CHAPTER 12 B S CORPORATIONS
Based on West Federal Taxation, Corporations, Partnerships, Estates, & Trusts, 2001 ed.
1.
INTRODUCTION
1.
2.
3.
IN GENERAL p.12-2
1.
S Corporation status provides a compromise for small businesses.
1.
Avoid double taxation and loss limitations inherent in the regular corporate form
2.
Enjoy many of the nontax benefits extended to C corporations.
2.
State law:
1.
S Corporations are treated as corporations under state law. They are recognized
as separate legal entities and generally provide shareholders with the same
liability protection afforded by C corporations.
2.
Some states impose an income or franchise tax on S corporation meaning that the
corporation may not owe federal corporate tax but would owe state income tax.
3.
S corp status must be elected by a qualifying corporation and consented to by its
shareholders.
AN OVERVIEW OF S CORPORATIONS p.12-3
1.
The growth of S corporations has continued even though the individual income tax rate
has remained above the corporate rate. In 1986, only 24.1% of corporations were S
corporations, but by 1996 the percentage had grown to 49.8% or 2.3 million S
corporations.
2.
Two recent developments have affected the popularity of S corporation status.
1.
New entities called limited liability companies(LLCs) avoid restrictions that are
imposed on S corporations.
2.
Small Business Protection Act of 1996 liberalized several S corporation rules
which provide greater flexibility in forming, operating, and restructuring S
corporations.
WHEN TO ELECT S CORPORATION STATUS p.12-4
Consider these factors:
1.
Shareholders with high marginal rates relative to C corp. rates may want to avoid S
status.
2.
S corp. status allows shareholders to realize tax benefits from corporate losses
immediately such as the benefits of an NOL used to shelter other income (not available
with a C corp).
3.
If the entity electing S corporation status is currently a C corporation, any NOL
carryovers form prior years cannot be used in an S corporation year.
4.
Distributions of earnings from C corporations are usually taxed as ordinary income.
5.
S corporation rules impose significant requirements for qualifying as an S corporation.
Acct 432, Ch 12 Outline, Page 1
6.
2.
State and local tax laws should also be considered when making the S election.
QUALIFYING FOR S CORPORATION STATUS
1.
DEFINITION OF A SMALL BUSINESS p.12-5
Corporation must have these characteristics:
1.
Ineligible Corporations
1.
S corp status only granted to domestic corporations
2.
S corp status is not permitted for foreign corporations, certain banks, insurance
companies, and Puerto Rico or possessions corporations.
2.
2.
One Class of Stock B A small business corporation may have only one class of stock
issued and outstanding (does not consider different voting rights as different classes of
stock).
3.
Number of Shareholders B Maximum of 75 shareholders (35 prior to 1997). Be careful
of divorce situations.
4.
Type of Shareholder Limitation B Small business corporation shareholders may be
resident individuals, estates, certain trusts, and certain tax-exempt organizations.
5.
Nonresident Aliens B Nonresident aliens cannot own stock in a small business
corporation.
6.
Ethical consideration B p.12-8
MAKING THE ELECTION p.12-8
To be an S corporation , a small business corporation must file a valid election with the IRS.
1.
Use Form 2553
3.
2.
For existing corporations B File election either in the previous year or by the 15th day of
the third month of the tax year.
3.
For new corporations B File election at the earliest of the following dates:
1.
2 2 months from the date corporation has shareholders
2.
2 2 months from the date corporation acquires assets
3.
2 2 months from the date corporation begins doing business.
4.
Corp must qualify for S election for entire tax year for which election is made.
5.
Obtain consent for S election from all shareholders.
SHAREHOLDER CONSENT p.12-9
Acct 432, Ch 12 Outline, Page 2
4.
1.
A qualifying election requires the consent of all of the corporation=s shareholders.
Consent must be in writing, and must generally be filed by the election deadline.
2.
Both husband and wife must consent if they own their stock jointly (as joint tenants,
tenants in common, tenants by the entirety, or community property).
