R3: S Corporations & Partnerships

S corporation basics

• C corps may elect “S” status, a flow-through entity where individual owners are taxed on their proportionate share of earnings

S status requirements

1. Must be a domestic corporation

2. Corporations/partnerships not eligible to be SHs

3. No more than 100 shareholders

4. 1 class of stock (preferred stock not allowed)

*S can own shares in C, C cannot own shares in S

S election timing

• if filed before Mar 15, treated as S status for entire year starting Jan 1

• if filed after Mar 15, doesn’t take effect until Jan 1 of next year

new shareholders

after S election is in effect, the consent of a new SH is not required

termination of S election

S corporation status will terminate as a result of the following:

1. SHs owning more than 50% stock consent to a voluntary revocation (can specify termination date or default dates come into effect)

2. Corporation fails to meet S status requirements (terminated immediately)

3. More than 25% of the corporation’s gross receipts are from passive investment income for 3 consecutive years but only if corporation has prior C corp E&P (terminated @ beginning of year)

short tax years

termination of S corp election can result in 2 short tax years because:

• S corp for part of year

• C corp for part of year

*corporation must allocate income for the year between S corp & C corp by either:

1. allocating based on the relative # of days

2. closing the books on the date of conversion

re-electing S status

5-year waiting period

S corp income or loss

• S corps income/loss flows through to personal return of the shareholders

• SH’s share of business income is not subject to SE tax

separately stated items

items that flow through separately to the SH:

• rental income/loss (Sch E)

• interest & dividend income (Sch B)

• net short-term & long-term capital gain/loss (Sch D)

• Net section 1231 gain/loss (Sch D)

• charitable contributions (Sch A)

• Sec 179 expense deduction

fringe benefits

• benefits for all non-SH employees → deductible by S corp

• benefits for SH employees owning <2% → deductible

• benefits for SHs owning >2% → not deductible unless S corp includes benefits on W-2

stock basis & debt basis

stock basis & debt basis are tracked separately but are combined to form tax basis

tax basis limitation

loss can only be flowed through to an S corp’s individual income tax return to the extent of the tax basis

• loss in excess of tax basis is suspended until tax basis is reinstated (debt basis reinstated first)

• suspended loss due to insufficient tax basis can be carried forward indefinitely

accumulated adjustments account (AAA)

• the accumulated earnings & profits during the years the corporation is an S corp

• previous undistributed income & can be withdrawn tax free

partnership

• very similar to an S corp (flow-through entity, has K-1s)

• Form 1065

• individual partners pay tax on partnership income

• each partner is liability only for taxes on their distributive share of partnership income as reported on Sch. K-1

guaranteed payments

• like salaries to the partner

• expense for partnership, taxable income to partner

• not included in QBI for purposes of the Sec 199A QBI deduction

health insurance paid by partnership

• included in guaranteed payments

• “above the line” deduction to arrive at AGI

retirement plan contributions paid by partnership

• not included in guaranteed payments

• “above the line” deduction to arrive at AGI

organizational & start up costs

*same rules as corporations

• first $5,000 of start-up & first $5,000 of organizational expenses can be deducted

• any amount over $50,000 is reduced dollar-by-dollar

• costs to raise capital not eligible

partner’s basis in a partnership

partner’s capital account + partner’s share of partnership debt

this is different from an S Corp

• remember that for an S Corp, partner’s share of debt is not included in basis, but for a partnership it is

tax basis limitation

can’t deduct loss in excess of basis, loss is suspended until tax basis is reinstated

partnership items to reinstate suspended basis

1. ordinary business income

2. separately stated income & gains

3. additional contributions

4. increase in partnership debt

treatment of suspended losses when partnership is disposed

these suspended losses are lost when the partnership is disposed

LLC (limited liability company)

• separate legal entity from its owners

• “members” not personally liable for obligations of the business

• all members have limited liability

An LLC with at least 2 owners is taxed as a:

partnership unless an election is made to have the LLC taxed as a C corp

single-member LLC

considered a disregarded entity for income tax purposes