Enrolled Agent > EA - Part 2: Businesses > Unit 15: S Corporations > Flashcards

Unit 15: S Corporations Flashcards

Understand S corp requirements, pass-through rules, and limits. (48 cards)

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1
Q

What is the primary benefit of an S corporation compared to a C corporation?

A

An S corporation is a pass-through entity that avoids double taxation on corporate income by passing earnings and losses to shareholders, who report them on their personal tax returns.

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2
Q

What are the main requirements for a corporation to qualify as an S corporation?

A
  • Must be a domestic corporation
  • Have 100 or fewer shareholders
  • Shareholders must be U.S. citizens or U.S. residents or certain kinds of trusts, or estates (not partnerships or corporations)
  • Only one class of stock allowed
  • Must file Form 2553 to elect S status

For new entities, Form 2553 must be filed within two months and 15 days from the date of formation. For existing entities, it must be filed during the prior tax year or by the 15th day of the third month of the tax year the election is to apply.

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3
Q

How must profits and losses be allocated in an S corporation?

A

Profits and losses must be allocated to shareholders in proportion to each one’s interest in the business.

Unlike partnerships, S corporations do not have provisions for special allocations, meaning that unequal allocations of profit and loss are not permitted.

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4
Q

Which form is used by S corporations to report each shareholder’s distributive share of income?

A

Schedule K-1 (Form 1120-S)

This schedule reports each shareholder’s share of the corporation’s income, deductions, credits, and other financial items.

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5
Q

What happens if an S corporation’s shareholder count exceeds 100 due to a divorce?

A

The S corporation’s status is terminated, and it is taxed as a C corporation.

A married couple counts as a single shareholder, but if they divorce, they count as two separate shareholders, potentially exceeding the 100-shareholder limit.

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6
Q

What is a ‘qualified Subchapter S subsidiary’?

(QSSS)

A

A domestic corporation that is 100% owned by an S corporation, for which the parent S corporation elects QSSS status. The subsidiary is disregarded as a separate entity for federal tax purposes, and all its assets, liabilities, and income are treated as those of the parent S corporation.

If a proper Q-Sub election is not filed, the acquired corporation will be treated as a C corporation for tax purposes.

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7
Q

What must be written on Form 1120-S if a late S-election is made?

A

“INCLUDES LATE ELECTION FILED PURSUANT TO REV. PROC. 2013-30.”

This notation is required when a late S-election is made by attaching Form 2553 to the corporation’s Form 1120-S.

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8
Q

True or False:

An S corporation can have more than one class of stock.

A

False

An S corporation can only have one class of stock, but that stock can have differences in voting rights.

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9
Q

What is the filing requirement for an S corporation regardless of income or loss?

A

An S corporation must file an annual tax return using Form 1120-S.

Filing a tax return is mandatory for an S corporation until it is legally dissolved.

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10
Q

Fll in the blank:

S corporations must e-file their corporate tax return and all information returns (Forms 1099 and W-2) if they issue ______ or more information returns in a calendar year.

A

Ten

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11
Q

When is the Form 1120-S for a calendar-year S corporation due?

A

March 15

A six-month extension can be requested using Form 7004, pushing the due date to September 15.

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12
Q

What are the general tax year requirements for an S corporation?

A
  • A calendar year (January 1 - December 31)
  • A natural business year
  • An ownership tax year
  • A fiscal year under section 444
  • A 52-53 week year
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13
Q

How is the stock basis of an S corporation shareholder adjusted annually?

A
  • Increased for income items and excess depletion
  • Decreased for distributions
  • Decreased for nondeductible, noncapital expenses
  • Decreased for items of loss and deductions
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14
Q

What is Form 7203, S Corporation Shareholder Stock and Debt Basis Limitations?

A

It is used by S corporation shareholders to calculate and report their stock and debt basis. It ensures shareholders only deduct losses and claim distributions to the extent of their basis.

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15
Q

What limits the deductibility of an S corporation shareholder’s losses?

A

Losses are limited first by the shareholder’s stock and debt basis, then by the at-risk rules, and finally by the passive activity loss rules.

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16
Q

How does an S corporation handle cancellation of debt income?

