A corporation that has been an S corporation from its
Have both passive and nonpassive income
Be owned by a bankruptcy estate
(d) The requirement is to determine whether a corporation
that has been an S corporation from its inception may have
both passive and nonpassive income, and be owned by a bankruptcy
estate. To qualify as an S corporation, a corporation must
have one hundred or fewer shareholders who are individuals
(other than nonresident aliens), certain trusts, or estates (including
bankruptcy estates). If a corporation has been an S corporation
since its inception, there is no limitation on the amount
or type of income that it generates, and it can have both passive
and nonpassive income.
Bern Corp., an S corporation, had an ordinary loss of
$36,600 for the year ended December 31, 2012. At January 1,
2012, Meyer owned 50% of Bern’s stock. Meyer held the stock
for forty days in 2012 before selling the entire 50% interest to an
unrelated third party. Meyer’s basis for the stock was $10,000.
Meyer was a full-time employee of Bern until the stock was sold.
Meyer’s share of Bern’s 2012 loss was
(b) The requirement is to determine Meyer’s share of an
S corporation’s $36,600 ordinary loss. An S corporation’s items
of income and deduction are allocated on a daily basis to anyone
who was a shareholder during the taxable year. Here, the
$36,600 ordinary loss would be divided by 366 days to arrive at a
loss of $100 per day. Since Meyer held 50% of the S corporation’s
stock for forty days, Meyer’s share of the loss would be
($100 × 50%) × 40 days = $2,000.
A calendar-year corporation whose status as an S corporation
was terminated during 2012 must wait how many years
before making a new S election, in the absence of IRS consent to
an earlier election?
(c) The requirement is to determine the period that a
calendar-year corporation must wait before making a new S election
following the termination of its S status during 2012. Generally,
following the revocation or termination of an S election, a
corporation must wait five years before reelecting subchapter S
status unless the IRS consents to an earlier election.
Which one of the following will render a corporation
ineligible for S corporation status?
(d) The requirement is to determine which will render a
corporation ineligible for S corporation status. Answer (d) is
correct because an S corporation is limited to 100 shareholders.
Answers (a) and (b) are incorrect because a decedent’s estate
and a bankruptcy estate are allowed as S corporation shareholders.
Although an S corporation may only have one class of stock
issued and outstanding, answer (c) is incorrect because a difference
in voting rights among outstanding common shares is not
treated as having more than one class of stock outstanding.
With regard to S corporations and their stockholders, the
“at risk” rules applicable to losses
(d) The requirement is to determine the correct statement
with regard to the application of the “at-risk” rules to S
corporations and their shareholders. The at-risk rules limit a
taxpayer’s deduction of losses to the amount that the taxpayer
can actually lose (i.e., generally the amount of cash and the adjusted
basis of property invested by the taxpayer, plus any liabilities
for which the taxpayer is personally liable). The at-risk rules
apply to S corporation shareholders rather than at the corporate
level, with the result that the deduction of S corporation losses is
limited to the amount of a shareholder’s at-risk investment. The
application of the at-risk rules does not depend on the type of
income reported by the S corporation, are not subject to any
elections made by S corporation shareholders, and are applied
without regard to the S corporation’s ratio of debt to equity.
An S corporation may deduct
(d) The requirement is to determine the item that may
be deducted by an S corporation. Items having no special tax
characteristics can be netted together in the computation of the S
corporation’s ordinary income or loss, with only the net amount
passed through to shareholders. Thus, only ordinary items (e.g.,
amortization of organizational expenditures) can be deducted by
an S corporation. Answer (a) is incorrect because foreign income
taxes must be separately passed through to shareholders so
that the shareholders can individually elect to treat the payment
of foreign income taxes as a deduction or as a credit. Answer (b)
is incorrect because a net Sec. 1231 loss must be separately
passed through to shareholders so that the Sec. 1231 netting
process can take place at the shareholder level. Answer (c) is
incorrect because investment interest expense must be separately
passed through to shareholders so the deduction limitation (i.e.,
limited to net investment income) can be applied at the shareholder
An S corporation’s accumulated adjustments account,
which measures the amount of earnings that may be distributed
(d) The requirement is to determine the correct statement
regarding an S corporation’s Accumulated Adjustments
Account (AAA). An S corporation that has accumulated earnings
and profits must maintain an AAA. The AAA represents the
cumulative balance of all items of the undistributed net income
and deductions for S corporation years beginning after 1982.
The AAA is generally increased by all income items and is decreased
by distributions and all loss and deduction items except
no adjustment is made for tax-exempt income and related expenses,
and no adjustment is made for federal income taxes attributable
to a taxable year in which the corporation was a C corporation.
The payment of federal income taxes attributable to a
C corporation year would decrease an S corporation’s accumulated
earnings and profits (AEP). Note that the amounts represented
in the AAA differ from AEP. A positive AEP balance represents
earnings and profits accumulated in C corporation years
that have never been taxed to shareholders. A positive AAA balance
represents income from S corporation years that has already
been taxed to shareholders but not yet distributed. An S corporation
will not generate any earnings and profits for taxable years
beginning after 1982.
If a calendar-year S corporation does not request an automatic
six-month extension of time to file its income tax return,
the return is due by
(b) The requirement is to determine the due date of a
calendar-year S corporation’s tax return. An S corporation must
file its federal income tax return (Form 1120-S) by the 15th day
of the third month following the close of its taxable year. Thus, a
calendar-year S corporation must file its tax return by March 15,
if an automatic six-month extension of time is not requested.
An S corporation is not permitted to take a deduction for
(c) The requirement is to determine the item for which
an S corporation is not permitted a deduction. Compensation of
officers, interest paid to nonshareholders, and employee benefits
for nonshareholders are deductible by an S corporation in computing
its ordinary income or loss. However, charitable contributions,
since they are subject to percentage limitations at the
shareholder level, must be separately stated and are not deductible
in computing an S corporation’s ordinary income or loss.
An S corporation may
(d) An S corporation may have as many as 100
shareholders. However, an S corporation cannot have both
common and preferred stock outstanding because an S corporation
is limited to a single class of stock. Similarly, a partnership is
not permitted to be a shareholder in an S corporation because all
S corporation shareholders must be individuals, estates, or certain
trusts. Additionally, an S corporation cannot have a nonresident
alien as a shareholder.