EA2 Study Unit 17.1-17.3 S Corporation Eligibility and Election, Operations and Distributions
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Questions and Answers

Which event would NOT cause the termination of an S corporation election?

  • Transferring stock to a partnership.
  • A revocation of the election approved by a majority of shareholders.
  • Failing the passive income test for three consecutive years.
  • Sale of stock to a resident alien. (correct)

An S corporation has been operating for several years. Which situation would lead to the termination of its S election?

  • The corporation issues non-voting preferred stock to raise capital.
  • A shareholder gifts some of their stock to a qualified charitable organization.
  • The corporation consistently generates 15% of its gross receipts from passive investment income.
  • The corporation's sole shareholder transfers half of their shares to a trust that does not qualify as an eligible S corporation shareholder. (correct)

Shareholders holding what percentage of the outstanding shares must consent to revoke an S corporation election?

  • Two-thirds
  • A simple majority (correct)
  • Unanimous consent
  • 90%

An S corporation that fails the passive income test for three consecutive years will experience what outcome?

<p>Involuntary termination of its S election. (A)</p> Signup and view all the answers

What happens to an S corporation upon the occurrence of a terminating event?

<p>It becomes a C corporation. (C)</p> Signup and view all the answers

An S corporation shareholder owns 60% of Company X and 40% of Company Y. Both companies elect to expense the maximum amount under Section 179. What is the shareholder's maximum deductible amount, considering the Sec. 179 limit?

<p>$1,160,000 (B)</p> Signup and view all the answers

Which of the following is the correct tax treatment for charitable contributions made by an S corporation?

<p>The charitable contributions are a pass-through item, and the shareholders deduct them on their individual income tax returns. (C)</p> Signup and view all the answers

An S corporation distributes appreciated property to a shareholder. How is the value of the property determined for distribution purposes?

<p>The fair market value (FMV) of the property on the distribution date. (D)</p> Signup and view all the answers

An S corporation distributes a patent back to a shareholder. How does this distribution affect the shareholder's basis?

<p>Decreases the basis by the patent's fair market value (FMV). (C)</p> Signup and view all the answers

Which of the following entities is NOT eligible to be a shareholder in an S corporation?

<p>A domestic partnership. (C)</p> Signup and view all the answers

If a shareholder loans money to their S corporation by taking out a home mortgage, how does this affect the shareholder's basis?

<p>The money loaned increases the shareholder's debt basis. (B)</p> Signup and view all the answers

An S corporation has ordinary income and also tax-free income. In which order are the following accounts increased when applying distribution rules: AAA (Accumulated Adjustments Account), OAA (Other Adjustments Account), and new AB (Adjusted Basis)?

<p>AAA, OAA, new AB (D)</p> Signup and view all the answers

If an S corporation is insolvent and has debt cancelled, what is the effect on the shareholder's stock basis?

<p>The amount of cancelled debt has no effect on the basis in the shareholder's stock. (D)</p> Signup and view all the answers

Which of the following is NOT deductible by an S corporation when calculating its taxable income?

<p>Net Operating Loss (NOL) Carryovers (D)</p> Signup and view all the answers

A shareholder's basis in an S corporation is increased by which of the following?

<p>Tax-Exempt Interest (C)</p> Signup and view all the answers

An S corporation must file Form 2553 to elect S corporation status. What is the deadline for filing this form?

<p>2 months and 15 days after commencing business or since the beginning of the tax year (B)</p> Signup and view all the answers

Which of the following best describes the 'one class of stock' requirement for S corporations?

<p>All outstanding shares must have identical rights to profits and assets. (D)</p> Signup and view all the answers

Which of the following events would NOT terminate an S corporation election?

<p>A temporary increase in passive investment income (A)</p> Signup and view all the answers

Which accounting method is an S corporation required to use?

<p>An S corporation is not required to use the accrual method (A)</p> Signup and view all the answers

What tax year must an S corporation generally adopt?

<p>Calendar Tax Year (D)</p> Signup and view all the answers

Which of the following is a separately stated item for an S corporation that must be reported to shareholders?