3.
Shareholders from the year before election for S status is made must also consent to
election.
LOSS OF THE ELECTION p.12-10
An S election remains in force until it is revoked or lost.
3.
1.
Voluntary Revocation
1.
Requires the consent of shareholders owning a majority of shares on the day that
revocation is to be made.
2.
Unless otherwise indicated on the revocation, C corp status will become effective
(1)
for the current tax year if filed by March 15th of that year.
(2)
for the next tax year if filed after March 15th of that year.
3.
Corp can select a future date at which point the C status will become effective.
All income for that year would then be allocated between the S corp status and
the C corp status depending on the number of days of the year for each status.
2.
Loss of Small Business Corporation Status
1.
If an S corp fails to qualify at any time after the election has become effective, its
status as an S corporation ends.
2.
Termination date of the S corp is the date corp failed to qualify as an S corp.
3.
Passive Investment Income (PII) Limitation
1.
The code provides a PII limitation for:
(1)
S corporations that were previously C corporations OR
(2)
S corporations that have merged with C corporations.
2.
If an S corp has C corp E & P and passive income in excess of 25% of its gross
receipts for three consecutive taxable years, the S election is terminated as of the
beginning of the fourth year.
3.
Passive income includes dividends, interest, rents, gains & losses from sale of
securities, etc.
4.
Reelection after Termination
After S status is terminated, a corp must wait five years before reelecting S corporation
status. The five year waiting period is waived if:
1.
there is > 50% change in ownership after the 1st year for which the termination is
applicable, or
2.
the event causing the termination was not reasonably within the control of the S
corporation or its majority shareholders.
OPERATIONAL RULES
Acct 432, Ch 12 Outline, Page 3
1.
COMPUTATION OF TAXABLE INCOME p.12-12
1.
S corporations can amortize organizational expenditures and must recognize gains, but
not losses, on distributions of appreciated property to shareholders.
2.
Dividends received deduction does not extend to S corporations.
3.
In general, S corporation items are divided into
1.
nonseparately stated income or loss and
2.
separately stated income, losses, deductions, and credits that could affect the tax
liability of any shareholder in a different manner and are reported on Schedule K
of Form 1065. (See p.12-13 for list of separately stated items.)
PROBLEM 12
2.
ALLOCATION OF INCOME AND LOSS p.12-14
1.
In general:
1.
Each shareholder is allocated a pro rata portion of nonseparately stated income or
loss and of all separately stated items. The pro rata allocation method assigns an
equal amount of each of the S items to each day of the year. Formula:
S corp item x % of shares owned x % of year shares owned = Amt to be
reported
2.
2.
If a shareholder=s stock holding changes during the year, this allocation assigns
the shareholder a pro rata share of each item for each day the stock is owned.
The allocation for the day of transfer is assigned to the transferor (not transferee).
3.
The per day allocation must be used, unless the shareholder disposes of his or her
entire interest in the entity.
4.
If a shareholder dies during the year, his or her share of the pro rata items up to
the date of death is reported on the final individual income tax return.
The Short-Term Election
1.
If a shareholder=s interest is completely terminated by death or disposition before
end of the S corp=s year, all shareholders and corp can elect to split the tax year
and allocate items as they accrue (per-books method) instead of prorata.
2.
Short-term election can help protect the value of the estate of a deceased
shareholder.
PROBLEM 14
Acct 432, Ch 12 Outline, Page 4
3.
TAX TREATMENT OF DISTRIBUTION TO SHAREHOLDERS p.12-16
Distributions to S corp shareholders equals the cash they receive plus the FMV of the property
distributed. Be careful!! The shareholders may be taxed on the distribution if the corporation
used to be a C corp.
1.
No AEP from C Corporation Years
1.
Distributions to S corp shareholders are considered tax-free if:
(1)
S corp never was a C corp OR
(2)
S corp (that used to be a C corp) has no accumulated earnings and profits
(AEP)
2.
