Taxation of S Corporations in a Nutshell
Authors:
Kahn, Douglas A. / Kahn, Jeffrey H. / Perris, Terrence G.
Edition:
2nd
Copyright Date:
2017
21 chapters
have results for Taxation of S Corporations in a Nutshell
Chapter 9 Taxation of Built-in Gains 68 results (showing 5 best matches)
- If left unchecked, an S corporation could be used in another manner to permit a C corporation to escape double taxation on the appreciation of its assets. An S corporation could acquire appreciated assets of a C corporation in a nonrecognition, carryover basis transaction so that any gain on the subsequent disposition of those assets would be recognized by the S corporation and passed through to its shareholders—thereby escaping double taxation. To prevent that abuse, such assets are subject to the § 1374 tax on built-in gains. § 1374(d)(8) . In this book, assets that were acquired by an S corporation from a C corporation in a carryover basis transaction are sometimes referred to as “C assets.”
- The recognized built-in gain for a corporation can be increased by a carryover from a prior year of the amount of the corporation’s net recognized built-in gain that escaped taxation because of the taxable income limitation, which is discussed below. § 1374(d)(2)(B) . This carryover provision is discussed below in connection with the explanation of the meaning of the term “net recognized built-in gain.”
- An S corporation’s net recognized built-in gain for a taxable year also cannot exceed a modified version of the corporation’s taxable income for that year. § 1374(d)(2)(A)(ii) . This is referred to as “the taxable income limitation.” For this purpose, the S corporation’s taxable income is modified in the same manner as is employed in determining the taxable income limitation on the taxation of passive investment income. The prescribed modifications include eliminating net operating loss carryovers and carrybacks, as well as any deductions allowable by §§ 241 . §§ 1374(d)(2)(A)(ii)
- In the absence of a remedial provision, a C corporation that has appreciated assets could avoid the imposition of a corporate tax on that appreciation by making an election to become an S corporation. Once the election became effective, the corporation’s recognition of gain would be passed through to its shareholders and therefore would be taxed only once at individual rates. Without the S election, the gain would have been taxed twice—once at the corporate level and again at the individual shareholder’s level when the proceeds are distributed to the shareholders. To discourage the use of the Subchapter S election as a device for escaping corporate taxation of appreciation that arose prior to the effective date of the election, Congress imposed a corporate tax on the “net recognized built-in gain” of an S corporation when it is recognized within a specified period. This tax is set forth in § 1374
- If the net recognized built-in gain for a taxable year is equal to the S corporation’s taxable income for that year because the taxable income limitation applies, the additional amount that would have been taxed under § 1374 if taxable income had not been the smaller figure will be carried forward and added to the corporation’s recognized built-in gains for the next taxable year. § 1374(d)(2)(B) . Thus, a corporation’s recognized built-in gains for a taxable year include the amounts from prior years that escaped taxation because of the taxable income limitation.
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Chapter 6 Distributions Received from an S Corporation 65 results (showing 5 best matches)
- As noted in Section 11 of Chapter 3, there are two circumstances in which an S corporation can inherit the of a C corporation—(1) where the was earned by the corporation at a time when it was a C corporation because it had not yet made the election for Subchapter S treatment, and (2) where the S corporation acquired a C corporation that had earnings and profits in either a nonrecognition reorganization (such as a statutory merger) or as a liquidation of a controlled subsidiary. When such an S corporation makes a distribution to its shareholders, the question arises whether the distribution is to be treated as having been made from earnings obtained by an entity while it was a C corporation, or from earnings obtained while it was an S corporation, or partly from each. Distributions of the former earnings are subjected to double
- As previously noted, double taxation is a major feature of the treatment of C corporations whereas Subchapter S was adopted in order to permit certain small corporation to escape from double taxation in most circumstances. The purpose of the AAA provisions is to treat corporate distributions by an S corporation as first coming from earnings it had while the S election was in effect, and only after those earnings have been distributed will its subsequent distributions be treated as having been made from its
- Distributions of cash or other property made from an S corporation to a shareholder will not be treated as a dividend if the corporation has no . § 1368(a) . As previously noted, an S corporation can have in a prior year in which it was a C corporation, or if it inherited the of another corporation pursuant to a reorganization or liquidation. If the corporation has no , the amount of the distribution will reduce the shareholder’s basis in his stock (but not in his debt instruments) and any excess of the distribution over the stock’s basis is treated as a gain from the sale of the stock. § 1368(b)
