Welcome Back Atef Abuelaish 1 Welcome Back Time
Welcome Back Atef Abuelaish 1
Welcome Back Time for Any Question Atef Abuelaish 2
Chapter 22 S Corporations Atef Abuelaish 3
Learning Objectives 1. Describe the requirements and process to elect S corporation status. 2. Explain the events that terminate the S corporation election. 3. Describe operating issues relating to S corporation accounting periods and methods, and explain income and loss allocations and separately stated items. 4. Atef Abuelaish 4
Learning Objectives 4. Explain stock-basis calculations, loss limitations, determination of self-employment income, and fringe benefit rules that apply to S corporation shareholders. 5. Apply the tax rules for S corporation operating distributions and liquidating distributions. 6. Describe the taxes that apply to S corporations, estimated tax requirements, and tax return filing requirements. Atef Abuelaish 5
S Corporation Elections • Formation – § 351 • Qualification requirements o Shareholder type and number o limits on corporation type o 1 class of stock • Filing the election • Effective date Atef Abuelaish 6
S Corporation Election? • Suppose CCS was formed with Nicole Johnson, Sarah Walker, and Chanzz Inc. , a corporation owned by Chance Armstrong, as shareholders. Would CCS be eligible to elect S corporation status? [No. No Because one of its shareholders is a corporation (Chanzz Inc. ), CCS would not be eligible to elect S corporation status] • Suppose Nicole, Sarah, and Chance recruited 97 U. S. residents to become shareholders of CCS. Meanwhile, Nicole gave several of her CCS shares to her grandfather and his bride as a wedding gift. After the transfer, CCS had 102 shareholders. Can CCS elect S corporation status? [Yes. Nicole (descendant of common ancestor), her grandfather (common ancestor), and her grandfather’s wife (spouse of common ancestor) are treated as one shareholder for purposes of the 100 -shareholder limit] Atef Abuelaish 7
S Corporation Terminations • Voluntary Terminations o Elected by shareholders with > 50% stock o Effective date • Involuntary Terminations o Failing S corporation requirements o Passive investment income in excess of 25 percent of gross receipts for 3 years • Restricted to S corporations with “earnings and profits” • Passive investment income; Gross receipts Atef Abuelaish o Effective date 8
S Corporation Terminations • Short tax years o Allocation of income across S and C corporation years o Daily method o Specific identification method o Tax return due dates • S corporation reelections o Generally available at the beginning of the 5 th year after year of termination o Early IRS consent Atef Abuelaish 9
Operating Issues 1) Accounting periods and methods: o Elected at entity level o Methods carryover from C corporation years o May choose cash, cash accrual, accrual or hybrid methods o Must use a calendar year-end unless establish year business purpose for alternative year-end or natural business year-end Atef Abuelaish 10
Operating Issues 2) Income and loss allocations: o Allocate profit and loss pro rata, rata based on shares owned each day of the year o If sell shares during the year, pro rata, per day allocations o If all shareholders with changing ownership percentages agree, the S corporation can use its normal accounting rules to allocate income and loss to the specific periods in which it realized income and losses Atef Abuelaish 11
Income and Loss Allocations • Assume CCS was formed as a calendar-year S corporation with Nicole Johnson, Sarah Walker, and Chance Armstrong as equal (one-third) shareholders. On June 14, 2016, Chance sold his CCS shares to Nicole. CCS reported business income for 2016 as follows: January 1 through June 14 (166 days) June 14 through December 31 (200 days) January 1 through December 31, 2016 (366 days) $100, 000 266, 000 $366, 000 How much 2016 income is allocated to each shareholder if CCS uses the daily method of allocating income? Nicole’s allocation is $188, 667; $188, 667 Sarah’s is $122, 000; $122, 000 and Chance’s is $55, 333 Atef Abuelaish 12
Operating Issues 3) Separately stated items: o Form 1120 S, Schedule K-1 o Ordinary business income vs. separately stated items Atef Abuelaish 13
Operating Issues Atef Abuelaish 14
Shareholder’s Basis 1) Initial basis: o Exchange: • Tax basis of property transferred, less any liabilities assumed by the corporation on the property contributed (substituted basis) • Increased by any gain recognized; Reduced by the fair market value of any property received other than stock o Purchase: • Purchase price of the stock Atef Abuelaish 15
