Topic 4 (Tax Treatment for S Corps)

Question 1

S corporations may have no more than 50 shareholders, but members of the same family only count as one shareholder.

Answer 1

False

S corporations may have no more than 100 shareholders; family members and their estates count as one.

Question 2

Differences in voting powers are permissible across shares of S corporation stock as long as the shares have identical distribution and liquidation rights.

Answer 2

True

Question 3

Bobby T (95% owner) would like to elect S corporation status for DJ, Inc. but Dallas (5% owner) does not want to elect S corporation status. Bobby T cannot elect S status for DJ, Inc. without Dallas’ consent.

Answer 3

True

All shareholders on the date of the election must consent to the election.

Question 4

If an S corporation never operated as a C corporation, it may earn passive investment income without fear of an involuntary S election termination.

Answer 4

True

Question 5

If an S corporation shareholder sells her stock to a nonresident alien, it will automatically terminate the S election.

Answer 5

True

Question 6

The specific identification method is a method an S corporation may use to allocate its income across short tax years that result from an involuntary S election termination.

Answer 6

True

Question 7

Which of the following is prohibited from being an S corporation shareholder?

1. Foreign citizens that are U.S. residents.
2. U.S. citizens.
3. C Corporations.
4. 51 unrelated individuals.

Answer 7

C Corporations

Question 8

Which of the following would not result in an S election termination?

1. Having 120 unrelated shareholders.
2. Having a C corporation as a shareholder.
3. Issuing a second class of stock.
4. Having excess passive investment income for two consecutive years.

Answer 8

Having excess passive investment income for two consecutive years.

Question 9

Separately stated items are tax items that are treated similarly for tax purposes as a shareholder’s share of ordinary business income (loss).

Answer 9

False

Question 10

S corporations are not entitled to a dividends received deduction.

Answer 10

True

Question 11

For S corporations without earnings and profits from prior C corporation years, the taxation of cash distributions to the shareholder is very similar to the rules for partnerships.

Answer 11

True

Question 12

When an S corporation distributes appreciated property to its shareholders the S corporation recognizes gain as though it had sold the appreciated property for its fair market value just prior to the distribution.

Answer 12

True

Question 13

S corporations are required to recognize both gains and losses on non-liquidating distributions of property to shareholders.

Answer 13

False

Question 14

S corporation distributions of cash are not taxable to the shareholder to the extent of the combined shareholder’s stock and debt basis.

Answer 14

False

Question 15

Which of the following is not a separately stated item for S corporations?

1. Dividends.
2. Interest income.
3. Charitable contributions.
4. Investment interest expense.
5. All of the above

Answer 15

All of the above

Question 16

Clampett, Inc. has been an S corporation since its inception. On July 15, 2019, Clampett, Inc. distributed $50,000 to J. D. His basis in his Clampett, Inc. stock on January 1, 2019, was $30,000. For 2019, J. D. was allocated $10,000 of ordinary income from Clampett, Inc. and no separately stated items. How much capital gain does J. D. recognize related to Clampett, Inc. in 2019?

1. $60,000.
2. $50,000.
3. $20,000.
4. $10,000.

Answer 16

$10,000.
$10,000 from distribution in excess of basis ($50,000 distribution − $30,000 basis − $10,000 increase in basis from distributive share of ordinary income).

Question 17

Assume that at the end of 2018, Clampett, Inc. (an S corporation) distributes long-term capital gain property (fair market value of $40,000, basis of $25,000) to each of its four equal shareholders (aggregate distribution of $160,000). At the time of the distribution, Clampett, Inc. has no corporate E&P and J. D. has a basis of $15,000 in his Clampett, Inc. stock. How much income does J. D. recognize as a result of the distribution?

1. $0.
2. $15,000.
3. $25,000.
4. $40,000.
5. None of the choices are correct.

Answer 17

$25,000.
$15,000 distributive share of the gain on the distribution ($40,000 − $25,000) plus $10,000 due to the $40,000 distribution exceeding J. D.’s $30,000 basis ($15,000 original basis + $15,000 increase in basis from gain from property distribution).

Question 18

Which of the following S corporations would be subject to the excess net passive income tax?