- On the first day that a corporation is an S corporation, its AAA is zero. Its AAA is then increased or decreased by the adjustments required by § 1368(e)(1) . Only adjustments attributable to the most recent continuous period that the corporation was an S corporation are taken into account, and no adjustments for a taxable year beginning prior to 1983 are taken into account. § 1368(e)(1)(A) . In certain circumstances, transitional rules apply for distributions of income that was earned in pre-1983 years. See Section 4 of this chapter. The most recent continuous period, including only taxable years that began after 1982, that a corporation has been an S corporation is referred to as the “S period.” § 1368(e)(2) . Thus, except for the application of the post-termination transition period rules, which are discussed in Section 2(a) of this chapter, once a
- An accumulated adjustments account ordinarily will not need to be maintained for a corporation that has always been an S corporation, unless it is a successor to a C corporation as a result of a reorganization or liquidation transaction, because such an S corporation will not have any accumulated . Even with respect to an S corporation that previously had accumulated as a result of having previously been a C corporation or being a successor to a C corporation, the S corporation will not need to maintain an AAA if it has previously distributed all of its accumulated
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Chapter 3 Effect of an S Election 43 results (showing 5 best matches)
- A valid Subchapter S election does not eliminate the electing corporation as an entity for tax purposes. It does, however, relieve the corporation from federal income tax liability for most tax items. Subject to four exceptions (one of which is nearly obsolete), an S corporation is not subject to federal income taxation and instead serves as a conduit whose tax attributes are passed through to its shareholders. One of those exceptions occurs when a C corporation that uses the LIFO (last in-first out) method to account for its inventory becomes an S corporation. See Section 2(g) of Chapter 9. A second occurs when an S corporation recaptures an investment credit that was taken by the corporation when it was a C corporation; in that event, the corporation (rather than its shareholders) will be liable for the recapture of the tax credit. § 1371(d)(2)
- provided only that the amount of the built-in gain that is passed through to shareholders be reduced by the amount of the § 1374 tax; the provision was amended in 1989 to characterize the tax as a loss. This amendment was designed to cure a problem that arose with merely reducing the pass-thru of built-in gains by the § 1374 tax because of a change made in the Technical and Miscellaneous Revenue Act of 1988 to the taxation of built-in gains when the corporation’s taxable income is less than the amount of its net built-in gains. The 1988 amendment put a ceiling on the amount of a corporation’s net recognized built-in gain so that it cannot exceed a modified version of the corporation’s taxable income determined as if it were a C corporation. However, any recognized built-in gain that escaped taxation because of that limitation is carried over to and taxed to the corporation in succeeding years when it has sufficient taxable income. § 1374(d)(2)(B)
- Also, as will be explained later, in certain circumstances, a corporation’s taxable year can be divided into two parts, in one of which it will be an S corporation and in the other it will be a C corporation. See Section 6 of Chapter 7, infra. Of course, the corporation will be subject to federal income taxation on that amount of its income that is attributable to the portion of the year that it is a C corporation.
- One of the circumstances in which an S corporation will incur income tax liability is when it has so-called “built-in gains.” § 1374 . A built-in gain refers to income recognized by an S corporation that is attributable to appreciation or other unrecognized income that arose in the hands of what was then a C corporation and is subsequently recognized by a corporation when it is an S corporation. When recognized, such gains are referred to as “recognized built-in gains.” Thus, the tax imposed by § 1374 will generally not apply to a corporation that has always been an S corporation and has not received any assets from a C corporation in a carryover basis transaction. Even then, as discussed in Chapter 9, the § 1374
- With one exception, no carryover or carryback arising in a taxable year of a C corporation can be carried to a year in which that corporation is an S corporation; but the S corporation year is counted as an elapsed year in determining the number of years to which an item can be carried forward or back. § 1371(b) . The one exception is that a net operating loss carryover and a capital loss carryover from a C corporation year can be utilized in a subsequent S corporation year as a deduction against the S corporation’s “net recognized built-in gain” for that year. § 1374(b)(2)
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Preface 7 results (showing 5 best matches)
- The organization of the book begins with an examination of the requirements that a corporation must meet in order to qualify to make an election to be an S corporation. This includes an examination of the types and number of shareholders that are permitted, the manner and timing of an election, and the date on which a valid election becomes effective. The book then addresses the tax treatment accorded to an S corporation and its shareholders. This part includes the pass through of the corporation’s tax items, the extent to which shareholders can deduct pass-through losses, the carryover of deductions that a shareholder cannot utilize in a taxable year, and the treatment of distributions from a corporation to a shareholder both while the corporation is still an S corporation and afterwards. The book then examines how an election for Subchapter S treatment can be terminated—voluntarily or involuntarily. The book examines the consequences of a termination of an election, especially...