Shareholder’s Basis 2) Annual basis adjustments: o Increase for: • Contributions • Shareholder’s share of income/gain items (including tax-exempt income) o Decrease for: • Distributions • Shareholder’s share of nondeductible expenses • Shareholder’s share of expense/loss items o Basis can never be < 0 Atef Abuelaish 16
Shareholder’s Basis • Assume that Nicole’s beginning of year basis in CCS is $115, 000. This year, her allocated share of S corporation items are: $80, 000 business income; $2, 000 interest income; $1, 000 dividends; $400 tax-exempt interest income. What is Nicole’s basis at the end of 2016? Atef Abuelaish 17
Shareholder’s Basis • Assume that Nicole’s beginning of year basis in CCS is $115, 000. This year, her allocated share of S corporation items are: $80, 000 business income; $2, 000 interest income; $1, 000 dividends; $400 tax-exempt interest income. What is Nicole’s basis at the end of 2016? Description (1) Initial tax basis (2) Ordinary business income $115, 000 80, 000 (3) Interest income 2, 000 (4) Dividends 1, 000 Tax basis in stock at end of 2016 Atef Abuelaish Nicole $198, 000 18
Loss Limitations 1) Tax Basis Limitation: o Losses limited first to the shareholder’s tax basis in stock shares o and then to any basis in any direct loans made to their S corporations o In subsequent years, any net increase in basis for the year first restores the shareholder’s debt basis and then the shareholder’s stock basis o Any loan repayment in excess of the shareholder’s Atef Abuelaish debt basis triggers a taxable gain to the shareholder 19
Loss Limitations 1) Tax Basis Limitation (cont. ): o Losses not deductible due to the tax basis limitation are suspended until the shareholder generates additional basis o If the shareholder sells the stock before creating additional basis, the suspended loss disappears unused 2) At risk Limitation o shareholders may deduct S corporation losses only to Atef Abuelaish the extent of their at-risk amount (§ 465) 20
Loss Limitations 2) At risk Limitation (cont. ): o S corporation shareholders are deemed at risk only for direct loans they make to S corporations o S corporation shareholder’s at-risk amount is generally the same as stock basis o Losses limited under the at-risk rules are carried forward indefinitely until the shareholder generates additional at-risk amounts to utilize them or sells the S corporation stock Atef Abuelaish 21
Loss limitations • Suppose at the beginning of 2017, Nicole’s basis in her CCS stock was $14, 000. During 2017, Nicole loaned $8, 000 to CCS and CCS reported a $60, 000 ordinary business loss and no separately stated items. How much of the $20, 000 ordinary loss allocated to Nicole clears the tax basis hurdle for deductibility in 2017? All $20, 000. The first $14, 000 of the loss reduces her stock basis to $0, and the remaining $6, 000 reduces her debt basis to $2, 000 ($8, 000 – $6, 000). • Suppose in 2018, CCS allocated $9, 000 of ordinary business income to Nicole and no separately stated items. What are Nicole’s CCS stock basis and debt basis at the end of 2018? Her stock basis is $3, 000; her debt basis is $8, 000. The income first restores debt basis to its original amount and then increases her stock basis. Atef Abuelaish 22
Loss Limitations • Post-termination Transition Period (PTTP) Loss Limitation: • § 1366(d) allows shareholders to treat suspended losses existing at the S termination date as occurring on the last day of the PTTP • This rule allows shareholder to create stock basis (by capital contributions) during PTTP to utilize suspended losses • PTTP period Atef Abuelaish 23 • Any suspended losses not utilized during PTTP are
Loss Limitations 3) Passive Activity Loss Limitation: • As in partnerships, the passive activity loss rules limit the ability of S corporation shareholders to deduct losses unless they are involved in actively managing the business • No differences in the application of these rules for S corporations Atef Abuelaish 24
Self-Employment Income • S corporation shareholder’s allocable share of ordinary business income (loss) is not classified as self-employment income • Shareholder salary as employees is subject to social security taxes • Tax planning incentives Atef Abuelaish 25
