PPT for Chapter 12 Essay

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Pages: 16

Chapter 12
S Corporations

Corporations, Partnerships,
Estates & Trusts
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The Big Picture (slide 1 of 2)
• Cane, Inc., has been a C corp. for a number of years, earning taxable income of less than $100,000 per year. – Thus, the business has been subject to the lower C corporation tax rates.

• Due to cheap imports from China, Cane’s two owners, Smith and Jones, expect operating losses for the next two or three years.
– They hope to outsource some of the manufacturing to
Vietnam and turn the company around.

• How can they deduct these anticipated future losses?

The Big Picture (slide 2 of 2)
• The corp. receives some tax-exempt income, generates a small domestic production activities deduction (DPAD), and holds some C corp. E&P.
• Each owner draws a salary of $92,000.
• Cane has two classes of stock, voting and non-voting common stock. – Cane is located in Texarkana, Texas.
– Smith lives in Texas, and Jones lives in Arkansas.
• Both are married to nonresident aliens.

• Should Smith and Jones elect to be taxed as an S corporation?
– Do they need to liquidate or go through some type of reorganization to do so?

• Read the chapter and formulate your response.

Subchapter S Issues
(slide 1 of 6)

• S corporations provide many of the benefits of partnership taxation
– Also gives the owners limited liability protection from creditors

• S corporation status is obtained through an election by a qualifying corporation with the consent of its shareholders

Subchapter S Issues
(slide 2 of 6)

• S corporations are still corporations for legal purposes – Owners receive the benefits of limited liability, ability to raise capital (within limits), etc...

Subchapter S Issues
(slide 3 of 6)

• Taxation resembles partnership taxation
– Certain items (primarily business income and certain expenses) are accumulated and passed through to shareholders
– Other items are “separately stated” and each item is passed through to shareholders

Subchapter S Issues
(slide 4 of 6)

• An S corporation is a reporting (rather than tax-paying) entity
• Tax liability may still arise at the entity level for: – Built-in gains tax, or
– Passive investment income penalty tax

Subchapter S Issues
(slide 5 of 6)

• An S corporation is not subject to the following taxes:

Corporate income tax
Accumulated earnings tax
Personal holding company tax
Corporate alternative minimum tax

Subchapter S Issues
(slide 6 of 6)

• Entity is subject to Subchapter C rules for a transaction unless Subchapter S provides alternate rules

When to Elect S Corp Status
• Following factors should be considered:
– If shareholders have high marginal tax rates vs C corp rates
– If NOLs are anticipated
– If currently C corp, any NOL carryovers from prior years can’t be used during S corp years
• Still reduces 20 year carryover period

– Character of anticipated flow-through items
– State and local tax laws
– A variety of other factors

S Corp Qualification
Requirements (slide 1 of 3)
• To elect under Subchapter S, a corporation must meet the following requirements:
– Must be a domestic corporation
– Must not otherwise be “ineligible”
• Ineligible corporations include certain banks, insurance companies and foreign corporations
• Any domestic corp. that is not an ineligible corp. can be a qualified Subchapter S Subsidiary (QSSS) if:
– S corp owns 100% of its stock, and
– Elects to treat the subsidiary as a QSSS

S Corp Qualification
Requirements (slide 2 of 3)
• Corporation may have only one class of stock
– Can have stock with differences in voting rights but not in distribution or liquidation rights
– It is possible for debt to be reclassified as stock
• Results in unexpected loss of S corp status
• Safe harbor provisions mitigate concern over reclassification of debt

The Big Picture – Example 3

One Class of Stock