- The S corporation was introduced in 1958 when Congress added Subchapter S to the Code. As originally adopted, it was available only to closely held corporations (the number of permissible shareholders was limited to ten, and the types of persons who were permitted to hold stock of an S corporation were severely restricted), and its pass-through treatment of tax items was narrower than that of partnerships. The scope of the Subchapter S provisions has been expanded over the years. An S corporation can now have as many as one hundred shareholders, and it can have even more than that because of the liberal treatment of a broad range of family members as a single shareholder for purposes of the 100-shareholder limit. The types of persons who are permitted to hold stock in an S corporation also have been expanded. The pass-through treatment of tax items to an S corporation’s shareholders has become much more similar to the manner in which partnership tax items pass through to the...
- S corporations are a popular form of conducting business, especially for small business operations. They combine the advantages of a corporate structure, including access to the nonrecognition tax provisions that apply to certain combinations of corporate entities, with the pass-through of tax attributes that partnerships provide. With the rise of the Limited Liability Company (LLC) form of conducting business, many predicted that the use of S corporations would shrink as most small businesses would choose the LLC form. Contrary to those expectations, while the LLC has proved to be a popular vehicle, the use of S corporations has continued to thrive. In 2015, over 4.7 million returns were filed by S corporations. That number represents a 24 percent increase from 2005 and more than 2.5 million returns than were filed by C corporations in 2015.
- Anyone who plans to engage in advising closely held businesses needs to have an understanding of the requirements and operation of the Subchapter S provisions in order to be able to compare the relative advantages and disadvantages of each form that is available for conducting a specific business. The S corporation’s application of a pass-through system may induce a deceptive inference that the provisions are relatively simple to apply. Unfortunately, that is not the case.
- The goal of this book is to provide the reader with a foundation in the basic structure of Subchapter S. We do examine some of its details so that the reader will be better able to understand the benefits and costs of conducting business in this form. We also discuss the historical background of some provisions to provide the reader with a fuller understanding of the current provisions and what problems they were designed to cure. We have not attempted to cover every aspect of Subchapter S. That would require a multi-volume treatise. We have, however, covered all of the material that is likely to be included in a law school course on this subject.
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Chapter 1 Introduction 32 results (showing 5 best matches)
- The purpose of Subchapter S is to prevent the double taxation of corporate income for certain qualified and electing corporations. An S corporation generally does not pay taxes on its income. Instead, the income and other tax items of an S corporation, as determined at the end of its taxable year, pass through to its shareholders in proportion to their stock holdings. In general, the shareholders will increase the basis in their corporate stock for income that passes through to them, and they will reduce their basis in the corporation’s stock for losses or deductions that pass through to them.
- Subchapter S permits certain relatively small corporations to elect not to be taxed on most or all of their income and, instead, to have their income, deductions and credits allocated to their shareholders. The reference to “small” corporations refers to the number of shareholders the corporation has; the size of the corporation’s net worth and gross receipts is of no consequence in determining whether the corporation qualifies. Thus, the S corporation form can be available for very large businesses that are already in corporate form and desire to escape the burden of the double tax regime that is a prime element of Subchapter C of the Code, which governs the taxation of corporations other than S corporations. For example, some public companies with a relatively small number of public shareholders have made the decision to “go private” through leveraged buy-out transactions and then, with the benefit of the resulting reduced number of shareholders, to elect to be an S corporation.
