Prentice Hall's Federal Taxation 2011: Corporations, 24e (Pope) Chapter 11 S Corporations

1) The S corporation rules were enacted to allow small corporations to enjoy the nontax advantages of the corporate form of business without being subject to the tax disadvantage of double taxation. Answer: T !"
#age ef.: $:11%&

&) !p to six generations of a family are considered as one shareholder for purposes of the 1'' shareholder limit. Answer: T !"
#age ef.: $:11%(

)) $orporations and partnerships can be S corporation shareholders. Answer: *A+S"

#age ef.: $:11%(

() A testamentary trust can be an S shareholder for two years, beginning on the date the stoc- transfers to the trust. Answer: T !"
#age ef.: $:11%.

.) The election of Subchapter S status by a corporation is valid only if all shareholders consent to the election. Answer: T !"
#age ef.: $:11%/

0) A corporation must ma-e an S election for the current year after 1arch 1. in the case of a calendar year corporation. Answer: *A+S"
#age ef.: $:11%/

2) All shareholders must consent to the revocation of S status. Answer: *A+S"

#age ef.: $:11%3

/) "ven if the termination of an S election is considered to be inadvertent, the election to terminate is irrevocable. Answer: *A+S"
#age ef.: $:11%11

3) Tax%exempt interest earned by an S corporation is not reported to its shareholders because it is excluded from the shareholders4 gross income. Answer: *A+S"
#age ef.: $:11%1.

1') S shareholders are allocated shares of income, gain, loss, deduction, and credit based on their number of shares of stoc- and period of time for which the stoc- is held. Answer: T !"
#age ef.: $:11%13

11) S shareholders cannot increase the basis of their stoc- by a ratable share of the general S corporation liabilities. Answer: T !"
#age ef.: $:11%&1

1&) The accumulated adjustments account is the cumulative total of ordinary income or loss and separately stated items 5excluding tax%exempt income and expenses) for the most 1 Copyright 2011 Pearson Education, Inc.

recent continuous period during which the corporation has been an S corporation. Answer: T !"
#age ef.: $:11%&3

1)) 6dentify which of the following statements is true. A) The S corporation rules were enacted to allow small corporations to enjoy the nontax advantages of the corporate form of business without being subject to the tax disadvantage of double taxation. 7) A partnership can elect to be taxed as a corporation under the chec-%the%box regulations. As a corporation, an S election can be made. $) *or $ corporations that desire to be taxed li-e a partnership, the S corporation rules provide a practical alternative for an existing $ corporation to obtain many of the tax benefits of being taxed as a partnership. 8) All are true. Answer: 8
#age ef.: $:11%&

1() 9hich of the following corporate tax levies are imposed on an S corporation: A) corporate income tax 7) corporate alternative minimum tax $) accumulated earnings tax 8) ;one of these taxes are imposed on an S corporation. Answer: 8
#age ef.: $:11%)

1.) 6dentify which of the following statements is true. A) A partnership can be an S corporation shareholder. 7) A nonresident alien can be an S corporation shareholder. $) An S corporation can have more than 1'' shareholders since families are treated as a single shareholder. 8) All are false. Answer: $
#age ef.: $:11%(

10) 9hich one of the following individuals or entities is ineligible to be an S corporation shareholder: A) an estate 7) resident alien of the !nited States $) a voting trust where all of the beneficiaries are !.S. citi<ens 8) a partnership where all of the partners are !.S. citi<ens Answer: 8
#age ef.: $:11%(

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12) 9hich of the following statements about stoc- ownership is not correct: A) A $ corporation can own stoc- of an S corporation. 7) An S corporation can own stoc- of a $ corporation. $) A tax%exempt charity can own stoc- of an S corporation. 8) An S corporation can own stoc- of a =ualified Subchapter S Subsidiary. Answer: A
#age ef.: $:11%(

1/) Trusts that can own S corporation stoc- include all of the following except A) charitable remainder unitrusts. 7) =SSTs. $) grantor trusts. 8) testamentary trusts. Answer: A
#age ef.: $:11%.

13) 9hich of the following would terminate a Subchapter S election: A) "state becomes a shareholder. 7) >rantor trust becomes a shareholder. $) ?oting trust becomes a shareholder. 8) #artnership becomes a shareholder. Answer: 8
#age ef.: $:11%(, $:11%.

&') 9hich one of the following is not one of the corporation%related re@uirements for S corporation status: A) The corporation must be a domestic corporation. 7) The corporation must not have any foreign%sourced income. $) The corporation must not be an AineligibleA corporation. 8) The corporation must have only one class of stoc-. Answer: 7
#age ef.: $:11%.

&1) 6dentify which of the following statements is true. A) A trust can own S corporation stoc- and have a $ corporation as a beneficiary as long as the corporation is the sole beneficiary. 7) A =SST is an arrangement whereby the stoc- owned by a number of shareholders is placed under trust control for purposes of exercising the stoc- voting rights. $) A testamentary trust can be converted into a =SST trust. 8) All are false. Answer: $
#age ef.: $:11%.

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&&) 1ary, a !.S. citi<en owned &.B of the stoc- of *loran $orporation, an electing S corporation. At the time of her death, the *loran stoc- may go to all the following without affecting the S election except A) her estate. 7) testamentary trust. $) small business trust. 8) charitable remainder unitrust. Answer: 8
#age ef.: $:11%.