<p>Section 1231 gains and losses (A)</p> Signup and view all the answers

Which of the following decreases a shareholder's basis in their S corporation stock?

<p>Distributions by the S corporation that were not included in income (C)</p> Signup and view all the answers

What is the primary purpose of the Accumulated Adjustments Account (AAA) for an S corporation?

<p>Determining the taxability of distributions to shareholders when the S corporation has Subchapter C earnings and profits. (C)</p> Signup and view all the answers

What does the Other Adjustments Account (OAA) represent for S corporations?

<p>The cumulative balance of tax-exempt income and related expenses. (D)</p> Signup and view all the answers

An S corporation distributes property with a fair market value of $50,000 and an adjusted basis of $30,000 to a shareholder. What is the amount of gain or loss recognized by the S corporation on the distribution?

<p>$20,000 gain (C)</p> Signup and view all the answers

An S corporation contributes land with an adjusted basis of $25,000 and a fair market value of $40,000 to a qualified charity. By what amount does each shareholder reduce their basis in the S corporation stock?

<p>Their pro rata share of $25,000 (D)</p> Signup and view all the answers

An S corporation realizes $10,000 of income from the discharge of debt, which is excluded from the S corporation's income. How does this income affect the shareholders' basis in the S corporation?

<p>The income does not flow through to any shareholder and does not impact their basis. (A)</p> Signup and view all the answers

Which of the following would disqualify a corporation from S corporation status?

<p>Having a nonresident alien as a shareholder (A)</p> Signup and view all the answers

Corporation X has one class of stock with varying voting rights. Which of the following statements is most accurate regarding Corporation X's eligibility for S corporation status?

<p>Corporation X remains eligible because variation in voting rights within a single class of stock is permitted. (C)</p> Signup and view all the answers

Partnership P is considering investing in the stock of S Corporation Z. How would this investment affect S Corporation Z's status?

<p>It would terminate S Corporation Z's election because partnerships are not eligible S corporation shareholders. (D)</p> Signup and view all the answers

S Corporation Y currently has 99 shareholders. If S Corporation Y issues stock to a married couple, how many shareholders will S Corporation Y be considered to have?

<p>100, because the married couple is considered one shareholder. (A)</p> Signup and view all the answers

Which of the following events would cause an S corporation to lose its S corporation status?

<p>The transfer of stock resulting in 101 shareholders. (B)</p> Signup and view all the answers

S Corporation M has been operating for several years. Which of the following actions would NOT cause the termination of its S election?

<p>Transferring stock to a resident alien. (B)</p> Signup and view all the answers

An S corporation's election can be revoked by shareholders holding what percentage of the corporation's outstanding shares?

<p>More than 50% of the number of issued and outstanding shares. (C)</p> Signup and view all the answers

S Corporation Q is considering a transaction that will result in the corporation deriving more than 25% of its gross receipts from passive investment income. How many consecutive years can this occur before potentially terminating the S election?

<p>Three years. (A)</p> Signup and view all the answers

Which of the following actions would disqualify a corporation from making an S corporation election?

<p>Having a nonresident alien as a shareholder. (A)</p> Signup and view all the answers

An S corporation voluntarily terminates its S election. When is the earliest date the corporation can re-elect S status, absent IRS consent to an earlier election?

<p>5 years after the termination. (D)</p> Signup and view all the answers

Which of the following situations would cause an S corporation to cease qualifying as an S corporation?

<p>The transfer of its stock to a C corporation. (B)</p> Signup and view all the answers

Which of the following events will NOT cause the termination of an S corporation’s S election?

<p>Sale of stock to a resident alien. (C)</p> Signup and view all the answers

Which statement regarding the termination of an S corporation election is true?

<p>The election may be revoked with the consent of shareholders who, at the time the revocation is made, hold more than 50% of the number of issued and outstanding shares. (D)</p> Signup and view all the answers

S Corporation Z has Subchapter C earnings and profits (E&P). It inadvertently fails the passive income test for three consecutive years. Under what circumstances might the IRS waive the termination of the S election?

