Chapter 3-S Corporations Flashcards
What is an S-Corp?
a corporation that elects to be treated in a manner similar to partnerships, filing a tax return but not paying taxes directly. The income is allocated to the shareholders (K-1) who must report their shares of the S corporations income on their personal tax returns (flow through entity).
what must be satisfied for an entity to elect to be treated as an S-Corporation (simple and small)
- there can be no more than 100 shareholders (family members with a common ancestor no more than 6 generations above and their spouses may be treated as a single shareholder (meaning they are just one shareholder of the 100 possible shareholders) for purposes of this rule)
- all shareholders must be individuals (or certain estates or trust for the benefit of individuals) no corporations, partnerships or big trusts as shareholdersbut s corp can own stock in a C corp, another S Corp or be a partner in a partnershipgrantor & testamentary trusts are OKhusband and wife count as one until divorce is final
- all shareholders must be either residents or citizens of the United States
- the corporation must be a domestic corporation
- there can be only one class of stock (no preferred stock)
- A C CORP CANNOT BE ONE OF THE SHAREHOLDERS
as it relates to an S-Corp, what does only one class of stock mean?
it means only that each share must be allocated an equal amount of the INCOME of the corporation. it is acceptable for some of the shares to have voting rights and others to be non voting, so long as the income allocation requirement is satisfied.
how can a company become an S-Corporation?
the election to become an S corporation has to be a unanimous (100%) voted by the shareholders (including those with non-voting shares), since they are agreeing to be personally liable for the income taxes resulting from the election. the election can be made at any time, but it must be made by the 15th day of the 3rd month of the tax year (march 15 for calendar corporations, 2 1/2 months) in order to be effective for that year. any election made after that cannot become effective until the start of the FOLLOWING TAX YEAR. the tax year may be a calendar year or a fiscal year if it has an established business purpose
what is the structure of operations of a S Corp?
=initial basis (IT IS WHAT YOU INITIALLY PUT INTO THE CORPORATION EX. CASH AND PROPERTY)
+net business income (increases basis)
-net loss (decreases basis)
+municipal bond interest (increases basis & but it is not taxable income meaning it is not taxed)
-distributions received (reduces basis & is not taxable income)
+ OR - separately stated items
=net basis of the S Corp
Municipal bonds reported on separate line item
what are the types of income for an S Corp
- Income = ordinary income/loss + municipal bond interest + separately stated items (any amount that can hit a limit on an individuals tax return ex. capital gains and losses, section 1231 gains/losses, section 179 depreciation deduction; rent & royalty income; charitable contributions; interest income on investments. THESE ARE ALL CONSIDERED INCOME
- losses = limited to amount invested + amount loaned to company (the amount at risk for the investor & it cannot go below zero
- municipal bond interest = increases in basis, not taxable
- distributions received = reduces basis & its not taxed because it is taxed when the income is earned.
what is allocation of income?
a shareholders basis in their stock is increased by their share of income (INCLUDING NON TAXABLE INCOME) and reduced by their share of losses (including NON-DEDUCTIBLE EXPENSES). a shareholders basis is also reduced for dividends received from the corporation (in essence, all dividends are treated as RETURNS OF CAPITAL).
For purposes of determining the limitation on pass through losses and deductions, basis also includes the taxpayers share of bona fide S corporation indebtedness.
items are passed through according to their percentage of ownership based on a PER-SHARE/PER DAY METHOD. If no change in ownership during the year, then simply use the percentage of stock owned to determine the amount passed through. if a change in ownership occurred, then each shareholder percentage is weighted for the number of days the stock was held just like weighted average.
what goes on a schedule K for an s-corporation?
Sales -COGS -Rent expense -general and admin expense -salary and wages expense -charity donation -capital loss =net income
Shareholders Net Business Income (schedule k-1)
Net Income x % of ownership
-charitable contribution x % of ownership
-capital loss x % of ownership
=shareholders net business income
On 1040
can claim the capital loss up to the $3,000 limit and anything over that can be carried forward.
what the benefits of an S-Corporation?
THEY DO NOT HAVE TO PAY INCOME TAXES BUT ARE REQUIRED TO FILE AN INFORMATIONAL RETURN ANNUALLY (form 1120-s) reporting income and the allocation of that income to the various shareholders.
what does the Schedule K-1 show?
it is prepared for each shareholder and showing that particular owners allocated share of all of the items on the Schedule K. the schedule K summarizes ordinary income and then separately lists ll items that are not ordinary.
what are separately stated items and why are they not included in ordinary income?
- capital gains/losses (limit on deductible of net capital losses individuals cant take any more than 3,000 per year)
- section 1231 gains and losses (classification as a capital gain and you must net them against capital losses)
- dividends and interest (needed for investment interest limitation)
- passive activities (passive activity loss limitations you can only take 25,000 max per year)
- charitable contributions (must itemize to deduct up to 50% of AGI)
- section 179 depreciation election (dollar limit on use of election per year)
- tax credits (limited to tax liability)
- municipal bond interest
S-corporation DISTRIBUTIONS to owners are NON-TAXABLE to the extent of what?
the ACCUMULATED ADJUSTMENT ACCOUNT (AAA) and are applied to reduce the AAA and shareholder’s stock basis as a TAX FREE RETURN OF CAPITAL AND; DISTRIBUTIONS IN EXCESS OF STOCK BASIS ARE TREATED as A GAIN from the sale of stock
what does the accumulated adjustment account (AAA) represent?
- the cumulative total of all items of the undistributed net income and is decreased by distributions and all loss and deduction items EXCEPT NO adjustment is made for TAX-EXEMPT INCOME related expenses and NO ADJUSTMENT IS MADE for FEDERAL INCOME TAXES attributable to a taxable year in which the corporation was a C-corp for the S corporations taxable years beginning after 1982
- Are NOT TAXABLE when DISTRIBUTED
- A positive AAA balance represents income from S corporation years that has ALREADY BEEN TAXED to SHAREHOLDERS but NOT YET DISTRIBUTED. IT IS MONEY EARNED AS AN S-CORP
what does the accumulated Earnings and Profits (AEP) represent?
-earnings and profits that were accumulated (and never taxed to shareholders) during C corporation taxable years.
-distributions in EXCESS of the AAA are treated as ORDINARY DIVIDENDS to the extent of the corporations AEP
-the PAYMENT OF FEDERAL INCOME TAXES ATTRIBUTABLE TO A C corporation years (means money was earned when it was a C
Corp) would DECREASE an S corporations ACCUMULATED EARNINGS AND PROFITS (AEP). A positive AEP balance represents earnings and profits accumulated in C Corporation years that have NEVER BEEN taxed to shareholders.
how are distributions from an S corporation generally treated?
-as first coming from its accumulated adjustment account (AAA) and then are treated as coming from its accumulated earnings and profits (AEP). A positive balance in an S corporation AAA is generally NONTAXABLE when distributed because it represents amounts that have already been taxed to shareholders during S years. In contrast, an S corporations AEP represents earnings accumulated during C years that have never been taxed to shareholders and must be reported as DIVIDENDS INCOME when received.