Distributions in excess of basis are usually treated as capital gains.
2.
AEP from C Corporation Years
1.
If the S corp (that used to be a C corp) has accumulated earnings and profits, the
shareholders must be taxed on the money when it is distributed.
(1)
Distributions from AEP are taxed as dividends like they would be if it
were still a C corp.
(2)
Distributions from income earned by the S corp and taxed on the
shareholder=s return is not taxed a second time.
2.
All corps (but especially those corps that used to be C corps) must keep an
account entitled accumulated adjustments account (AAA) which accumulates the
S corp income. This income is eventually passed through tax-free to the
shareholders.
(1)
AAA is divided among the shareholders based on their proportional
interest in the stock (stock basis is irrelevant).
(2)
An S corp loss can cause a negative balance in the AAA.
(3)
A distribution by an S corp cannot cause a negative balance in the AAA.
3.
Distribution Ordering Rules
1.
A distribution from an S corp is deemed to come from the following accounts in
order:
(1)
AAA (limited to the basis in stock)
(2)
Previously taxed income (PTI) which is the same type of account as AAA
but for S corp formed before 1983.
(3)
AEP
(4)
Any additional distribution is usually treated as a capital gain.
2.
AAA bypass election B If all shareholders consent, S corp can elect to have a
distribution come first from AEP instead of AAA.
PROBLEM 22, 25
4.
Schedule M-2 B Made up of three columns (AAA, OAA, & PTI)
1.
OAA includes items that affect basis but not AAA. Examples include:
(1)
tax exempt income
(2)
related nondeductible expenses
2.
Distributions come from OAA only after AAA and AEP have $0 balances.
3.
Distributions from OAA are generally tax free.
Acct 432, Ch 12 Outline, Page 5
5.
4.
Effect of Termination the S Election B Be very careful when making distributions the
first year after the S election is terminated.
1.
Cash distribution? Treated as tax-free recovery of basis if it does not exceed
AAA.
2.
Property distributions? Do not get the same treatment.
TAX TREATMENT OF PROPERTY DISTRIBUTIONS BY THE CORPORATION p.12-20
1.
2.
5.
S corp is deemed to have sold the asset to the shareholder for the asset=s FMV
Gain?
1.
S corp passes the gain through to the shareholders who pay the tax.
2.
Gain is taxed as either capital or ordinary (depends on the asset distributed).
3.
Loss?
1.
S corp does not recognize the loss
2.
No pass through of the loss occurs.
4.
Shareholder has a basis of the FMV of the property.
SHAREHOLDER=S BASIS p.12-22
1.
Shareholder basis is increased by the following:
1.
Stock purchases
2.
Capital contributions
3.
Nonseparately computed income
4.
Separately stated income items
5.
Depletion in excess of basis in the property
2.
Shareholder basis is reduced by the following:
1.
Distributions not reported as income (e.g. AAA and PTI)
2.
Nondeductible expenses of the corporation
3.
Nonseparately computed loss
4.
Separately stated loss and deduction items
PROBLEM 20, 23
3.
To calculate basis, use the following order:
1.
Beginning basis
2.
Add: Income items
3.
Less: Distributions
4.
Less: Non-capital, nondeductible expenditures
5.
Less: Losses and Deductible expenditures
4.
Shareholder=s basis will never fall below zero. Once the zero limit is reached, any
additional losses or deductions (but not distributions) impact the shareholder=s basis in
any debt owed by the corporation to the shareholder.
1.
Any excess losses or deductions over both the stock basis and the debt basis are
suspended.
2.
Corporate loans from shareholders
PROBLEM 21
Acct 432, Ch 12 Outline, Page 6
(1)
(2)
3.
6.
Debt basis must be restored to its original amount before the
shareholder=s stock basis can be increased.
Get a note or evidence of the debt so that deductions can be substantiated.
Corporate loans from third parties
(1)
do not affect shareholder=s basis.
