report on its Form 1120S, U.S. Income Tax Return for an S corporation, Schedule K?
a. $48,000
b. $53,500
c. $53,000
d. $46,500
$46,500.
Choice "d" is correct. An S corporation reports both separately stated and non-separately stated (net business) items of income. The dividend income is a separately stated item and is not included in the calculation of net business income. Therefore, net business income is calculated as follows: Gross receipts $ 50,000 Supplies expense (2,000) Utilities expense (1,500) Net business income $ 46,500
Choice “b” is incorrect. Dividend income is not included in net business income. Supplies expense is included in net business income.
Choice “c” is incorrect. Dividend income is not included in net business income. Utilities expense is included in net business income
.
Choice “a” is incorrect. Utilities expense is included in net business income.
Boles Corp., an accrual-basis calendar-year S corporation, has been an S corporation since its inception and is not subject to the uniform capitalization rules. In Year 1, Boles recorded the following: Gross receipts $ 50,000 Dividend income from investments 5,000 Supplies expense 2,000 Utilities expense 1,500 On Bole's Year 1 S corporation Form Schedule K, Shareholders' Shares of Income, Credits Deductions, etc., what amount of income should be separately stated from business income? a. $0 b. $50,000 c. $5,000 d. $48,000
$5,000.
Choice “c” is correct. An S corporation reports both separately stated and non-separately stated (net business) items of income. The dividend income is a separately stated item and is not included in the calculation of net business income.
Choice “b” is incorrect. Dividend income is a separately stated item and is not included in net business income. Gross Receipts are included in net business income.
Choice “d” is incorrect. Dividend income is a separately stated item and is not included in net business income. Supplies expenses and utilities expense would be deducted from net business income.
Choice “a” is incorrect. Dividend income is a separately stated item and is not included in net business income. Supplies expenses and utilities expense would be deducted from net business income.
Which of the following entities may adopt any tax year end?
a. Trust. b. C corporation. c. Limited liability company. d. S corporation.
C corporation.
Choice “b” is correct. C corporations may adopt any year end, provided the year end is approved by the IRS.
Choice “d” is incorrect. S corporations must generally adopt a calendar year end; however, certain S corporations may establish a valid business purpose for a different fiscal year by filing an election using Form 8716.
Choice “c” is incorrect. Limited liability companies generally elect to be taxed as partnerships. Partnerships must generally use the year end of the majority of its partners. If there is no majority, then the partnership must generally use a calendar year end.
Choice “a” is incorrect. All trusts (except tax-exempt trusts) must use a calendar year end.
Evan, an individual, has a 40% interest in EF, an S corporation. At the beginning of the year, Evan’s basis in EF was $2,000. During the year, EF distributed $100,000 and reported operating income of $200,000. What amount should Evan include in gross income?
a. $38,000 b. $80,000 c. $118,000 d. $40,000
$80,000.
Choice “b” is correct. Like partnerships, S corporations report both separately and non-separately stated items of income and/or loss. Allocations to shareholders are made on a per-share, per-day basis in accordance with ownership percentage. Shareholders in an S corporation must include on their personal income tax return their distributive share of each separate “pass-through” item. Shareholders are taxed on these items, regardless of whether or not these items have been distributed to them during the year.
EF’s operating income $ 200,000
x Evan’s ownership % 40%
Gross income for Evan $ 80,000
Choice “a” is incorrect. This answer option incorrectly assumes that Evan’s gross income is calculated as 40% of the distribution for the year ($100,000 x 40% = $40,000) less the basis of $2,000 as of the beginning of the year ($40,000 - $2,000 = $38,000).
Choice “d” is incorrect. This answer option incorrectly assumes that Evan’s gross income is calculated as 40% of the distribution for the year ($100,000 x 40% = $40,000).
Choice “c” is incorrect. This answer option incorrectly assumes that Evan’s gross income is 1 - 40%, or 60%, of the corporation’s operating income for the year ($200,000 x 60% = $120,000), less the basis of $2,000 as of the beginning of the year ($120,000 - $2,000 = $118,000).