- There are numerous examples in which the provisions of Subchapter C have been applied to S corporations. Thus, the reorganization provisions (including nonrecognition of gain or loss) apply to S corporations. GCM 39768. Also, in that an S corporation qualifies to make a valid § 338 election for a target whose stock the S corporation had acquired in a qualified stock purchase. The reader will recall that a § 338 election is available only when a corporation makes a qualified stock purchase of a target corporation’s stock. § 338(a)
- Prior to the adoption of the Subchapter S Revision Act of 1982 (hereinafter referred to as the “SRA”), only a few of the tax items of an S corporation were passed through to the shareholders (for example, there was no pass through of the corporation’s capital losses in excess of its capital gains), and all corporate income that was passed through to a shareholder was treated either as ordinary dividend income or as a long-term capital gain. The SRA changed this feature of an S corporation, and made many other important changes in the treatment of S corporations and their shareholders. Tax items of an S corporation now pass through to its shareholders with the same character
- Subject to four exceptions, one of which is virtually obsolete, a corporation for which a valid Subchapter S election has been made will pay no federal income tax. The four exceptions that require an S corporation to pay an income tax in certain circumstances do not apply to a corporation that has been an S corporation since its inception and has not obtained from a C corporation, in a nonrecognition transaction, an asset that was appreciated in value at the time of the transfer to the S corporation. (d)(8)(B)(ii). The four exceptions are discussed later in this Section 2
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Chapter 4 Shareholder’s Basis in S Corporation’s Stock and Debt Obligations 47 results (showing 5 best matches)
- are similar to the adjustments made to a partner’s basis in his partnership interest under § 705 . Note, however, that there is no counterpart in Subchapter S for § 752 , which increases a partner’s basis in his partnership interest for his share of partnership liabilities. An S corporation’s liabilities do not increase a shareholder’s basis in his stock. Note also that there is no provision in partnership taxation for a reduction of a partner’s basis in partnership debt because of an allocation of the partnership’s tax items.
- The most significant special treatment for the basis of the stock of an S corporation is the adjustments that are made to that basis. Under § 1367 , a shareholder’s basis in his stock in an S corporation is adjusted to reflect the corporation’s items that have been allocated to that shareholder—e.g., his stock basis is increased by his share of the corporation’s income items (including tax-exempt income) and by his share of the excess of depletion deductions over the basis of the depletable property; and his stock basis is reduced (but not below zero) by his share of losses, deductions, non-capital expenses that are not deductible, the amount of oil and gas depletion deduction that does not exceed the shareholder’s proportionate share of the adjusted basis of the depletable property, and by § 301 distributions received from the corporation and not included in the shareholder’s income under § 1368
- As discussed in Section 1 of Chapter 5, infra, the amount of net loss that passes through to a shareholder from an S corporation can be deducted only to the extent of the shareholder’s basis in both the corporation’s stock and in debt that the corporation owed to the shareholder. § 1366(d)(1) . In addition, the deduction is limited by the at risk rules and passive activity loss limitations of §§ 465 and 469. Under § 1366(d)(2) , any loss that cannot be deducted by the shareholder because of the § 1366(d) limitation is carried over by the corporation indefinitely as a loss that is allocable to that shareholder. Such a carryover loss is sometimes referred to as a “§ 1366(d) loss.” Subject to the at risk limitation of § 465 and the passive activity loss limitation of § 469 , the shareholder can deduct such carryover losses in subsequent years to the extent that the shareholder then has a basis in his stock or debt. While this § 1366(d)
- In Year One, S corporation, which has no accumulated earnings and profits, had a capital gain of $500 and an ordinary loss of $800. On the last day of that same taxable year, the corporation made a distribution of $250 cash to its sole shareholder, who holds no debt of the corporation and who had a basis of $400 in the corporation’s stock at the beginning of the year. The shareholder’s basis in the stock will be increased by the $500 gain, decreased by the $800 ordinary loss, and decreased by the $250 cash distribution, subject to the limitation that his basis cannot be reduced below zero. The order in which those increases and decreases in basis take place will determine the extent to which the shareholder can deduct the pass-thru loss of the S corporation and the extent (if any) to which the cash distribution will cause the shareholder to recognize income. The order of adjustments to basis is explained below.