(2)
do not affect shareholder=s basis even if shareholder personally
guarantees the debt.
TREATMENT OF LOSSES p.12-24
1.
Net Operating Loss
1.
NOLs can be passed through to shareholders and used as a deduction on their
personal returns in the year in which the S corp. tax year ends.
2.
Shareholder=s basis in the stock is reduced to the extent of the NOL. NOL
deduction is not allowed on the shareholder=s tax return for an amount exceeding
shareholder=s basis in his stock and any debt due to him by the corp.
3.
Shareholder=s AAA is reduced by the same deductible amount
4.
If S corp incurs more than one type of loss (e.g., NOL, passive loss, capital loss),
the loss must be allocated appropriately.
PROBLEM 27
5.
6.
Distributions adjustments are made to the shareholder=s stock basis prior to
applying any of the loss limitations for the year.
Any unused losses (i.e., losses that exceed shareholder=s stock basis and debt
basis) can be carried forward and used by that same shareholder when he has
restored his debt basis or his stock basis.
PROBLEM 28
7.
7.
If the AS@ status is lost or revoked, any unused carried over loss is lost forever
after one-year.
2.
Passive Losses and Credits B OMIT
3.
At-Risk Rules B OMIT
TAX ON PRE-ELECTION BUILT-IN GAINS p.12-27
1.
S-corporations converting from C-corporation status may be subject to three taxes:
1.
Built-in gains tax (' 1374)
2.
LIFO recapture tax
3.
Passive investment income tax
2.
General Rules (for Built-in Gains Tax)
1.
Applies to C-corporations converting to S-corp status after 1986.
2.
S corp is taxed at corp level on any built-in gain recognized when it disposes of
an asset within 10 calendar years after date of S-corp status election.
3.
Designed to catch those corporations seeking to avoid double tax on disposition
of appreciated property by electing S-corp status.
Acct 432, Ch 12 Outline, Page 7
4.
5.
6.
7.
Base for tax includes any unrealized gain on appreciated assets (real estate, cash
basis receivables, goodwill).
Highest corporate tax rate (now 35%) to unrealized gain when assets are sold.
Gain on sale (less the ' 1374 tax) passes through as a taxable gain to
shareholders.
Maximum amount of recognized gain
(1)
C corp=s unrealized gain less unrealized losses at time of S election.
(2)
Appreciation on assets after S-corp election is subject to S corp pass-thru
rules.
8.
Loss assets:
(1)
Built-in losses/gains are netted each year to determine annual '1374 tax
base.
(2)
Any loss asset contributed to a C corp within 2 years of the S election will
not reduce corp net unrealized built-in gain.
9.
AAs-if@ taxable income:
(1)
Built-in gain recognized in any year is limited to Aas-if@ taxable income
(as if corporation were a C-corporation).
(2)
Any excess is carried forward for recognition in future when income is
sufficient.
10.
Sales or distributions
(1)
Gains on sales or distributions of assets of S-corporations are presumed
built-in gains unless taxpayer can prove appreciation occurred after
conversion to S-corp status.
(2)
Get an appraisal on date of S election.
11.
Carryovers B Normally tax attributes of C corp do not carry over to converted Scorporation, however, S-corporation can utilize the following C corp leftover
items.
(1)
unexpired NOLs OR
(2)
capital losses OR
(3)
business credits
12.
Calculation of Built-In Tax Liability
(1)
Use smaller of built-in gain or taxable income (Any excess built-in gain
over taxable income is carried forward if within 10-year recognition
period)
(2)
Less:
(1)
unexpired NOLs
(2)
capital loses
(You are now at your tax base.)
(3)
Multiply tax base in step 2 by top corporate income tax rate (35%)
(4)
Deduct any business credit carryforwards and AMT credit carry-overs
arising in C-corp year from amount obtained in step 3.