Magic Corp., a regular C corporation, elected S corporation status at the beginning of the current calendar year. It had an asset with a basis of $40,000 and a fair market value (FMV) of $85,000 on January 1. The asset was sold during the year for $95,000. Magic’s corporate tax rate was 35%. What was Magic’s tax liability as a result of the sale?
a. $19,250 b. $0 c. $3,500 d. $15,750
$15,750.
Choice "d" is correct. A distribution or a sale of an S corporation's assets may result in a tax on any "built-in gain" at the corporate level. An unrealized "built-in gain" results when the following two conditions occur: (1) a C corporation elects S corporation status, and (2) the fair market value of the corporate assets exceeds the adjusted basis of corporate assets on the election date. The two conditions exist in the facts of the question. The net unrealized built-in gain is the excess of the fair market value of corporate assets over the adjusted basis of corporate assets at the beginning of the year in which the S corporation status is elected. FMV at January 1 $ 85,000 Adjusted basis at January 1 $ (40,000) Excess $ 45,000 × 35% tax rate *35% Corporate tax liability = $ 15,750
Note: The gain to the corporation is a total of $55,000 ($95,000 − $40,000). An S corporation generally does not pay tax at the corporate level; however, in this case, there was built-in gain of $45,000 upon the election to become an S corporation, so the related C corporation tax must be paid upon the sale of the asset.
Choice “b” is incorrect. The gain to the corporation is a total of $55,000 ($95,000 − $40,000). An S corporation generally does not pay tax at the corporate level; however, in this case, there was built-in gain of $45,000 upon the election to become an S corporation, so the related C corporation tax must be paid upon the sale of the asset.
Choice “c” is incorrect. This choice incorrectly assumes that the tax is calculated as 35% of the difference between the sales price of the asset ($95,000) and the fair market value at the effective date of the S election ($85,000). [$95,000 − $85,000 = $10,000; $10,000 × 35% = $3,500].
Choice “a” is incorrect. This choice incorrectly uses the actual total gain on the sale (the sales price of $95,000 less the basis of $40,000) and then calculates the tax liability as 35% of that amount. [$95,000 − $40,000 = $55,000; $55,000 × 35% = $19,250].
Commerce Corp. elects S corporation status as of the beginning of the current year. At the time of Commerce’s election, it held a machine with a basis of $20,000 and a fair market value of $30,000. In March of the current year, Commerce sells the machine for $35,000. What would be the amount subject to the built-in gains tax?
a. $15,000 b. $0 c. $10,000 d. $5,000
$10,000.
Choice “c” is correct. The built-in gain for the machine is $10,000, the difference, on the date of the election of S status, between the $20,000 adjusted basis of the machine to the C corporation and the $30,000 fair market value. That is the amount of the gain that occurred while the corporation was a C corporation, and it is also the amount that is subject to the built-in gains tax.
Choice “b” is incorrect. The $0 indicates that there is no built-in gain on the machine. There are a number of exceptions to the built-in gains tax, but none of them apply in this question.
Choice “d” is incorrect. The $5,000 is the amount of the gain recognized on the sale ($35,000 - $20,000 - $10,000) that is not built-in gain. The $5,000 gain occurred while the corporation was an S corporation and is not subject to the built-in gains tax.
Choice “a” is incorrect. The $15,000 is the total gain recognized on the sale ($35,000 - $20,000), not the amount of gain subject to the built-in gains tax.
Sandy is the sole shareholder of Swallow, an S corporation. Sandy's adjusted basis in Swallow stock is $60,000 at the beginning of the year. During the year, Swallow reports the following income items: Ordinary income $ 30,000 Tax-exempt income $ 5,000 Capital gains $ 10,000 In addition, Swallow makes a nontaxable distribution to Sandy of $20,000 during the year. What is Sandy's adjusted basis in the Swallow stock at the end of the year? a. $60,000 b. $70,000 c. $85,000 d. $80,000
$85,000.