A

At the entity level, not the shareholder level.

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17
Q

How is income allocated to S corporation shareholders?

A

On a pro-rata basis according to the number of shares held by each shareholder.

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18
Q

What is the tax treatment of S corporations regarding corporate-level income tax?

A

S corporations are generally not subject to taxation at the corporate level, as they are primarily pass-through entities. However, they may be subject to taxes due to:

  • Excess net passive investment income
  • Built-in gains
  • Investment credit recapture
  • LIFO recapture

These taxes usually apply to corporations that were once C corporations and then converted to S corporations.

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19
Q

What types of taxes might an S corporation be responsible for aside from income taxes?

A

An S corporation may be responsible for:

  • Payroll taxes
  • Excise taxes
  • Franchise taxes
  • Penalties

Excise taxes can include taxes on diesel fuel and gasoline, highway usage, indoor tanning, and wagering activities.

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20
Q

What is Excess Net Passive Income (ENPI) Tax and when does it apply?

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A

It applies if an S corporation has accumulated earnings and profits (E&P) from when it was a C corporation, and its passive investment income exceeds 25% of its gross receipts.

The tax rate on excess net passive income is 21% and is applied against the lesser of ENPI or taxable income figured as though the corporation were a C corporation.

21
Q

What is the consequence if an S corporation’s passive investment income exceeds 25% of its gross receipts for three consecutive years?

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A

The S election is terminated as of the beginning of the fourth year, and the corporation will be taxed as a C corporation.

To avoid termination, the corporation can distribute all accumulated E&P to shareholders before the end of the third year.

22
Q

What is a Built-in Gains (BIG) Tax?

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A

It applies to S corporations that were formerly C corporations with appreciated assets. The tax is on gains recognized when these assets are sold.

The tax is at the corporate rate of 21% and affects property dispositions during the five-year period after S election.

23
Q

What is the LIFO recapture tax?

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A

When a C corporation using LIFO inventory elects S status, it must recognize as income the LIFO reserve (FIFO value minus LIFO value). The tax on this recapture is paid in four equal annual installments.

24
Q

What is the Accumulated Adjustments Account (AAA) in an S corporation?

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A

When a C corporation elects S status, the AAA tracks accumulated, undistributed income already taxed to shareholders.

The ordering rules for distributions are: first from AAA, second from E&P, third from OAA, and additional distributions are considered a reduction in shareholder equity.