(5)
Corporation pays any tax resulting from step 4
Acct 432, Ch 12 Outline, Page 8
(6)
Unrealized gains of corporation are offset against unrealized losses; net
gain/loss sets upper limit on tax base for built-in gains tax.
PROBLEM 29
Acct 432, Ch 12 Outline, Page 9
3.
LIFO Recapture Tax
1.
If FIFO used in C corp=s last year before S election, built-in gain is recognized
and taxed as inventory is sold.
2.
If LIFO used, corp does not recognize gain unless it invades LIFO layer during
10-year recognition period
3.
To preclude deferral of gain recognition under LIFO, LIFO recapture amount at
time of S-corp election is subject to corporate level tax
4.
Taxable LIFO recapture = FIFO value - LIFO value
5.
If LIFO is more than FIFO, no tax benefit is derived.
6.
Tax payable in four equal installments:
(1)
Payment #1 due on due date of return for last C-corp year (disregard
extensions)
(2)
Payments # 2, 3, & 4 due on due dates of subsequent tax returns
(3)
No interest due if payments made by due dates
(4)
No estimated taxes due on four tax installments
7.
Basis of LIFO inventory adjusted to account for LIFO recapture but accumulated
adjustment amount is not decreased by tax payment
PROBLEM 30
8.
PASSIVE INVESTMENT INCOME PENALTY TAX p.12-31
1.
Tax imposed on excessive passive income of S-corp possessing accumulated earnings
and profits (AEP) from C-corp years.
1.
Tax rate is highest corp rate for the year
2.
Formula
Passive investment income in excess
Excessive Net Passive Income =
of 25% of gross receipts for year
X Net
Passive Investment
Passive investment income
Income for the Year
for the year
3.
4.
5.
6.
7.
9.
Passive investment income includes gross receipts derived from royalties, passive
rents, dividends, interest, annuities, and sales and exchanges of stocks and
securities.
Only net gain from disposition of capital assets (other than stocks and securities)
taken into account in computing gross receipts
Net passive income is passive income reduced by any deductions directly
connected with production of that revenue
Any passive income tax reduces amount shareholders must take into income
Excess net passive income cannot exceed C-corp taxable income for the year
before considering NOL deduction or special deductions allowed under ''241250 (except organizational expense deduction of '248)
OTHER OPERATIONAL RULES
Acct 432, Ch 12 Outline, Page 10
1.
2.
3.
4.
5.
6.
7.
8.
9.
4.
S-corp is required to make estimated tax payments due to exposure of recognized built-in
gain and excess passive investment income
S-corp is not subject to 10% of taxable income limit on charitable contribution as is a Ccorp.
Family members who provide services for S-corp must be paid reasonable compensation;
IRS can adjust compensation to reflect value of services rendered
Shareholder compensation is not considered self-employment income, but compensation
for services is subject to FICA taxes
S corp is placed on cash basis for purposes of deducting business expenses and interest
owed to cash basis related party; as such, timing of shareholder income and corporate
deduction must match
S-corp election not recognized in Dist. of Col., Connecticut, Michigan, New Hampshire,
& Tennessee?
Some or all of entity income may be subject to state-level income tax
If '1244 stock is issued to S-corp, it and its shareholders may not treat losses on stock as
ordinary losses; S-corp may issue '1244 stock to its shareholders to obtain ordinary loss
treatment
Losses may be disallowed due to lack of profit motive under the hobby rule of '183
TAX PLANNING CONSIDERATIONS
1.
WHEN THE ELECTION IS ADVISABLE
1.
2.
3.
4.
5.
2.
MAKING A PROPER ELECTION
1.
2.
3.
4.
3.
When losses are anticipated since losses pass directly to shareholders
If individual shareholders are in lower tax bracket.
S-corporation, while immune from Federal income tax laws, may be subject to state and
local corporate taxes or from several Federal penalty taxes
C-corp NOL carryover from prior year cannot be used in an S-status year (except for
built-in gains tax)
Choice of form of doing business may be dictated by other factors such as a need for
substantial capital or possibility of a public offering. Sometimes, a partnership or limited
liability company may better.
