Leadership
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May 3, 2007
Flow-Through
Taxation at S Corp Level
Taxation at Shareholder Level
Shareholder Basis
Stock Basis
Indebtedness Basis
Flow-Through
Taxation at S Corp Level
Subsection 1363(a)- S Corp is generally not subject to income tax
Subject to:
Employment tax
Excise tax
Exceptions to Income tax Rule 1363(a)
Passive Income
Built in Gains
Passive Income
S Corp that has subchapter C earnings and profit
S Corp with passive income
Gross receipts exceed 25 percent of passive activity (pay income tax)
Gross receipts exceeds 25 percent for 3 years (S Corp termination)
Built in Gains
Conversion from C Corp to an S Corp
Any appreciated assets as date of conversion are called Net Built in Gain
Within 10 years if you sell assets you are subject to tax
Subsection 1363(b)- S Corporations taxable income is calculated in the same manner as an individual
Exceptions to 1363(b):
Personal Exemptions under Section 152 are not deductible
Charitable Contributions under Section 170 are not deductible
Any additional itemized deductions (medical)
Taxation at Shareholder Level
Subsection 1366(a)- all items of income, deduction, loss, and credit recognition by S Corp are passed through to the shareholder
Knott v. Commissioner TC Memo 1991-352
Shareholders are taxed on their allowable share of income even if not distributed
Subsection 1366(b)- Character of any item included in a shareholder pro-rata shares shall be determined as if it we realized directly from the source and incurred in the same manner as a corporation
Exceptions to 1366:
Regulation 1.1366-1(b)(2)- if S Corp that is formed for a principle purpose of selling or exchanging contributed property that in the hands of the contributor would not be a capital gain, then the gain on the sale of the property is not capital gain (Purpose to avoid regular income tax obligations)
Regulation 1.1366-1(b)(3)- for the contributing shareholder it is capital loss and for the S Corp it is ordinary loss to the extent that the capital loss existed at the time of contribution
Shareholders Gross Income
Includes shareholders pro-rata share of S Corp gross income
Pro-rata- Subsection 1377(a)
Each shareholder pro-rata share of any item for any taxable year shall be the sum of the amounts determined
Assigning equal portion of each item to each day
Divide pro-rata among shareholders
Example in Notebook
Separately Stated Items of Income
Subsection 1361(a)(1)(A)- all items of income (tax exempt) income, deduction, or credit that could effect the liability of the shareholder need to be separately stated
Separate items include:
Capital gains and losses
1231 gains and losses
Dividend income
Interest income
Investment Interest Expense
Passive Activity items
Tax Exempt Income and Expenses
Foreign taxes, income and losses
Limitations on Losses
Section 1366(d)(1)- the aggregate amount of losses and deductions taken into account for any taxable year cannot exceed the sum of:
The tax basis in the stock of the S Corp
The tax basis in any indebt ness (Loans from the shareholder to the S Corp)
Example:
Stock basis 10,000
Pro-rata share of losses 12,000
Can only deduct 10,000 of losses
Other 2,000 of losses can be carry forward indefinitely (Section 1366(d)(2)
Section 1366-2(a)(5)- losses cannot be transferred to another person
Shareholder Stock Basis
Stock basis- why it is important
Section 1366(d)(1)- losses are only deductible to the extent of basis
Taxability of operating and liquidating distribution (Section1368)
Sale of Stock (Section 1001)
Beginning Stock Price
Purchase equals cost basis Section 1012
Contribution equals transferred basis (Section 351 basis of property)
Increase by gain on contribution
Decrease by boot (ASK ABOUT BOOT NEXT WEEK)
Adjustments
Stock basis adjusted for increases before it is adjusted for decreases