25
What is the **IRS requirement** for compensation of shareholder-employees in S corporations?
S corporations must pay reasonable wages to shareholder-employees before making distributions. ## Footnote If reasonable compensation is not paid, the IRS may reclassify distributions as wages, subject to employment taxes.
26
What constitutes '**reasonable compensation**' for S corporation shareholder-employees?
Factors include: * Duties and responsibilities * Time and effort devoted to the business * Payments to non-shareholder employees * Timing and manner of bonus payments * Comparative salaries in similar businesses * Formal compensation agreements * Use of a formula to determine compensation ## Footnote The IRS may reclassify distributions as wages if it determines compensation is unreasonably low, leading to additional employment taxes, penalties, and interest.
27
Under what **circumstances** can corporate officers not be considered employees for tax purposes?
If they do not perform significant services or perform minor tasks and receive no compensation. ## Footnote In such cases, they are not considered employees for tax purposes.
28
What is the impact of '**reasonable compensation**' wages on the Section 199A Qualified Business Income deduction for S corporations?
Reasonable compensation wages are excluded from the definition of 'qualified business income' (QBI), but all wages paid by the S corporation factor into the deduction limitation based on wages and qualified property. ## Footnote The QBI deduction is calculated on the remaining ordinary income after reasonable wages have been paid.
29
How are health insurance premiums treated for shareholder-employees with **at least 2% ownership** in an S corporation?
The premiums are: * Deductible by the S corporation * Reportable as wages on the shareholder-employee’s Forms W-2 * Excluded from wages subject to Social Security, Medicare, and FUTA taxes. ## Footnote The shareholder-employee can claim an AGI deduction if the coverage is established by the S corporation.
30
What happens if a shareholder in an S corporation **terminates** their interest during the tax year?
The corporation may elect to allocate income and expenses as if the tax year consisted of two separate short tax years with the consent of all affected shareholders. ## Footnote This election must be made by attaching a statement to a timely filed Form 1120-S, and 'SECTION 1377 (a)(2) ELECTION MADE' should be written on each affected shareholder’s Schedule K-1.
31
What are the circumstances under which an S election will **automatically terminate**?
* The corporation no longer qualifies as a small business corporation * More than 25% of gross receipts from passive investment income for three consecutive tax years * Creation of a second class of stock * Shareholders willingly revoke the S election. ## Footnote A revocation requires consent from the majority of shareholders owning more than 50% of the stock.
32
What is an '**inadvertent termination**' of an S election?
An inadvertent termination occurs when an S-election terminates due to an act that triggers ineligibility, but the act was not within the control of the corporation and was not intended to terminate the election. ## Footnote Revenue Procedure 2022-19 allows automatic relief for certain inadvertent terminations without requesting a private letter ruling.
33
What happens if an S corporation distributes **appreciated property** to shareholders?
It triggers a **taxable gain** to the S corporation.
34
What is a **late S-election**?
A late S-election is when an election made after the first **2.5 months** of the tax year becomes effective on the first day of the following tax year, unless IRS approval is received to make it retroactive.
35
What is required for a **late S-election** to be accepted by the IRS?
* The entity intended to be an S corporation and is eligible * Reasonable cause for late filing * Income reported consistent with an S corporation election * Less than three years and 75 days since the effective date ## Footnote The corporation must write "FILED PURSUANT TO REV. PROC. 2013-30" on the top margin when filing a late election.
36
What entities cannot elect **S corporation status**?
* A bank using the reserve method for bad debts * An insurance company * A domestic international sales corporation * Any foreign entity
37
What are the filing requirements for S corporations regarding **digital assets**?
S corporations must report any **financial interest** in digital assets on Schedule B of Form 1120-S.
38
How is a shareholder’s **basis** in S corporation stock determined if the stock was acquired by gift?
The donor’s basis ## Footnote Suspended passive activity losses can increase the basis of a gift.
39
# True or False: S corporation **distributions** are generally treated as dividends.
False ## Footnote Distributions are not treated as dividends and are not subject to income tax unless the corporation has accumulated E&P from years before it elected to become an S corporation.
40
What must an S corporation do if it distributes **appreciated property**?
The distribution is treated as a **sale** to the S corporation.
41
What is the consequence if an S corporation shareholder sells their stock with **suspended losses**?
Suspended losses are lost.
42
What are some items that must be **separately stated** on an S corporation’s tax return?
* Net income or loss from rental real estate activity * Portfolio income or loss * Capital gains or losses * Section 1231 gain or loss * Charitable contributions * Section 179 expense deduction * Foreign taxes paid or accrued * Business credits * Investment interest expense * Tax preference and adjustment items for AMT * Nonbusiness bad debts
43
# True or False: An S corporation is eligible for a **dividends-received deduction**.
False
44
When does the **built-in gains tax** not apply to an S corporation?
When the S corporation holds the assets long enough after electing S-status, beyond the **five-year recognition period**.
45
What is required for an S corporation to avoid the **excess net passive income tax**?
Distributing all of its **accumulated E&P** to its shareholders.
46
What triggers the **recapture of the investment credit** for an S corporation?
Disposing of an **asset** within five years after it was placed in service that had received an investment tax credit.
47
What is the **order of distribution** for an S corporation with accumulated E&P?
* First, from the Accumulated Adjustments Account (AAA). * Second, from E&P, and taxable as dividends. * Third, if applicable, from the corporation's Other Adjustments Account (OAA). * Additional distributions are a reduction in return of shareholder equity. * Distributions in excess of a shareholder's basis in his stock are considered capital gains. ## Footnote An S corporation will only have accumulated E&P if it was previously a C corporation or merged with another C corporation.
48
# True or False: An S corporation can immediately re-elect **S status** after termination.
False ## Footnote Normally, an S corporation cannot elect to become an S corporation again within the next five years (60 months) after termination, unless the IRS waives the restriction.
EA - Part 2: Businesses
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