All shareholders must consent
Election must be timely and properly filed; a copy of the filing should be part of the
corporation files
Be certain when the timely election period begins to run for a newly formed corporation;
corporation must be in existence before filing is made
Original shareholders have nothing to lose by complying with '1244; in event of
business failure, original shareholder can obtain an ordinary deduction for a loss on sale
or worthlessness of stock, asopposed to long-term capital loss treatment
PRESERVING THE ELECTION
Acct 432, Ch 12 Outline, Page 11
1.
2.
3.
4.
5.
6.
7.
8.
9.
4.
Election may be lost intentionally or unintentionally and requires waiting 5 years before
available again.
Make all shareholders aware of conditions under which election may be lost
Watch for disqualifying events
Divorce of a shareholder, accompanied by property settlement, could result in maximum
number of shareholders being exceeded (pre-1997, 35 limit; after 1997, 75 limit)
Death of shareholder resulting in non-qualifying trust becoming shareholder; can be
avoided with buy-sell agreement
Make sure a new majority shareholder does not file a refusal to continue the election
Watch for passive investment income limitation; avoid third year with excess passive
income if corporation has C-corp AEP, in which case, assets producing passive
investment income might be held by individual shareholders outside the corporation
Do not transfer stock to nonresident alien
Do not issue a second class of stock
PLANNING FOR THE OPERATION OF THE CORPORATION
1.
Accumulated Adjustments Account (AAA)
1.
2.
3.
4.
5.
2.
Most AAA used by S-corp with AEP from C-corp years
(1)
S-corp should maintain accurate record of AAA due to grace period for
distributions after termination of S-status
(2)
When AEP exists, a negative AAA may cause double taxation of S-corp
income.
(3)
With a negative AAA, a distribution of current income restores negative
AAA balance to zero. Distribution is considered to be in excess of AAA
and is taxable as a dividend to the extent of the AEP.
Distributions during year reduce stock basis for determining allowable loss for
year, but loss does not reduce the stock basis for determining tax status of
distributions made during year.
In determining tax treatment of distributions by S-corp have AEP, any net
adjustments (excess of losses and deductions over income) for the tax year are
ignored.
AAA bypass election may be used to reduce exposure to accumulated earnings
tax or PHC tax in Post S-status years. Bypass election allows AEP to be
distributed instead.
A net loss allocated to a shareholder reduces the AAA. This required adjustment
should encourage S-corp to make annual distributions of net income to avoid
reduction of AAA by future net loss.
Salary Structure
1.
Salary structure requires careful consideration
2.
Larger salary advantageous if maximum contribution for retirement plan has not
been met.
3.
Smaller salary beneficial if trying to shift taxable income to lower-bracket
shareholders, reduce payroll taxes, curtail reduction of Social Security benefits,
or restrict losses that do not pass through due to basis limitations
Acct 432, Ch 12 Outline, Page 12
4.
5.
6.
7.
8.
Reducing shareholder compensation reduces employment taxes; however, IRS
looks at services performed and may recharacterize distributions as wages subject
to FUTA and FICA
For planning purposes, some level of compensation should be paid to all
shareholder-employees.
Compensation paid to family members may be adjusted by IRS for
reasonableness.
Deductible compensation under '162 reduces S-corp taxable income relevant to
built-in gains.
Compensation may be one of larger items S-corp uses to reduce taxable income
to minimize built-in gains penalty tax and is subject to scrutiny by IRS
3.
Loss Considerations
1.
Net loss in excess of tax basis may be carried forward and deducted only by same
shareholder in succeeding years
2.
In sale of stock, seller should increase basis in stock/loan to flow through the
loss. Purchaser does not obtain the loss carryover.
3.
Unused loss carryover in existence at termination of S-status election may be
deducted only in the next year and is limited to the shareholders stock (not loan)
basis in post-termination year
4.