<p>If the termination was inadvertent and is corrected within a reasonable time after discovery. (A)</p> Signup and view all the answers

S Corporation R wants to terminate its S election and revert to C corporation status. What is required to effect this change?

<p>Consent from a majority of the shareholders. (C)</p> Signup and view all the answers

Flashcards

Charitable Contributions in S Corporations

Charitable contributions cannot be deducted by S Corporations and are passed through to shareholders.

Depreciation Pass Through

Depreciation for S Corporations is passed through to shareholders via Schedule K-1.

Distribution of Dividends

Dividends paid to shareholders are reported on a 1099-DIV, not on Schedule K-1.

Property Distributions

Distributions of appreciated property are valued at fair market value (FMV) on the distribution date.

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Debt Cancellation in Insolvency

Cancelled debt in an insolvent S Corporation can be excluded from income but does not increase stock basis.

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Shareholder's Basis Increase

When a shareholder loans money to an S Corporation, it increases their basis.

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Ordinary Income and Basis

Ordinary income affects basis and increases accumulated adjustments account (AAA) and other adjustments.

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Section 1250 Gains

Section 1250 gains or losses do not increase shareholder's basis as they are part of ordinary income.

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S Corporation Election Termination

An S corporation election is terminated through revocation, failing eligibility, or passive income issues.

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Revocation of S Corporation Election

Revocation requires majority consent from shareholders, holding more than 50% of shares.

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Eligibility Requirements for S Corporations

Shareholders must be individuals, citizens or residents of the U.S.; resident aliens are allowed.

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Passive Investment Income (PII)

S corporation election can be terminated if it earns excessive passive investment income for three consecutive years.

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Return to C Corporation

Upon a terminating event, an S corporation automatically converts into a C corporation.

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S Corporation Compensation Deduction

S Corporations can deduct officer compensation but not certain items.

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Tax Free Income Increase

Shareholders must increase their basis for tax-free income and non-separately stated income.

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Basis Reduction by Dividends

Dividends reduce the basis for S Corporation shareholders.

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S Corporation Filing Deadline

S Corporations have 2 months and 15 days to file for status after starting business or fiscal year.

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One Class of Stock

All shares in an S Corporation must have identical rights to profits and assets.

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Form 2553

The form used to elect S Corporation status.

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Termination of S Corporation Election

An S corporation status can be terminated by revocation, ineligibility, or excess passive income.

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Accrual Method Requirement

S Corporations are not required to use the accrual accounting method.

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Calendar Tax Year

S Corporations generally must adopt a calendar year for tax reporting.

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Separately Stated Items Examples

Examples include Sec. 1231 gains, charitable contributions, and foreign taxes.

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Shareholder Basis Reduction

Shareholders reduce basis by the adjusted basis of property donated to charity.

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Discharge of Debt Income

Income from the discharge of debt does not increase shareholder basis.

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Accumulated Adjustments Account (AAA)

The AAA tracks S Corporation's earnings for taxability of distributions.

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Other Adjustments Account (OAA)

The OAA represents tax-exempt interest and life insurance proceeds minus related expenses.

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Loss on Distribution of Property

S Corporations do not recognize a loss when distributing loss property.

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Resident Alien

An individual who qualifies to be a shareholder of an S corporation.

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S Corporation Status

A tax status allowing income to pass through directly to shareholders.

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Consent for Revocation

Requires over 50% of shareholders to approve ending S election.

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Over 100 Shareholders

A transaction resulting in more than 100 shareholders causes S election termination.

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Nonresident Alien

An individual who is not a U.S. citizen or resident and cannot be an S corporation shareholder.

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Passive Income Test

An S corporation fails if it has excessive passive income over three years.

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Small Business Corporation

A corporation that meets specific IRS criteria for S corporation status.

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Eligibility Requirements

Criteria that must be satisfied for S corporation election, including shareholders' status.

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Donation of Stock

Donation to a tax-exempt organization does NOT terminate S status.

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Termination Events

Events that can cause an S election to end, such as too many shareholders.

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Stock Transfer

Transferring stock to a resident alien does NOT disqualify S status.

