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Sting Tax Sec 1375

Sting Tax Sec 1375. Code Sec 1375 Sting Tax. If, for the tax year an S Corp has— AE&P at the close of the year, and gross receipts more than 25% of which are passive investment income, then the Sec 1375 tax (at the highest C corp rate) applies. (Sec 1375(a)). Definitions.

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Sting Tax Sec 1375

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  1. Sting TaxSec 1375

  2. Code Sec 1375 Sting Tax • If, for the tax year an S Corp has— • AE&P at the close of the year, and • gross receipts more than 25% of which are passive investment income, • then the Sec 1375 tax (at the highest C corp rate) applies. (Sec 1375(a))

  3. Definitions • The terms “passive investment income” and “gross receipts” are defined in Code Sec 1362(d) (per Sec 1375(b)(3). • Recall that under Code Sec 1362(d)(3)(A), an S election terminates if the S corporation has (1) AE&P, and (2) gross receipts more than 25% of which are passive investment income, for 3 consecutive years.

  4. PII and NPI • Passive investment income (PII) includes gross receipts derived from royalties, rents, dividends, interest, annuities, and sales or exchanges of stocks and securities. Sec 1362(d)(3)(B). • Only net gain (gains over losses) from disposition of capital assets (not stocks and securities) is included in the definition of gross receipts. • With stocks and securities (PII), only include gains. Reg. 1.1362-2(c)(4)(ii)(B). • Net passive income (NPI--relevant in calculating the Sting Tax) is passive income less directly related deductions.

  5. Sting Tax Calculation • ENPI X 35% = Penalty Tax • ENPI = Excess net passive income • PII > 25% of gross receipts • ENPI = NPI X ---------------------------------------- • PII • See Code Sec. 1375(b)(1).

  6. Taxable Income Limit • Excess net passive income (ENPI) cannot exceed corp taxable income before considering any NOL or other special deductions. Sec 1375(b)(1)(B).

  7. Interaction with BIG Tax • Passive investment income under Sec 1375 is reduced by any RBIG for any tax year under Sec 1374 (in other words the BIG tax has priority). Sec 1375(b)(4). • For purposes of shareholder income recognition, the Sec 1375 tax reduces each item of PII (passive investment income) by its proportionate share of the Sec 1375 tax (analogous to the treatment of the BIG Tax).

  8. Problem 2(a) on Page 442 • Gross receipts (GR) are $145,000 (75,000 + 5,000 + 12,000 + 35,000 + 18,000) • PII = $35,000 (5,000 Tax Exempt Int. + 12,000 Div. + 18,000 Stock Sale Gain) • (Tax Exempt income is included as interest income per Reg. Sec. 1.1362-2(c)(5)(ii)(D)(1)) • 35,000 (PII) ÷ 145,000 (GR) = 24.13% • The penalty tax DOES NOT APPLY! PII does not exceed 25% of gross receipts.

  9. Problem 2(b) on Page 442 • Gross receipts (GR) are $150,000 (75,000 + 10,000 + 12,000 + 35,000 + 18,000) • PII = $40,000 (10,000 Tax Exempt Int. + 12,000 Div. + 18,000 Stock Sale Gain) • 40,000 (PII) ÷ 150,000 (GR) = 26.66% • The penalty tax DOES APPLY! PII exceeds 25% of gross receipts.

  10. Problem 2(b) ENPI and Tax Calc. PII > 25% of gross receipts ENPI = NPI X ---------------------------------------- PII 40,000 – 37,500 $2,500 = $40,000 (NPI) X ------------------------------ $40,000 Sec 1375 Tax = $850 (35% X 2,500 ENPI) Assume sufficient taxable income calculated as if a C corp.

  11. Problem 3 on Page 442 • Assuming that Bay has C Corp AE&P, the issue here is the potential passive investment income (in excess of 25% of gross receipts) with respect to the rental income of Bay. • Reg Sec 1.1362-2(c)(5)(ii)(B)(2) provides that “rents” does not include rents derived from the active trade or business of renting property.

  12. Problem 3 on Page 442 • Rents are received in an active trade or business of renting only if, based on all facts and circumstances, the corporation provides significant services or incurs substantial costs in the rental business. • The concerns here are termination and the sting tax. • The biggest threat here is the berthing fees. Those may be non-business rental income (and are 1/3 of the income).

  13. Problem 3 on Page 442 • If the berthing fees are non-business rental income then one strategy would be to distribute the AE&P. This is particularly useful if the AE&P amount is small. • If the corporation has always been an S Corp, then the Sting Tax will not apply (no C Corp AE&P). • Recall that the BIG Tax can apply with or without C Corp AE&P.

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