Shareholder may wish to purchase more stock to increase tax basis in order to
absorb the loss.
5.
In last election year or post-termination year, if possible NOL is apparent or
possible to use up any loss carryover, each shareholder should examine his basis
to see if it can absorb its share of the loss. If not, additional investment may be
considered by additional stock purchase either from the corporation or its
shareholders.
4.
Avoiding the Passive Investment Income Tax
1.
Excess passive investment income may result in '1375 penalty tax and/or
termination of S-status election
2.
Avoid tax, or reduce tax by:
(1)
If small AEP exists, a AAA bypass to purge AEP
(2)
Corporation might reduce taxable income below excess net passive
income.
(3)
Passive investment income might be accelerated into years in which there
is offsetting NOL
(4)
Increase gross receipts without increasing passive investment income. PII
in excess of
(1)
25% of gross receipts is reduced
(2)
Perform significant services with respect to real estate to elevate
rent income to non-passive
5.
Managing the Built-In Gains Tax
1.
Taxable income limitations encourage S-corps to create deduction and accelerate
deductions into years when built-in gains are recognized
Acct 432, Ch 12 Outline, Page 13
2.
3.
4.
5.
6.
Time value of money makes postponement of built-in gain beneficial
Payment of compensation, rather than distribution, creates a deduction that
reduces taxable income and postpones the built-in gains tax
Contributing built-in gain prop. to charitable organization does not trigger builtin gains tax.
Built-in gain may be a preference item at the shareholder level for purposes of
AMT
To reduce/eliminate built-in gains tax, built-in loss property may be sold in the
same year as the built-in gain property is sold.
6.
Controlling Adjustments and Preferences Items
1.
Individual AMT more prevalent since tax base has expanded and difference
between regular tax rates and individual AMT has narrowed.
2.
AAlmost-AMT Taxpayer@ at risk
(1)
Tax preferences of S-corp may push taxpayer into AMT
(2)
All shareholders in S-corp might not be in same situation and avoidance
procedures could have beneficial effect on some and negative effect on
others; some may need deductions, others may not.
7.
Allocation of Tax Items
1.
At death of shareholder or stock transfer during taxable year, tax items may be
allocated on two bases:
(1)
Pro rata approach- equal portion of each item to each day of tax year and
dividing portion pro rata among shares outstanding on transfer day
(2)
Per books approach- divide taxable year into two taxable years; first
portion ends on date of termination; shareholder owns shares on date of
termination Per books method prevents income/loss allocation to
deceased shareholder from being affected by postdeath events
8.
Termination Aspects
1.
Always advisable to avoid AEP in S-corporation
2.
Always danger of terminating election due to excess passive investment income
in three consecutive years
3.
Try to eliminate AEP through dividend distribution or liquidation of S-corp with
subsequent reincorporation.
4.
If AEP account is small, all shareholders may consent to have distributions
treated as first from AEP rather than from AAA (AAA bypass election)
5.
If shareholders decide to terminate the election other than voluntary revocation,
do so in manner that possesses substance. If intent of parties is obvious and
represents technical non-compliance rather than real change, IRS may disregard
and force parties in S-status.
9.
Liquidation of an S Corporation.
1.
Many liquidation rules same as C-corporation
2.
Distribution of appreciated property to shareholders in complete liquidation
treated as if property sold to shareholder in taxable transaction
3.
S-corporation incurs no incremental tax on liquidation gain, since gains flow to
shareholders subject only to built-in gains tax.
Acct 432, Ch 12 Outline, Page 14
4.
5.
Corporation gain increase shareholder stock basis by a like amount and reduces
any gain realized by the shareholder when he or she receives the liquidation
proceeds
S-corporation avoids double tax imposed on C-corporation, however, when Scorp liquidates, all special tax attributes disappear (AAA, AEP, PTI, Corporaiton
NOLs, suspended losses)
Acct 432, Ch 12 Outline, Page 15