S Corporations

1. 11 Chapter S Corporations

2. S Corporations Basis Limitation for Losses

3. Basis Limitation for Losses • [IRC §1366(d)(1)] Deductions for losses from S corporations are limited to: • The shareholder’s basis in the stock plus • The shareholder’s basis in any indebtedness of the corporation to the shareholder

4. Basis Limitation for Losses • [IRC §1366(d)(1)(A)] To determine the basis limit, stock basis is adjusted for current year items in IRC §1367(a)(1) and (a)(2)(A) only

5. Basis Limitation for Losses • [IRC §1367(a)(2)] Basis is reduced by losses but not below zero • [IRC §1367(b)(2)(A)] Deductible losses reduce the basis of the stock first (but not below zero) and then reduce the basis of debt

6. Basis Limitation for Losses • [IRC §1367(b)(2)(B)] Restoration of basis: • Basis in debt obligations are restored first before restoring stock basis • [Rev. Rul. 64-162] If the corporation pays off the debt to the shareholder/creditor before the basis is restored, he/she must recognize a gain • If the debt was evidence by a security, the gain is a capital gain (otherwise, the gain is an ordinary gain)

7. Basis Limitation for Losses • [IRC §1366(d)(2)] Excess losses carry forward indefinitely and are deductible when the S corporation stock basis is restored

8. Basis Limitations • See Examples 2 & 3

9. S Corporations Penalty Taxes or “Sting Taxes”Built-In Gains

10. Built-In Gains Tax • Enacted to keep C corporations from avoiding paying taxes on liquidating distributions by electing S corporation status just before liquidating the corporation or selling its assets • Tax is imposed directly on the S corporation[IRC §1374(a)] • Tax applies only to S corporations that were formerly C corporations [IRC §1374(c)(1)]

11. Built-In Gains Tax • [IRC §1374(d)(1)] The net unrealized built-in gain equals: • The corporation’s aggregate asset FMV at the beginning of its first year as an S corporation less • The corporation’s aggregate asset adjusted basis at the beginning of its first year as an S corporation

12. Built-In Gains Tax • [IRC §1374(d)(3)] Recognized built-in gain means any gain recognized during the recognition period on the disposition of any asset exceptto the extent that: • The asset was acquired after the election of S corporation status, or • The gain exceeds the FMV less the asset’s adjusted basis at the time the S election was made

13. Built-In Gains Tax • [IRC §1374(d)(3)] Recognized built-inloss means any loss recognized during the recognition period on the disposition of any asset to the extent that: • The asset was held at the time S corporation status was elected, and • The loss does not exceed the asset’s adjusted basis less the FMV at the time the S election was made

14. Built-In Gains Tax • [IRC §1374(d)(7)] The recognition period means the first 10 years after the corporation becomes an S corporation

15. Built-In Gains Tax • [IRC §1374(d)(2)] The net recognized built-in gain means the lesser of: • The amount that would be taxable income for the year if only recognized built-in gains and recognized built in losses were taken into account, or • The corporation’s taxable income for the year under IRC §1375(b)(1)(B) • Items of taxable gross income less deductible expenses (without DRD or NOL carryovers)

16. Built-In Gains Tax • [IRC §1374(c)(2)] The amount of net recognized built-in gain taken into account for any year shall not exceed: • The net unrealized built-in gain less • The net recognized built-in gains for prior years

17. Built-In Gains Tax • [IRC §1374(b)] A 35% tax is imposed on the net recognized built-in gain for the year • The tax imposed is treated as a loss sustained by the corporation [IRC §1366(f)(2)] • The character of the loss depends on the character of the recognized built-in gain that gave rise to the tax [IRC §1366(f)(2)]

18. Built-In Gains Tax • See Examples 4 & 5