Net Investment Income Tax • S corporation shareholders are subject to the 3. 8% Net Investment Income tax on their share of an S corporation’s net investment income • Common types of investment income include interest, dividends, annuities, royalties, rents, passive income, and gains from disposing property Atef Abuelaish 26
Fringe Benefits • For shareholder-employees who own 2 percent or less of the S corporation, the S corporation gets a tax deduction and the benefit is nontaxable to shareholder-employee • For shareholder-employee who own > 2 percent of the S corporation, the S corporation gets a tax deduction but many benefits are taxable to the shareholder-employee Atef Abuelaish 27
Operating Distributions • S Corporations with No E & P o Distributions are tax-free to the extent of shareholder’s basis [ROC] ROC o Excess distribution is capital gain Atef Abuelaish 28
Operating Distributions • S Corporations with E & P o Distributions come from (1) AAA account, (2) E & P, and then (3) any remaining shareholder stock basis o Distributions from AAA are nontaxable to extent of shareholder’s basis; any excess is capital gain o Distributions from E & P are taxed as dividends o Distributions from shareholder basis are nontaxable to extent of basis; any excess is capital gain Atef Abuelaish 29
Operating Distributions • AAA account – calculation o Beginning of year AAA balance + Separately stated income/gain items (excluding tax exempt income) + Ordinary income − Separately stated losses and deductions − Ordinary losses − Nondeductible expenses that are not capital expenditures (except deductions related to generating tax-exempt income) − Distributions out of AAA = End of year AAA balance o AAA may have a negative balance but distributions may not cause the AAA to go negative or become more negative Atef Abuelaish 30
Operating Distributions • Before considering distributions, CCS’s AAA was $24, 000 and its accumulated E&P from 2015 was $40, 000. Also assume Nicole’s basis in her CCS stock is $80, 000. If CCS distributes $60, 000 on July 1 ($20, 000 to each shareholder), what is the amount and character Nicole (a 1/3 shareholder) must recognize on her $20, 000 distribution, and what is her stock basis in CCS after the distribution? Atef Abuelaish 31
Operating Distributions • Before considering distributions, CCS’s AAA was $24, 000 and its accumulated E&P from 2015 was $40, 000. Also assume Nicole’s basis in her CCS stock is $80, 000. If CCS distributes $60, 000 on July 1 ($20, 000 to each shareholder), what is the amount and character Nicole (a 1/3 shareholder) must recognize on her $20, 000 distribution, and what is her stock basis in CCS after the distribution? Atef Abuelaish 32
Property Distributions • S corporation consequences: o recognizes gain on distribution of appreciated property o does not recognize loss on distribution of property whose value has declined • Shareholder consequences: o recognizes distributive share of the deemed gain and increase stock basis accordingly o the property distribution is the FMV of the property received o taxability of distribution is determined based on distribution rules discussed previously o basis is FMV of property Atef Abuelaish 33
Post-termination Transition Period (PTTP) Distributions • § 1371(e) provides that cash distributions after an S election termination and during the PTTP are tax-free to the extent they do not exceed the corporation’s AAA balance and the shareholder’s basis in the stock • The PTTP for post-termination distributions is generally the same as the PTTP for deducting suspended losses Atef Abuelaish 34
Liquidating Distributions • S corporation rules follow C corporation rules • S corporations generally recognize gain or loss on each asset they distribute in liquidation • These gains and losses are allocated to the S corporation shareholders, increasing or decreasing their stock basis • In general, shareholders recognize gain on the distribution if the value of the property exceeds their stock basis; they recognize loss if their stock basis Atef Abuelaish exceeds the value of the property 35
S Corporation Taxes 1) Built-in gains tax o Only applies if have net unrealized built-in gain at conversion and if recognize net built-in gains during first five years as S corporation o Definitions of net unrealized built-in gains and net recognized built-in gains o Limit on net recognized unrealized built-in gains o Applicable tax rate o Allocation of built-in gains tax to shareholders Atef Abuelaish 36
