Federal Taxation Week 6

21-2. What are the eligibility requirements that a corporation must meet in order to qualify under Subchapter S? Answer: In order to qualify under Subchapter S, a corporation must be a small business corporation. The following additional requirements must be met in order to be a small business corporation: 1. Must be a domestic corporation 2. Must have no more than 100 shareholders 3. Must include only eligible shareholders 4.

Must have only one class of stock 5. Must not be an ineligible corporation (Smith 21-3) Smith, Harmelink & Hasselback. Federal Taxation: Comprehensive Topics. CCH, 2013. 21-13. What limits are placed on the selection of a tax year of an S corporation? How do these limits differ from those applicable to C corporations and partnerships? Answer: S corporation status must be elected by all of the shareholders of the corporation. Code Sec. 1362(a)(2).

An election made on or before the fifteenth day of the third month of a corporation’s tax year is effective beginning with the year when made. Code Sec. 1362(b)(1). For a newly created corporation, the first tax year begins at the earliest occurrence of any of the following events: (1) when the corporation has shareholders, (2) when it acquires assets, or (3) when it begins doing business. The corporation must meet all the eligibility requirements (including shareholder eligibility requirements) for the pre-election portion of the tax year.

All persons who held stock in the corporation at any time during the portion of the year before the election was made must consent to the election. Reg. §1. 1362-2(b)(1). However, a person who becomes a shareholder after the corporation is an S corporation does not have to consent to the election. A new shareholder does not have the power to terminate the election unless that shareholder owns more than 50 percent of the stock and elects to terminate the election.

The election will not become effective until the following tax year if: (1) the eligibility requirements are not met for the entire pre-election portion of the year for which the election is made, (2) consents of all shareholders who had disposed of their stock prior to the making of the election are not obtained, or (3) the election is made after the fifteenth day of the third month of the year. Reg. §1. 1362-1(a), (b). This rule prevents any allocation of income or loss to pre-election stockholders who either were ineligible to hold S corporation stock or did not consent to the election.

(Smith 21-6) Smith, Harmelink & Hasselback. Federal Taxation: Comprehensive Topics. CCH, 2013. A C corporation can use either a calendar year or fiscal year, which is 12 consecutive months and may end of the last day of any month except December. 21-26. Durrabusiness is organized as a regular C corporation in 1986. At the beginning of the present year, Durrabusiness elects to be an S corporation. Will the election cause a recapture of the general business investment credit taken on any property purchased while a C corporation?

Answer: The election as an S Corporation will not cause a recapture of the general business investment credit taken on any property purchased while the status was a C Corporation because the S Corporation election doesn’t get rid of the assets purchase when a C Corporation that lead to investment credit recapture. 21-53. Several individuals form Lang Corporation on May 1, 2012. The corporation begins acquiring assets on June 1, 2012, and begins business on August 1, 2012.

What is the latest date that Lang can file Form 2553 requesting S corporation status? Answer: The Form 2553 has to be filed no more than 2 months and 15 days after the beginning of the tax year. The form must be filed by August 16, 2012. The tax year would start when Lang Corporation started acquiring assets. 21-63. A shareholder purchases 30 percent of the stock of an S corporation two-thirds of the way through the year for $20,000. The S corporation incurs an operating loss of $300,000 for the year.

What is the amount that the shareholder may deduct on his personal income tax return, assuming the at-risk and passive activity rules do not apply? Answer: In most cases, the shareholder will receive a K-1 reporting a loss of approximately $300,000 X 122/365 X . 30 = 30,000. Regardless of what the K-1 says, the shareholder is subject to the passive activity loss rules and will only be able to deduct $20,000 on his return. The balance will be carried forward.