- Individual A is the sole shareholder of Corporation. As of January 1, Year One, A had a basis of $10,000 in his 100 shares of ’s stock, and A had a basis of $4,000 in a promissory note that evidences a debt that owes to A. At all relevant times in this example, is an S corporation that reports its income on a calendar year basis; and has no earnings and profits. In Year One, had a loss of $13,000. distributions to its shareholder in that year. The $13,000 loss passes through to
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Chapter 2 Eligibility to Qualify as an S Corporation 153 results (showing 5 best matches)
- In the view of the authors, the treatment of debt that was adopted in the current regulations makes far more sense than the position that Treasury initially adopted in the 1990 proposed regulations. Treasury properly discarded its earlier position on this issue. The policies at stake in deciding whether an S corporation’s obligation should be treated as debt or equity are significantly different from those at stake in deciding how a C corporation’s obligation should be treated. In the typical C corporation context, the “integrity” of the double-tax system is at issue since dividends create income for a shareholder without generating a deduction for the corporation. In the typical S corporation context, however, dividends have nothing to do with double taxation. All that should be at issue is whether the corporation’s capital structure has become so complex that it either is not feasible or for some reason is inappropriate to characterize the entity as a “small business corporation”—...
- An S corporation is permitted to be a subsidiary of another S corporation if certain conditions (described in Section 2 of this chapter) are satisfied. Such a subsidiary is referred to as a “Qualified Subchapter S Subsidiary” (QSSS), which is often referred to in practice and in the regulations as a “QSub.” The treatment of a Q Sub is discussed in Section 2 of this chapter. In all other respects, a corporation—even an S corporation—is not a permitted shareholder of an S corporation. An S corporation may be a stockholder of another corporation without disqualifying its S election, but its S election will be disqualified if another corporation acquires
- If more than 100 persons wish to form an S corporation, they can accomplish a similar result by forming two or more S corporations each of which has separate shareholders and does not violate the shareholder limitation. The several S corporations can then form a partnership to operate the business. Under partnership taxation (Subchapter K), the income of the business will be allocated among the several S corporations and then, in turn allocated among the shareholders of each corporation under Subchapter S rules. Reversing its prior position, the Service agreed in Rev. Rul. 94–43 that such an arrangement does not violate the shareholder limitation rule. With the substantial expansion of the number of persons who can be S corporation shareholders since that revenue ruling was published, it is less likely that this partnership structure will be needed to deal with the shareholder limit. However, it seems likely that such a partnership form can be utilized to avoid other restrictions on...
- An S corporation can own stock of other corporations, and it can have a controlling interest in another corporation regardless of whether its subsidiary is a C corporation or a QSub. However, an S corporation cannot file a consolidated return with another corporation. § 1504(b)(8)
- To qualify for Subchapter S treatment, an electing corporation must satisfy the requirements set forth in § 1361 . A corporation that qualifies to elect Subchapter S treatment is referred to as a “small business corporation.” Note that a “small business corporation” is one that meets the qualifications to make a Subchapter S election, but it will not be an S corporation unless a valid election is made. The “small” in that term refers to the number of shareholders that an S corporation is permitted to have; there are no limitations on the size of an S corporation’s net worth or on the amount of its income. A corporation must satisfy the following requirements to be a “small business corporation.” (§ 1361(b)
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Chapter 7 Termination of Election 40 results (showing 5 best matches)
- When the acquiring C corporation makes a unilateral election under § 338(g) —as contrasted with a joint election under § 338(h)(10) —the S corporation will actually have two C short years. The first C short year will commence and end on the acquisition date and the activities of the former S corporation on that date and all gain recognized from the § 338 election will be reported in that C short year. This will prevent the shareholders of the S corporation from being required to report the § 338 gain resulting from an election by the acquiring corporation in which they did not participate. The second C short year will begin on the day after the acquisition date and continue until the end of the taxable year and will reflect all activities of the corporation during that period.