S Corporation Taxes 2) Excess net passive income tax o Only applies to S corporations with C corporation E&P o Levied on excess net passive income calculated as: Net Passive Income × [(Passive Investment Income – (25% × Gross Receipts)) / Passive Investment Income] o Limit on excess net passive income o Applicable tax rate o Allocation of excess net passive income tax to shareholders o S corporation termination if tax applies three consecutive years Atef Abuelaish 37
S Corporation Taxes 3) LIFO recapture tax o C corporation must include the LIFO recapture amount (FIFO basis – LIFO basis) in gross income in the last year it operates as a C corporation o Applicable tax rate o Tax paid in four annual installments o The LIFO recapture amount increases the corporation’s adjusted basis in its inventory at the time it converts to an S corporation Atef Abuelaish 38
Estimated Taxes & Filing Requirements • Estimated taxes o Generally follow C corporation rules: S corporations with a federal income tax liability of $500 or more due must make quarterly estimated tax payments o Not required to make estimated tax payments for the LIFO recapture tax • Filing requirements o Form 1120 S due by the 15 th day of the third month after the S corporation’s year end o Automatic, six-month extension by filing Form 7004 Atef Abuelaish 39
Comparing C and S Corporations and Partnerships Atef Abuelaish 40
Comparing C and S Corporations and Partnerships Atef Abuelaish 41
Comparing C and S Corporations and Partnerships Atef Abuelaish 42
Comparing C and S Corporations and Partnerships Atef Abuelaish 43
Comparing C and S Corporations and Partnerships Atef Abuelaish 44
Homework assignment Ø Using Connect – 4 Questions for 60 Points for Chapter 22. Ø Tax Return; Course Project: Corporation Tax Return Problem # 2 “Blue Catering Service Inc. 's (BCS) 2016 Form 1120” on Pages C-16 till C-18. Happiness is having all homework up to date Atef Abuelaish 45
Break for 10 Minutes Atef Abuelaish 46
The First Class Case Study for SPRING 2017 – for ACNT 1347 Course Atef Abuelaish 47
FORM 1120 u. s. corporation income tax return Atef Abuelaish 48
Alvin's Music, Inc. , 355 Music Way, East Palo Alto, CA 94303 Atef Abuelaish 49
Alvin's Music, Inc. ØEIN (employer Identification Number) #: 29 -5748859. ØINCORPORATED Date: Date June 12, 2007. ØBusiness Activity Code Number: Number 451140 ØProduct or Services: Services Retail sales - Music -related products. Atef Abuelaish 50
PAGE # 1 - LABEL Atef Abuelaish 51
PAGE #1 - EIN Atef Abuelaish 52
PAGE #1 - DATE INC Atef Abuelaish 53
PAGE #1 - TOTAL ASSETS Atef Abuelaish 54
PAGE #1 - COST OF GOODS SOLD Atef Abuelaish 55
PAGE #1 - LINE # 03 Atef Abuelaish 56
PAGE #1 - LINE # 04 Atef Abuelaish 57
PAGE #1 - LINE # 05 Atef Abuelaish 58
PAGE #1 - LINE # 08 Atef Abuelaish 59
PAGE #1 - LINE # 09 Atef Abuelaish 60
PAGE #1 - LINE # 11 Atef Abuelaish 61
PAGE #1 - LINES # 12 & 13 Atef Abuelaish 62
PAGE #1 - LINE # 14 Atef Abuelaish 63
PAGE #1 - LINE # 15 Atef Abuelaish 64
PAGE #1 - LINE # 17 Atef Abuelaish 65
PAGE #1 - LINE # 18 Atef Abuelaish 66
PAGE #1 - LINE # 19 Atef Abuelaish 67
PAGE #1 - LINE # 20 Atef Abuelaish 68
PAGE #1 - LINE # 22 Atef Abuelaish 69
PAGE #1 - LINE # 23 Atef Abuelaish 70
PAGE #1 - LINE # 26 Atef Abuelaish 71
PAGE #1 - LINES # 27 & 28 Atef Abuelaish 72
PAGE #1 - LINE # 29 B Atef Abuelaish 73
PAGE #1 - LINES # 31 - 36 Atef Abuelaish 74
PAGE # 2 – DRD LINE 1 TO 12 Atef Abuelaish 75
PAGE # 2 – DRD LINE 12 TO 20 Atef Abuelaish 76
PAGE # 3 – SCH J PART 1 Atef Abuelaish 77
PAGE # 3 – SCH J PART 2 Atef Abuelaish 78
PAGE # 4 – SCH K Atef Abuelaish 79
PAGE # 4 – SCH K Atef Abuelaish 80
PAGE # 4 – SCH K Atef Abuelaish 81
PAGE # 4 – SCH K Atef Abuelaish 82
PAGE # 4 – SCH K Atef Abuelaish 83
PAGE # 4 – SCH K Atef Abuelaish 84
PAGE # 4 – SCH K Atef Abuelaish 85
PAGE # 4 – SCH K Atef Abuelaish 86
PAGE # 5 – SCH L Atef Abuelaish 87
PAGE # 5 – SCH M 1 Atef Abuelaish 88
PAGE # 5 – SCH M 1 Atef Abuelaish 89
PAGE # 5 – SCH M 1 Atef Abuelaish 90
PAGE # 5 – SCH M 1 Atef Abuelaish 91
PAGE # 5 – SCH M 1 Atef Abuelaish 92
PAGE # 5 – SCH M 1 Atef Abuelaish 93
PAGE # 5 – SCH M 1 Atef Abuelaish 94
PAGE # 5 – SCH M 2 Atef Abuelaish 95
PAGE # 5 – SCH M 2 Atef Abuelaish 96
PAGE # 5 – SCH M 2 Atef Abuelaish 97
PAGE # 5 – SCH M 2 Atef Abuelaish 98
THANK YOU AND GOOD LUCK Atef Abuelaish 99
Thank you and See You Next Week at the Same Time, Take Care Atef Abuelaish 100
- Slides: 100