1. An S corporation that never operated as a C corporation.
2. An S corporation that has previously distributed all earnings and profits from prior C corporation years.
3. An S corporation with no earnings and profits from prior C corporation years and with passive investment income that exceeds 30% of its gross receipts.
4. An S corporation with $2,000 of earnings and profits from prior C corporation years and with passive investment income that equals 22% of its gross receipts.
5. None of the above
   5.

Answer 18

None of the above
To be subject to the excess net passive income tax, the S corporation must have earnings and profits from prior C corporation years and have passive investment income that exceeds 25% of its gross receipts.

Question 19

Like partnerships, an S corporation shareholder’s basis is dynamic and must be adjusted annually.

Answer 19

True

Question 20

S corporation shareholders are not allowed to include any S corporation-level debt in their stock basis.

Answer 20

True

Question 21

S corporation allocated losses to a shareholder not deductible due to the tax basis limitation rules are carried over by the shareholder to future years for potential utilization.

Answer 21

True

Question 22

S corporations without earnings and profits from prior C corporation years are not subject to the excess net passive income tax.

Answer 22

True

Question 23

Which of the following is not an adjustment to an S corporation shareholder’s stock basis?

1. Increase for any contributions to the S corporation during the year.
2. Increase for shareholder’s share of ordinary business income.
3. Decrease for shareholder’s share of nondeductible items.
4. Increase for distributions during the year.

Answer 23

Increase for distributions during the year.

Question 24

Suppose at the beginning of 2018, Jamaal’s basis in his S corporation stock was $27,000 and that Jamaal has directly loaned the S corporation $10,000. During 2018, the S corporation reported an $80,000 ordinary business loss and no separately stated items. How much of the ordinary loss is deductible by Jamaal if he owns 50% of the S corporation?

1. $10,000.
2. $27,000.
3. $37,000.
4. $40,000.

Answer 24

$37,000.

Losses are limited to stock basis ($27,000) plus debt basis ($10,000).

Question 25

Which of the following is not a true statement?

1. For shareholder-employees who own 2 percent or less of the entity, the S corporation gets a tax deduction for qualifying fringe benefits, and the benefits are nontaxable to the employees.
2. For shareholder-employees who own more than 2 percent of the S corporation, the S corporation gets a tax deduction, but the otherwise qualifying fringe benefits are taxable to the more-than-2-percent shareholder-employees.
3. S corporation owners have a tax incentive to pay themselves a low salary.
4. An S corporation shareholder’s allocable share of ordinary business income (loss) is not classified as self-employment income for tax purposes.
5. None of the above

Answer 25

None of the above

Question 26

Clampett, Inc. has been an S corporation since its inception. On July 15, 2019, Clampett, Inc. distributed $50,000 to J. D. His basis in his Clampett, Inc. stock on January 1, 2019, was $30,000. For 2019, J. D. was allocated $10,000 of ordinary income from Clampett, Inc. and no separately stated items. What is J. D.’s basis in his Clampett, Inc. stock after all transactions in 2019?

1. $40,000.
2. $30,000.
3. $20,000.
4. $10,000.
5. None of the above

Answer 26

None of the above
J. D.’s basis is $0 because the $50,000 distribution exceeds his basis of $40,000 prior to the distribution ($30,000 original basis + $10,000 increase in basis from his distributive share of income) and distributions cannot cause stock basis to drop below zero.

Question 27

Clampett, Inc. has been an S corporation since its inception. On July 15, 2019, Clampett, Inc. distributed $50,000 to J. D. His basis in his Clampett, Inc. stock on January 1, 2019, was $45,000. For 2019, J. D. was allocated $10,000 of ordinary income from Clampett, Inc. and no separately stated items. What is J.D.’s basis in his Clampett, Inc. stock after all transactions in 2019?

1. $40,000.
2. $30,000.
3. $20,000.
4. $5,000.

Answer 27

$5,000.
J. D.’s basis is $5,000 ($45,000 original basis + $10,000 increase in basis from his distributive share of income − $50,000 distribution).

Question 28

Assume that Clampett, Inc. has $200,000 of sales, $150,000 of cost of goods sold, $60,000 of interest income, and $40,000 of dividends. What is Clampett, Inc.’s excess net passive income?

1. $0.
2. $25,000.
3. $75,000.
4. $100,000.

Answer 28

$25,000.
$25,000 = $100,000 net passive investment income x [(($100,000 passive investment income) − 25% × gross receipts (25% x ($200,000 sales + $100,000 passive income)))/$100,000 passive investment income].