R3 M5 - S Corporation Overview (notes)

Question 1

What is the requirement that must be met to qualify as an S corporation?

Answer 1

• Must be a domestic corporation (not a foreign entity)
• All shareholder (voting and nonvoting must agree to a valid election Form 2553 –> Taxed as an S. Corp)

Question 2

What is the eligibility shareholder limit?

Who can be eligible shareholders?

Side note: There is one class of stock outstanding common stock.

Preferred stock is not permitted under the S. Corp.

Answer 2

• S. Corporation can have no more than 100 shareholders.
• Family members (ancestors, lineal descendants, spouses or former spouses) are considered as 1 shareholder

Question 3

An S. Corporation can own shares in a C Corporation.

• S corporation cannot file a consolidated tax return with the C Corporation.
• S corporation can own shares in C Corporation, but C Corporation cannot own shares in S Corporation.
• S corporation may have an S subsidiary.

Question 4

When does S corporation election take effect?

Answer 4

• S election filed by March 15 it becomes effective on January 1 of the current year.
• S election filed after March 15 it becomes effective on January 1 of the following year.

Ex: If form 2553 is filed between 1/1/Y10 and 3/15/ Y10, the effective date is 1/1/Y10

Ex: If form 2553 is filed after 3/15/ Y10, the effective date is 1/1/Y11

Question 5

What is a voluntary S Corp termination status?

Answer 5

• Need a majority of outstanding shares to vote to terminate the election of a S Corp.

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Question 6

What is an involuntary S Corporation termination?

Sidenote:

• S Corporation files form 1120S (Due March 15)
• There is no tax at corporate level
• S corporations are taxed like partnerships, double taxation is for C Corporation

All earnings are passed through to shareholders and taxed at the individual shareholder level.

Answer 6

• You violated the rules of S Corporation like selling your shares to an C Corporation.

Question 7

Termination of S election

Answer 7

1. Shareholders holding more than 50% of stock (voting & nonvoting) consent to voluntary terminate (revoke)
2. The corporation fails to meet any qualification for S status
   - Corporation or partnership owners owns S corporation.
   - Foreign Owner
   - More than 100 shareholder (Family member counts as 1 shareholders)
3. Excess passive investment income more than 25% of the corporation’s gross receipts are from passive investment for three consecutive years and the corporation has prior C corporation earning and profit.

If the S corporation did not have prior C corporation earning and profit that would be fine.

Question 8

Effective Date of Termination:

Answer 8

1. If shareholders vote to voluntarily terminate the S. Corporation they can choose when they want to terminate the S. Corporation.

• If no date is specified and the revocation (termination) is done by March 15, the revocation takes into effect Jan 1 of the current year.
• After March 15 –> It will take effect on January 1 of the following year.

2. If they failed to meet the requirement to maintain an S Corporation status. The S corporation is terminated immediately.
3. With excess passive income, S corporation status is terminated at the beginning of the 4th year.

Question 9

If you decided to voluntary terminate how long do you have to wait to re-elect to become an S corporation?

Answer 9

5 years

Question 10

What are separately stated items?

Answer 10

They are not included in the ordinary business income of the corporation.

• Rental real estate income or loss –> Schedule E (passive income)
• Interest income –> Schedule B (passive income)
• Dividend income –> Schedule B (passive income)
• Royalties —> Schedule E (passive income)
• Net Short-term capital gain/loss —> Schedule D
• Net Long-term capital gain/loss —> Schedule D
• Net section 1231 gain/loss —> Sch. D
• Charitable contribution –> Schedule A (itemized deduction)
• Section 179 Expense

Question 11

Answer 11

Question 12

Answer 12

Question 13

What are fringe benefits?

Answer 13

Fringe benefits refer to supplemental benefits that an employee may receive in addition to their salary.

For example, Company car, subsidized meals

Question 14

Stock Basis & Debt Basis = Tax Basis

How do you Calculate Stock Basis?

Answer 14

Please note that S Corporation does not include debt basis in the ending balance of a stock basis.

Stock and debt basis cannot be reduced below zero.

Question 15

Answer 15

Step1: Calculate Jan’s share of the ordinary business income and separately stated items:

Ordinary business income: $30,000 x 50% = $15,000
Interest income: $10,000 x 50% = $5,000
Section 1231 gain: $50,000 x 50% = $2,500
Charitable Contribution: $5,000 x 50% = $2,500

Question 16

Tax basis limitation

What happens if there is a loss in excess of the shareholder’s tax basis?

Answer 16

• A loss in excess of the shareholder’s tax basis is suspended until tax basis is reinstated in future years.
• Tax basis can be reinstated by an increase in stock basis; income, gains additional contributions
• Any increase in future years reinstate the debt basis first

What happened to suspended loss ?

They are carried forward indefinitely.

Question 17

Answer 17

Question 18

Answer 18

Question 19

Accumulated Adjustments Account (AAA)

What is AAA?

Answer 19

Previously undistributed income that you can withdraw tax free.

Is accumulated earning and profits during the year the corporation is an S corporation.

Distribution may not reduce AAA below zero, However AAA maybe negative due to S corporation losses and deductions

Question 20

Answer 20