R3 Module 5

Question 1

S corporation

Answer 1

-a flow-through entity taxed in a similar way to partnerships
-all income, gains, losses, and deductions of corporation are passed (or flowed) through to shareholders
-individual owners taxed on proportionate share of S corp. earnings regardless if earnings are distributed to owners

Question 2

Eligibility for S corporation status (Qualified Corporation)

Answer 2

1) domestic corporation
2) own any interest in C corporation
3) not file a consolidated tax return within C corporation
4) create qualified S subsidiary in which it owns 100% of stock
5) two S corporations file as one entity for tax purposes

Question 3

Eligible Shareholders in S corporation

Answer 3

1) must be individuals, estates, or certain types of trusts
2) individual shareholder may not be a nonresident alien
3) qualified retirement plans and 501(c)(3) charitable orgs. can be shareholders
Note: corps and partnerships NOT eligible

Question 4

S corp shareholder limit

Answer 4

1) no more than 100 shareholders
2) family members may elect to be treated as one shareholder
3) family members include common ancestors, lineal descendants of common ancestors, and current or former spouses

Question 5

One class of stock for S corp eligibility

Answer 5

-there may be no more than one class of stock outstanding
-differences in common stock voting rights are allowed
-preferred stock not permitted

Question 6

S corp election takes into effect

Answer 6

-all shareholders (voting and nonvoting) consent to valid election on Form 2553 filed to IRS
-election filed by 15th day of 3rd month is effective first day of tax year (including retroactively)
-For calendar yr corporation, and S election filed by March 15th effective January 1 of that year
-election filed after March 15, effective on January 1 of subsequent yr

Question 7

New shareholders for elected S corp

Answer 7

-after election is in effect, consent of new shareholder is not required
-S corporation status continues until there is a voluntary or involuntary termination

Question 8

S corporation tax year

Answer 8

-S corps file Form 1120S and must adopt calendar year, unless a valid business purpose for a different taxable year is established
-return is due by 15th day of 3rd month (March 15) after close of tax year

Question 9

Termination of S corp election

Answer 9

1) shareholders holding more than 50% of stock (voting and nonvoting) consent to a voluntary revocation
2) corporation fails to meet any qualifications of S status
3) excess passive investment income > 25% of corporation’s gross receipts are from passive investment income for 3 consecutive yrs (but only if corp has prior C corporation E&P)

Question 10

Reelecting S status

Answer 10

-once a corp. election terminated, corporation must wait until beginning of 5th yr after yr termination before it can elect S corp status again

Question 11

S corporation income

Answer 11

-S corps flow through ordinary business income or loss and separately stated items of income, gain, loss, and deductions to shareholders
-allocations to shareholders are made on per-share, per-day basis
-S corporation shareholder’s share of ordinary business income is not subject to self-employment tax even if shareholder actively involved in business

Question 12

Separately stated items flowed through to S corp shareholder

Answer 12

1) rental real estate income or loss
2) interest income
3) dividend income
4) royalties
5) net ST capital gain or loss
6) net LT capital gain or loss
7) net section 1231 gain or loss
8) charitable contributions
9) section 179 expense deduction

Question 13

separately stated items that are income and expenses items are:

Answer 13

1) subject to special limitations and calculations
2) reported on different tax forms OR
3) taxed at different rates
Note: all other income and expense items would be included as ordinary income or loss (ex. Section 1231 gains reported on Form 4797)

Question 14

Section 199A QBI Deduction

Answer 14

shareholder may take a below-the-line deduction of 20% of QBI on ordinary business income flowed-through from an S corporation

Question 15

Fringe Benefits for S corp

Answer 15

-deductible fringe benefits for non-shareholder employees and employee shareholders owning 2% or less of S corp deductible by S corp in calculating ordinary business income

-cost of fringe benefits for shareholders owning > 2% not deductible by S corp UNLESS corp includes benefits in employee/shareholder’s W-2 income

Question 16

S corp shareholder stock basis and debt basis

Answer 16

Initial stock basis (contributions)
+ additional contributions
+ income items (ordinary business income, separately stated income/gain items, and tax-exempt interest income)
-Distributions to shareholders
-Nondeductible expenses
-Loss/deduction items (ordinary business loss, separately stated loss/deduction items)
= Ending basis in S corp. stock

Question 17

S corp shareholder treatment of debt in stock basis

Answer 17

-do not include any S corp debt in stock basis
-does have separate debt basis in loans from shareholder to S corp
-when S corp repays part or all of loan, shareholder’s basis in debt is reduced
-stock basis and debt basis cannot be reduced below 0. It affects both pass-through of S corps losses/deductions and tax treatment of distributions to shareholders

Question 18

S corp tax basis limitation

Answer 18

-loss only flowed through to S corp shareholder’s income tax return to extent of shareholder’s tax basis
-includes shareholder’s stock basis and basis in any direct loans from shareholder to S corp
-loss in > of shareholder’s tax basis is suspended until tax basis reinstated in future yrs
-tax basis can be reinstated by any of items that increase stock basis: income, gains, and added contributions
-any increases in future yrs reinstate debt basis first then stock basis
-suspended loss due to insufficient tax basis can be carried forward indefinitly. However, any suspended losses due to insufficient tax basis remaining when shareholder disposes of his or her S corp stock are lost

Question 19

Accumulated Adjustments Account (AAA) for S corps

Answer 19

-the accumulated earnings and profits during yrs corp is an S corp. Distributions may not reduce AAA below 0
-AAA may be negative due to S corp losses and deductions

Question 20

Increases and decreases to AAA

Answer 20

Increases
1) ordinary business income
2) separately stated income and gain items (other than tax-exempt income)
Decreases
1) ordinary business losses
2) separately stated losses and deductions
3) nondeductible expenses (other than expenses related to tax-exempt income)
4) distributions (not reduce AAA below 0)

Question 21

Tax basis limitation formula

Answer 21

stock basis (reduced by any distributions) + Debt basis (direct shareholder loans to S corporation)

Question 22

Tax basis limitation procedures (debt basis reinstated first before stock basis)

Answer 22

1) calculate shareholder’s % in ordinary business loss - tax basis formula
2) remaining loss in 1) can be reduced from shareholder’s individual income tax return (ordinary business income * percentage of ownership)
3) subsequent yr ending debt basis: PY debt basis from loan of shareholders + reinstated debt basis from ordinary basis income
4) reinstated stock basis: ordinary business income - reinstated debt basis - PY suspended loss = ending stock basis of CY