- A new shareholder who acquires stock after a Subchapter S election has been made does not have the unilateral power to revoke unless he owns more than one-half of the corporation’s shares. There is no requirement that a new shareholder consent to the election. However, a shareholder (new or otherwise) can terminate the Subchapter S election by transferring one share of his stock to a person (such as a C corporation) who is not a permissible shareholder of an S corporation. As explained in section 4 below, a corporation’s S status is terminated upon the date that it ceases to satisfy the requirements of Subchapter S. If such a transfer of a
- Unless an S corporation has accumulated , there is no penalty for having passive investment income—i.e., such income does not cause the termination of the election nor does it cause the imposition of any federal income taxes on the S corporation. You will recall that there are only two circumstances in which an S corporation can have accumulated during a time when it was a C corporation, or (2) it acquired the of another corporation as a consequence of an acquisitive reorganization or a liquidation of that corporation.
- A corporation’s election will terminate at any time that it ceases to qualify as an S corporation. For example, the issuing of a second class of stock or the acquisition of any of its stock by a C corporation will terminate the election. The termination is effective on and after the date on which the corporation ceases to qualify. § 1362(d)(2) . Such a termination will occur whether the terminating event is deliberate or unintentional. However, in certain circumstances, the Commissioner will exempt an S corporation from having its status terminated by an inadvertent event.
- If any shareholder terminates his entire interest in an S corporation during a taxable year and if the corporation’s S election is not terminated thereby, the corporation and the “affected shareholders” can elect under § 1377(a)(2) to have that taxable year treated as two short taxable years, the first of which ends on the close of the day on which the shareholder’s interest is terminated. This division into two short years applies only for making allocations to the “affected shareholders;” and so the determination of allocations to other shareholders of the corporation is not affected by the election. Both short years will be subject to Subchapter S. This election is sometimes referred to as a “terminating election,” and the shareholder whose interest in the corporation is terminated is sometimes referred to as a “terminating shareholder.”
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Chapter 5 Limitations on Deductions 47 results (showing 5 best matches)
- As of January 1, Year One, Y Corporation was an S corporation that reports its income on a calendar year basis. owned all 100 shares of Y’s outstanding stock, and B had a basis of $10,000 in those shares. In Year One, Y had a net loss of $18,000 which ’s basis in the was permitted to deduct only that amount of the pass-thru loss. The remaining $8,000 of Y’s loss is carried over as a carryover § 1366(d) loss. B’s basis in the Y stock was reduced to zero. Y had no net income or loss in Year Two, and so B’s basis in the Y stock was still zero at the end of Year Two. The corporation had an $8,000 carryover § 1366(d)
- A shareholder can deduct a loss or deduction passed through to him from an S corporation only to the extent of his basis in the S corporation’s stock and in any indebtedness owing to him from the corporation. In addition, a loss that passes the basis limitation requirement is deductible only to the extent permitted by §§ 465 469. See Section 4 of this chapter. As described in Section 2 of Chapter 4, for this purpose, the shareholder’s basis in the S corporation’s stock is determined at the end of the S corporation’s taxable year after taking into account adjustments under § 1367(a)
- If a shareholder’s stock or debt of an S corporation becomes worthless, the deduction and loss items of the corporation that pass through to the shareholder in that taxable year will be deducted by the shareholder and reduce the shareholder’s basis in the corporation’s stock and debt instruments before a deduction is taken under § 165(g)
- In addition to the limitations imposed by § 1366(d) on the deductibility of a shareholder’s share of an S corporation’s losses and deductions, a shareholder is also subject to the “at risk” limitations of § 465 and the passive activity loss and credit limitations of § 469 . The at risk limitations and the passive activity loss and credit limitations are not applied to the S corporation itself. §§ 465(a)(1) ; 469(a)(2) . Since the tax items of an S corporation are passed through to its shareholders, who themselves are subject to the at risk and passive activity loss and credit limitations, there is no reason to subject an S corporation to those limitations.
- In effect, each shareholder is given a period of time in which to increase his basis in the corporation’s stock and thereby qualify to deduct that amount of his share of the carryover § 1366(d) loss. Note that only an increase in the basis of stock will permit the deduction of the carryover loss; an increase in the basis of a debt of the corporation during that grace period will not enable the shareholder to deduct any of the carryover loss.