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IRS Waiver

The IRS may waive termination of S election due to inadvertent issues.

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Sale of Stock

Selling stock to a resident alien does NOT terminate S status.

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Charitable Remainder Trusts

These types of trusts are not eligible as S corporation shareholders.

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Majority Consent

More than 50% of shareholders must agree for significant S-corp decisions.

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Study Notes

S Corporation Operations and Distributions

  • Charitable Contributions: Not deductible by the S corporation; considered a pass-through item for shareholders.
  • Depreciation: A pass-through item reported on Schedule K-1 to shareholders. Maximum pass-through is limited to $1,160,000 (Section 179). Excess disallowed deductions carry over to the next year.
  • Dividends: Reported on Form 1099-DIV, not Schedule K-1.
  • Property Distributions: (other than cash) Require a statement on Form 1120 detailing acquisition date, distribution date, fair market value (FMV) on the distribution date, and original basis.
  • Domestic Partnerships: Not eligible to be shareholders of an S corporation.
  • Patent Contributions/Distributions: Contribute increases basis; distribution decreases basis by FMV. Gain allocated proportionally to ownership.
  • Distribution vs. Capital Loss: Distributions are taken before capital loss deductions; any remaining loss carries forward.
  • Insolvency: Cancelled debt excluded from income; does not increase shareholder basis.
  • Insurance Companies & DISC: Cannot take S corporation status.

S Corporation Basis Adjustments

  • Home Mortgage Loan: If a shareholder loans money to the S corporation (e.g., home mortgage), their basis increases.
  • Loss Deduction exceeding Basis: Reduces basis of debt owed to the shareholder. Future earnings restore debt basis first, then increase stock basis.
  • Section 1250 Gains/Losses: Not added to shareholders' basis as already included in ordinary income.

S Corporation Deductions and Income

  • Deductible Items: Compensation of officers.
  • Non-Deductible Items: NOL carryovers, charitable contributions, foreign income taxes (separately stated items).
  • Shareholder Basis Increases: Tax-free income, non-separately stated income, and excess depletion deduction (over the basis of depleted property).
  • Dividends: Reduce shareholder basis.
  • Gain Reporting: Shareholders are taxable on their proportionate share of the corporation's gain.
  • S Corporation Election Timeframe: Two months and 15 days from commencing business or the first day of the tax year. Use Form 2553 to elect S corporation status.

S Corporation Election Termination

  • Termination Events:

    • Effective revocation by shareholders (consent of shareholders who hold > 50% stock).
    • Failure to meet any eligibility requirements.
    • Passive investment income termination.

  • Stock Transfer Examples (Disqualification): A corporation may not have more than 100 shareholders, shareholders that are not individuals, estates, or certain trusts, or more than one class of stock. A partnership cannot be a shareholder.

Accumulated Adjustments Account (AAA) and Other Adjustments Account (OAA)

  • Purpose: Used to determine taxability of distributions when the S corporation has Subchapter C earnings.
  • OAA: Cumulative balance of tax-exempt interest and life insurance proceeds, reduced by expenses.
  • Loss Property Distribution: No loss is recognized by the S corporation upon distribution.

Separately Stated Items

  • Included in shareholder's tax return (e.g., Section 1231 gains/losses, net short-term capital gains/losses, dividends, charitable contributions, foreign taxes, Section 179 deduction, etc.).
  • Items whose treatment separately affects the shareholder's tax liability (disallowed deductions in computing S corporation income). Real estate activities are examples.

Shareholder Basis Reductions

  • Property Contribution to a Charity: Reduced by the adjusted basis of the property.
  • Excluded income from debt discharge: Does not flow through or increase shareholder basis.
  • Shareholder's pro-rata share of non-separately stated loss and depletion deductions reduces shareholder basis. Non-deductible expenses also reduce basis, along with non-income distributions.

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Explore S corporation operations, including charitable contribution handling as pass-through items. Understand depreciation, dividend reporting, and property distribution requirements. Learn about shareholder eligibility, patent transactions, and the relationship between distributions and capital loss deductions.

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