Rules: The rules for determining a shareholder’s basis in S corporation stock follow:
Initial basis (or beginning of year)
+ Income items (separately and non-separately stated items)
+ Additional shareholder investments in corporation stock
- Distributions to shareholders
- Loss or expense items
= Ending basis
Choice “c” is correct.
Initial basis (or beginning of year amount) $60,000
Income items (separately and non-separately stated items) $45,000
Additional shareholder investments in corporation stock − $0
Distributions to shareholders ($20,000)
Loss or expense items − $0
Ending basis $ 85,000
Choice “a” is incorrect. This is only the amount of Sandy’s basis at the beginning of the year ($60,000). The income items and distributions also affect Sandy’s basis as of the end of the year.
Choice “b” is incorrect. This answer option includes the $60,000 basis at the beginning of the year plus the $10,000 in capital gains during the year, but it incorrectly excludes the ordinary and tax-exempt income from the year and the effect of the distributions during the year.
Choice “d” is incorrect. This answer option incorrectly excludes the $5,000 of tax-exempt income received by Swallow during the year.
Which of the following can be an advantage of a limited liability company over an S corporation?
a. Appreciated property can be distributed tax-free to an owner.
b. Incentive stock options can be used to compensate owners.
c. Owners receive limited liability protection.
d. Double taxation of profits is avoided.
Appreciated property can be distributed tax-free to an owner.
Rule: IRC Section 311 controls the taxability of corporate distributions. An S corporation (and a C corporation) recognizes a gain on any distribution of appreciated property (a property dividend) in the same manner as if the asset had been sold to the shareholder at its fair market value.
Choice “a” is correct. An S corporation cannot distribute appreciated property to its shareholders without gain. In general, a partnership can distribute appreciated property tax-free to its partners (in general, a non liquidating distribution to a partner is nontaxable). Since a limited liability company (LLC) is taxed like a partnership (an LLC properly structured and with two or more owners is taxed like a limited partnership with no general partners), a limited liability company can distribute appreciated property to its owners tax-free.
Choice “c” is incorrect. Owners receive limited liability protection with both an S corporation and a limited liability company so there is no advantage for a limited liability company over an S corporation here.
Choice “b” is incorrect. Incentive stock options can be used to compensate owners with both an S corporation and a limited liability company. There is no entity restriction for these stock options, other than that they can be granted only by corporations. There is no advantage for a limited liability company over an S corporation here.
Tap, a calendar-year S corporation, reported the following items of income and expense in the current year:
Revenue $ 44,000
Operating expenses 20,000
Long-term capital loss 6,000
Charitable contributions 1,000
Interest expense 4,000
What is the amount of Tap’s ordinary income?
a. $24,000
b. $19,000
c. $20,000
d. $13,000
$20,000.
Rule: IRC Section 1366 controls the pass-through of S corporation income items to shareholders. In general, items are divided into separately stated items (items that could potentially affect the tax liability of the shareholders) and non-separately stated items. Non-separately stated items are lumped together and constitute the S corporation’s ordinary income. Separately stated items are passed through to the shareholders (in a manner similar to partnerships) and retain their tax attributes to the shareholders.
Choice “c” is correct. Tap’s ordinary income is calculated as follows:
Revenue $ 44,000
Operating expenses (20,000)
Interest expense (4,000)
Ordinary income $ 20,000
The long-term capital loss and the charitable contributions are not included in Tap’s ordinary income. They are separately stated items and thus are passed through to the shareholders and retain their tax attributes.
Choice “d” is incorrect. The $13,000 would include both the long-term capital loss and the charitable contributions.
Choice “b” is incorrect. The $19,000 would include the long-term capital loss but not the charitable contributions.
Choice “a” is incorrect. The $24,000 would not include the interest expense.
