What are the tax rules for a tax-free contribution of property to an S-Corp?
The event is tax-free, just like forming a C-Corp, if it is a
Contribution of property (assets or money) and not services
Solely in exchange for stock, and
After the transfer, the shareholder(s) have control of the corp through 80% stock ownership
What are the tax consequences of property contributions to an S-Corp in exchange for stock that do not result in 80% ownership?
The transfer is treated as a taxable sale with gain/(loss) recognized by the new shareholder.
What is the basis of property received from a transferor in a tax-free exchange for stock?
The greater of
++ the adjusted basis, plus any gain recognized by the transferor OR
++ debt assumed by the S-Corp (transferor may recognize gain to prevent a negative basis)
What is the basis of property received from a transferor in a non-tax-free exchange for stock?
What are the requirements to qualify as an S-Corp?
Must be a domestic corp.
The S-Corp may own any portion of a C-Corp (even 100%), but must not file a consolidated return
Shareholders can include: individuals, estates, trusts, qualified retirement plans, 501(c)(3) orgs, grantor, or voting trust
Shareholders can NOT include: corporations, partnerships, and non-resident aliens.
There may not be more than 100 shareholders, but family members may elect to be treated a one shareholder.
There can only be one class of stock, even if differences in voting rights. Preferred stock is not permitted.
True / False: S-Corps pay tax at the corporate level.
Generally False, Except
Tax consequences are passed through to the shareholders, whether or not they receive a distribution from the S-Corp.
LIFO Recapture Tax
Built-in Gains Tax
Tax on Passive Investment Income
What is the LIFO Recapture Tax imposed on an S-Corp?
When a company first operates as a C-Corp, and it uses LIFO for inventory tracking, and then elects to be treated as an S-Corp, the C-Corp must include in taxable income for the last C-Corp year the excess of inventory computed under FIFO over LIFO on a cumulative basis. The resulting tax is paid in 4 equal installments, the first of which is due with the final C-Corp return, and the remainder paid by the S-Corp.
Describe the Built-in Gains Tax imposed on an S-Corp: When is it imposed? How much is the tax?
A C-Corp turns into an S-Corp and the basis of the assets is less than FMV
The S-Corp later sells or distributes the asset for a gain.
The S-Corp is taxed at 35% of the of the lesser of:
++ the built-in gain (FMV at date switched to S-Corp minus book value on same date) less any previously recognized gain OR
++ the taxable income of the S-Corp as if it were a C-Corp
Describe the exemptions that can be used to avoid the Built-In Gains Tax that could be imposed on an S-Corp?
If the S-Corp was never a C-Corp (no built-in gain occurred in transfer because there was no transfer)
The sale occurred 10 years after S-Corp election
The asset’s appreciation occurred after S-Corp election
The asset itself was acquired after S-Corp election
The built-in gain was recognized in previous years
Describe the Passive Investment Income Tax imposed on an S-Corp: When is it imposed? How much is the tax?
The tax is 35% on the lesser of
++ Net income OR
++ Excess passive investment income IF the following 2 conditions are met
++++ The S-Corp has accumulated earnings attributable to prior periods in which the entity was a C-Corp AND
++++ The passive investment income exceeds 25% of gross receipts
What items are considered passive income?
But NOT gains on sales of securities
Ordinary income of an S-Corp is allocated to shareholders via a K-1 on which basis?
Per-share owned, on a per-day basis
This is important when shares have been sold part-way through the year.
How is the shareholder’s basis in an S-Corp determined? What is excluded?
The adjusted basis in the stock
Loans made by a shareholder directly to the S-Corp. A nonrecourse loan (the shareholder is not personally liable) increases basis, but not the at-risk amount. Loans made by the S-Corp with a bank do NOT increase basis.
Not included: shareholder guarantees b/c guarantees are to a bank, but the loan is made by the S-Corp.
True / False: A shareholder takes out a loan from a bank. The shareholder then takes the loan money and makes a separate loan directly with the S-Corp. The shareholder's loan will add to his basis.
If the S-Corp had made the loan with the bank, it would not add to the shareholder's basis, but making a loan with the shareholder does.
The S-Corp must then pay the shareholder, and the shareholder then pays the bank.
How is the at-risk amount in an S-Corp determined?
INCREASES TO AT-RISK AMOUNT
Generally it is equal to the shareholder’s stock and direct-loans. A nonrecourse loan does NOT increase the at-risk amount. A recourse loan DOES increase the at-risk amount.
Plus contributions of cash or other property to the S-Corp
Plus the allocable share of income undistributed
DECREASES TO AT-RISK AMOUNT
Allocable share of losses
Distributions of cash or other property
What amount of S-Corp loss may a shareholder deduct from personal taxes?
The lesser of the basis in the S-Corp, or the shareholder’s at-risk amount
When are fringe benefits deductible vs not deductible to the S-Corp?
Deductible: for non-shareholder employees and those employee shareholders owning 2% or less of the S-Corp
Not-Deductible: for employee shareholders owning >2% of the S-Corp unless the benefits are included in W-2 income
What is the Accumulated Adjustments Account used for? What is the balance at the inception of the S-Corp?
The AAA tracks earnings and profits (retained earnings) of the S-Corp since inception, and then distributions paid to shareholders.
The balance at S-Corp inception = $0 (b/c the S-Corp hasn’t earned any money)
What items increase the Accumulated Adjustments Account?
Separately and non-separately stated income and gains EXCEPT
tax-exempt income and certain life insurance proceeds
What items decrease the Accumulated Adjustments Account?
Corporate distributions, but distributions cannot reduce the balance of the AAA below zero.
Corporate expenses and losses. (A corp operating loss can reduce AAA below zero.)
An entity first operated as a C-Corp, and then elected to become an S-Corp. The C-Corp had a positive earnings and profits (E&P=retained earnings) balance. Distributions are now being made to shareholders by the S-Corp. In what order and from which accounts are distributions made?
1st: from the AAA balance until depleted (tax-free distribution to shareholders)
2nd: from the carryover C-Corp E&P until depleted (shareholders taxed as dividend income)
3rd: as return of capital until basis depleted
4th: as a capital gain distribution (long-term if held >1 yr, otherwise short-term)
Why are distributions to shareholders made from the Accumulated Adjustments Account tax-free?
Because the shareholders paid tax when the income was created and are receiving a distribution on an amount that was already taxed.
An S-Corp elects to liquidate. What are the tax implications to the S-Corp and its shareholders?
The S-Corp must recognize gain/(loss) on the distribution of property as if it were sold at FMV. The gain/(loss) is passed as an adjustment to shareholder basis.
Distributions to shareholders are treated as a sale of their stock (property received = stock sold) and gain/(loss) recognized