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Chapter 8 Taxation of Passive Investment Income 18 results (showing 5 best matches)
- It is possible that gain recognized by an S corporation from the disposition of an asset could constitute both passive investment income and a “recognized built-in gain” as defined in § 1374(d)(3) . To prevent a double tax, the amount of an S corporation’s passive investment income is determined by excluding any of the corporation’s recognized built-in gains and losses that are recognized during the “recognition period.” § 1375(b)(4) . The meaning of the terms “recognized built-in gains,” “recognized built-in loss,” and “recognition period” are explained in Chapter 9, infra in the discussion of § 1374
- As noted in Section 7 of Chapter 7, an S corporation that has accumulated earnings and profits and has a substantial portion of its gross receipts from passive investment income is given three consecutive years to get its house in order before the election will be terminated. But, in addition to the termination provision, a corporation is subject to tax consequences in any taxable year in which a significant percentage of its gross receipts is passive investment income if it also has accumulated at the end of that taxable year. The definition of passive investment income is described in Section 7 of Chapter 7. Section 1375 imposes a tax (sometimes called a “sting tax”) on an S corporation for any taxable year in which it has both:
- Corporation conducted a personal service business as a C corporation in Year One, but it became an S corporation beginning January 1, Year Two. reports its income on a calendar year basis. In Year Two, had gross receipts of $100,000 of which $37,500 constitute interest from bonds of publicly held corporations and $62,500 constitute receipts from the conduct of a personal service business. Individual A is the sole shareholder of made no distributions to its shareholder in Year Two. had deductible expenses in Year Two of $25,000 of which $7,500 is attributable to the interest it earned. The remaining $17,500 of deductible expenses are attributable to the receipts from the personal service business. At the beginning and end of Year Two, of $18,000.
- tax is computed by multiplying the “excess net passive income” by the highest ordinary income tax rate that is applicable to corporations (currently, that rate is 35 percent). By “ordinary” rate, we refer to the corporate income tax rates exclusive of surtaxes. The “net passive income” of a corporation is the difference between its passive investment income (as defined in § 1362(d)(3)(C) and the corporation’s deductions that are directly connected with the production of such income (other than net operating loss deductions and certain special deductions allowable only to corporations such as the dividend-received deduction). § 1375(b)(2) . The “excess net passive income” is an amount that has the same ratio to net passive income as the excess of passive investment income over 25 percent of gross receipts has to the corporation’s passive investment income.
- The amount of excess net passive income for a taxable year cannot exceed a modified version of the corporation’s taxable income for that year. For this purpose, the corporation’s taxable income is computed by excluding all net operating loss carryovers and carrybacks and by excluding the deductions allowed by §§ 243–247 . Note that the special calculation of taxable income of an S corporation that ordinarily is required by § 1363(b) does not apply to the taxable income limitation of this section, which instead provides its own special definition.
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Chapter 10 Fringe Benefits 1 result
- In applying the provisions that deal with employee fringe benefits (including qualified deferred compensation plans), the same tax provisions that apply to partnerships and partners will apply to S corporations and to persons who own (or are deemed to own after applying § 318 stock attribution rules) more than two percent of an S corporation’s outstanding stock or more than two percent of the total combined voting power of the corporation’s stock. § 1372 . Thus, there usually will be no difference in the tax treatment of fringe benefits whether a partnership form or Subchapter S form is utilized.
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- Robert A. Sullivan Professor of Law Emeritus, University of Michigan
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- Publication Date: February 24th, 2017
- ISBN: 9781683282204
- Subject: Taxation
- Series: Nutshells
- Type: Overviews
- Description: The Subchapter S rules are complex. This book describes the basic rules that apply to S corporations and their shareholders with sufficient detail to alert the reader to potential pitfalls. The topics covered include: (1) the qualification requirements for a Subchapter S election, (2) the allocation of tax items among the shareholders, (3) the effect of those allocations on a shareholder’s basis in stock and debt, (4) the limitations on the deduction of pass through items, (5) the treatment of corporate distributions, (6) the voluntary and involuntary termination of Subchapter S status, (7) the treatment of the year in which a Subchapter S election is terminated, (8) the limited availability of certain Subchapter S provisions after a Subchapter S election is terminated, and (9) the taxation of an S corporation’s passive investment income and built-in gains. The discussion of these issues is supplemented by numerous examples.
