R3 - Big topic 2/3 - S corp

Question 1

1. Eligibility

Answer 1

Eligible Shareholders

• must be an individual, estate, or certain types of trust
• resident alien
• qualified retirement plans, trusts, organization can also be shareholders
• corporation and partnership CANNOT be shareholders
• Grantor and voting trust can be shareholders
• • cannot be more than 100 shareholders
• • only one class of stock - common stock (yes!); pref stock (no)

Question 2

2. Elections

Answer 2

when? - anytime during the year and by 3/15, retroactive to the beginning of the year.
New shareholders during the year? - ignore

Question 3

3. Effect of S corp election

Answer 3

Effect #1 - must use calendar year - 12/31 is year end. 3/15 is tax due.

Effect #2 - No corporate tax

Effect #3 - Few S corporate level taxes

1. LIFO recapture (从来没见过）
2. Build-in gain Tax
   
   • 2.1 c-corp elects S corp status
   • 2.2 fmv exceeded adj basis on the election date
3. Tax on passive investment income

Question 4

3. effect of S Copr election -> Effect #3 (few s corp level tax) -> build in gain tax

• basics
• exemptions
• calculations

Answer 4

Build in gain tax

1. C-corp elect S corp status
2. FMV of assets exceeded adj. basis on the election date.

Exemptions:

1. S corp was NEVER a C corp
2. sale and transfer NOT within 10 years
3. can approve appreciation happened AFTER S election
4. asset gain AFTER S election
5. Gain recognized BEFORE S election

Calculation:
35% x LESSER of
1. recognized build-in gain (ready to be taxed)
2. taxable income if this is a c corp.

Question 5

4. Effect on Shareholders

Loss intake thresholds
Flow through to shareholders
Fringe benefits
AAA

Answer 5

A. Pass through

1. Separately
2. Allocation = per day, per share basis
3. 吃loss的limit = shareholder’s adjusted basis
   * * Guarantees DONT Increase basis.
4. flow through to the shareholders
   - ordinary incomes (include recaptured and unearned revenues)
   - rental income/loss (include recaptured and unearned revenues)
   - Portfolio income (interests, dividends, royalties)
   - Tax-exempt interests
   - percentage depletion
   - foreign income
   - section 1232 capital gain and ordinary loss
   - charitable contributions
5. FRINGE Benefits 周边benefits (2%)
   - deductible fringe benefits: non-shareholder employees and shareholders owning 2% or less
   - nondeductible fringe benefits: owning 2%+ shareholders (included in that shareholder’s income, k-1)
6. AAA (accum. adjustment account)
   Beginning point = AAA = Zero
   Increase to AAA (separated and nonsep income and gains - except tax-exempt income and life insurance proceed)
   Decrease to AAA (distributions, separated non-sep expenses and losses, non-deductible expenses - except life insurance proceed)

Question 6

K-1

Answer 6

each shareholder gets a K-1

individual reports on 1040 Schedule “E”

Question 7

Shareholder’s basis

Answer 7

Initial Basis
+ Income Items (ALL INCOME : include tax free income)
+Additional shareholder investments in corp stock
- distribution to shareholders
- Loss or expense (可以吃loss的limitation)
= Ending Basis

• *Loss Limitations = Basis + Direct shareholder loan (recourse) - Distributions
• • must be recourse loan
• *the entity’s bank loan 不会increase 或者decrease shareholder basis.

Question 8

Distribution

• no C corp E&P
• with C corp E&P

Answer 8

1. No C-Corp E&P
   level 1 - extent of beginning stock basis (nontaxable, reduce stock basis, “return of Capital”)
   level 2 - leftover - “capital gain”, taxable)
2. With C-Corp E&P
   level 1 - reduce AAA (nontaxable, reduce stock basis)
   level 2 - old c corp e&p (taxable, not reduce stock basis, taxable income) -> this is a c corp transaction.
   level 3 - extent of stock basis (nontaxable, reduce stock basis, “return of capital”)
   level 4 - leftover (taxable, no more stock basis, “capital gain”)

Question 9

Remember!

Answer 9

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. (tax exempt or not, i dont care. I take all.)

Question 10

经典题 -
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?

Answer 10

Part 1 - end basis and gross income
Beg. basis 2,000
\+ income + 40%*200,000
- distribution -40%*100,000
- loss and expenses -0
= end basis = 42,000

Gross income - 80,000

Part 2 - distribution between return of capital (nontaxable) and capital gain (taxable)
Distribution = 40%*100,000 = 40,000
Beg basis = 2,000

No previous E&P from c corp
2,000 = return of capital (nontaxable, reduce stock basis)
38,000 = capital gain (taxable, over stock basis)

有c-corp e&p的顺序是: AAA (nontaxable, reduce stock basis) -> C corp EP (taxable, not reduce stock basis) -> extent of stock basis (return of capital,nontaxable, reduce basis) -> left over (capital gain, taxable, over stock basis)

Question 11

Build-in Gain 例题

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?

Answer 11

满足build in gain的两个条件

1. c corp - > S corp
2. fmv> adj basis when election

85,000
-40,000
= 45,000 * 35% = 15,750

when sale at 95,000, no tax paid on s corp level.

Question 12

Loss limitation 例题

Stone owns 100% of an S corporation and materially participates in its operations. The stock basis at the beginning of the year is $5,000. During the year, the corporation makes a distribution of $3,500 and passes through a loss from operations of $2,000 for the year. What loss can Stone deduct on Stone’s personal tax return?

Answer 12

loss limitation = beg. basis + direct loan to shareholder - distribution

5,000 + 0 - 3,500 = 1500

1500 -> offset 1500 operating loss
-> remaining 500 will carry forward indefinitely + ONLY can deduct future stock basis!!!!