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

Answer 8

Choice “D” is correct.

Rule:

1. A corporation that has always been an S corporation may have excess passive income without losing its S corporation status.

2.Shareholders of an S corporation must be: individuals, estates, a voting trust, a grantor trust, and/or a bankruptcy estate.

Choices “A”, “B”, and “C” are incorrect, per the above rule.

Question 9

Effective Date of Termination:

Answer 9

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 10

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

Answer 10

5 years

Question 11

What are separately stated items?

Answer 11

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 12

Answer 12

Question 13

Answer 13

Question 14

What are fringe benefits?

Answer 14

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

For example, Company car, subsidized meals

Question 15

Stock Basis & Debt Basis = Tax Basis

How do you Calculate Stock Basis?

Answer 15

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 16

Answer 16

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 17

Tax basis limitation

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

Answer 17

• 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 18

Answer 18

Question 19

Answer 19

Question 20

Accumulated Adjustments Account (AAA)

What is AAA?

Answer 20

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 21

Answer 21

Question 22

Lane Inc., an S corporation, pays single-coverage health insurance premiums of $5,800 per year and family coverage premiums of $5,100 per year. Mill is a 10 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 includable in Mill’s gross income?

A.	$5,800

B.	$120

C.	$5,100

D.	$0

Answer 22

Answer is C

If the fringe benefit from a non-shareholder employee and the employee shareholder owes 2% or less than the S Corporation will deduct it, but if the shareholder owns more than 2 % of the S corporation than the deduction will impact the shareholders’ gross income.

Question 23

A corporation elected S corporation status. All shareholders gave their written consent, except for a missing shareholder who owns 1% of the outstanding stock. Which of the following statements about this situation is correct?

A.	The election requires two-thirds of the shareholders' written consent to be valid.

B.	The election is invalid because all shareholders must give their written consent.

C.	The election requires 51% of the shareholders to give their written consent to be valid.

D.	The election is valid if the board of directors gives its written consent.

Answer 23

Choice “B” is correct. In order for an S corporation election to be valid, it must be agreed upon, in writing, by all shareholders. If all shareholders do not give their written consent, the election is invalid.

Choice “A” is incorrect. The election to be taxed as an S corporation must be approved, in writing, by all shareholders; approval by two-thirds of the shareholders is not sufficient.

Choice “C” is incorrect. The election to be taxed as an S corporation must be approved, in writing, by all shareholders; approval by 51 percent of the shareholders is not sufficient.

Choice “D” is incorrect. The election to be taxed as an S corporation must be approved, in writing, by all shareholders; whether or not the board of directors approves is irrelevant in determining whether the election is valid (although the election would probably not be sought in the first place if the board of directors had not approved).

Question 24

Mark and Mary formed MM Inc. as an S corporation. Each contributed $50,000 in exchange for five shares of corporate stock. In addition, MM obtained a $60,000 loan from a local bank that was still outstanding at the end of the year. In MM’s first year of operation, it reported a loss of $20,000 and did not make any distributions to the shareholders. What is Mark’s basis in his MM shares at the beginning of the second year?

A.	$70,000

B.	$50,000

C.	$100,000

D.	$40,000

Answer 24

Question 25

For which of the following entities is the owner’s basis increased by the owner’s share of profits and decreased by the owner’s share of losses but is not affected by the entity’s bank loan increases or decreases?

A.	Partnership.

B.	C corporation.

C.	Limited liability company.

D.	S corporation.

Answer 25

Question 26

Graphite Corp. has been a calendar year S corporation since its inception on January 2, Year 1. On January 2, Year 4, Smith and Tyler each owned 50 percent of the Graphite stock, in which their respective bases were $12,000 and $9,000. For the year ended December 31, Year 4, Graphite had $80,000 in ordinary business income and $6,000 in tax-exempt income. Graphite made a $53,000 cash distribution to each shareholder on December 31, Year 4. What total amount of income from Graphite is includable in Smith’s Year 4 adjusted gross income?

A.	$43,000

B.	$93,000

C.	$40,000

D.	$96,000

Answer 26

Question 27

A taxpayer owns 50 percent of the stock of an S corporation and materially participated in the corporation’s activities. At the beginning of the year, the taxpayer had an adjusted basis in the stock of $25,000 and made a loan to the corporation of $13,000. During the year, $3,000 of the loan was repaid, and the taxpayer’s share of the corporation’s loss for the year was $40,000. What is the amount of the loss that may be deducted on the taxpayer’s tax return?

A.	$38,000

B.	$35,000

C.	$40,000

D.	$25,000

Answer 27

Choice “B” is correct. A taxpayer can deduct loss from an S corporation equal to the taxpayer’s stock basis and debt basis in the S corporation. At the end of the year, the taxpayer’s stock basis is $25,000 and debt basis is $10,000 ($13,000 − $3,000). The taxpayer can deduct $35,000 ($25,000 + $10,000) of the $40,000 loss.

Choice “A” is incorrect. Debt repayments reduce a taxpayer’s debt basis in an S corporation.

Choice “C” is incorrect. Loss from an S corporation is limited to the taxpayer’s tax basis in the S corporation.

Choice “D” is incorrect. A taxpayer may use his or her debt basis in an S corporation to deduct loss from an S corporation.