&)) Alligood $orporation has two classes of common stoc- outstanding. The $lass A and $lass 7 common stoc- give the shareholders identical rights and interests in the profits and assets of the corporation. $lass A stoc- has one vote per share. $lass 7 stoc- is nonvoting. Alligood $orporation may A) not ma-e the S election due to different voting rights. 7) ma-e the S election once the $lass 7 is retired. $) ma-e the S election any time. 8) not ma-e the S election due to two classes of stoc-. Answer: $
#age ef.: $:11%0, "xample $:11%&

&() 6dentify which of the following statements is true. A) An S corporation cannot own any stoc- of another corporation. 7) An S corporation cannot own 1''B of the stoc- of another S corporation. $) An S corporation that owns all of the stoc- of a =ualified Subchapter S Subsidiary 5=Sub) must report all the income, deductions, and losses of the subsidiary on its own tax return. 8) All are true. Answer: $
#age ef.: $:11%0

&.) 6dentify which of the following statements is true. A) $onvertible debt issues might be considered Astoc-A for purposes of the S corporation single class of stoc- re@uirement. 7) The S election must be made no later than the fifteenth day of the fourth month of the tax year for which the election is to be effective. $) A majority of shareholders must consent to the S corporation election. 8) All are false. Answer: A
#age ef.: $:11%2

&0) 6dentify which of the following statements is true. A) Shareholders who ac@uire stoc- in an S corporation after the election date and prior to the election4s effective date must consent to the election. 7) S corporation consent by shareholders is binding on the current tax year and all future tax years. $) Cnly shareholders who own stoc- on the date an S election ta-es effect must consent to the election. 8) All are false. Answer: 7
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&2) A $ corporation was formed five years ago and is a fiscal year taxpayer with a Dune )' year%end. The $ corporation wants to ma-e an S election for its tax year beginning in the current year. The election must be made by EEEEEEEE 5assuming permission can be obtained to continue using the fiscal year from the 6 S). A) Dune )' of the current year 7) September 1. of the current year $) Dune )' of the next year 8) September 1. of the next year Answer: 7
#age ef.: $:11%/, "xample $:11%)

&/) Felmut and Sergei own all the stoc- of Gappo $orporation, a calendar year domestic corporation. Cn Danuary )' of the current year, Sergei sells his entire interest in the Gappo stoc- to ;ils. All three individuals are !.S. citi<ens. $an an S election be made for the current year: A) ;ot for the current year but for the next year. 7) 6f Felmut and ;ils agree to report all of the corporation4s income for the entire year. $) 6f Sergei will also join in the election with Felmut and ;ils. 8) 6f Felmut and ;ils agree to file a short%period return and Sergei also agrees to the return. Answer: $
#age ef.: $:11%/

&3) 8avies $orporation is a calendar%year taxpayer that is owned e@ually by ?ivian, ob, 8anny, and 8oug 8avies. At the close of business on 1ay )1, ob 8avies sells his &.B stocinterest to #aula 7ryan. 9hich of the following statements about the S election is correct: A) #aula must consent to the S election, otherwise the election terminates at the close of business on 1ay )1. 7) A new S election form must be filed by Dune )' of the same year, with all shareholders consenting to the election. 6f a new S election is not filed, the election terminates on Dune )' of that year. $) #aula has )' days to terminate the S election, otherwise the election remains in place for the entire year and all subse@uent years. 8) ;one of the above statements are correct. Answer: 8
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)') The passive income test relating to an S corporation election is applied A) daily. 7) monthly. $) @uarterly. 8) annually. Answer: 8
#age ef.: $:11%1'

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)1) 6dentify which of the following statements is true. A) All of the shareholders of an S corporation must consent to a revocation of the S election. 7) A revocation of an S corporation election can be retrospective to any date. $) An S election will not be terminated due to excess passive income if the corporation does not have Subchapter $ "H#. 8) All are true. Answer: $
#age ef.: $:11%1'

)&) 9hich of the following conditions will not cause an S election to be terminated: A) "xceeding the 1'' shareholder limit. 7) $reating a second class of stoc- having a dividend preference. $) Selecting an improper tax year. 8) *ailing to file a timely tax return. Answer: 8
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))) Cn Dune )' of the current year, the S election of >reat $orporation is terminated thus creating a six%month S short year and a six%month $ short year. >reat $orporation is a calendar%year taxpayer. The S short year return is due A) September 1.. 7) 8ecember 1.. $) 1arch 1. of the next year. 8) Dune )' of the next year. Answer: $
#age ef.: $:11%11

)() Irause $orporation ma-es an S election believing that it has no current or accumulated "H#. Fowever, after an 6 S audit, Irause is found to have failed the passive investment income test for three consecutive years and also to have a Subchapter $ "H# balance from its three pre%election tax years. The 6 S A) will automatically terminate the election and Irause cannot reelect for a .%year time period. 7) will retroactively revo-e the election to the first day on which it was effective and Irause will not be able to reelect. $) will treat the error as such and allow the election to continue unbro-en. 8) will li-ely treat the termination as inadvertent and will probably approve a continued S election if the corporation distributes the Subchapter $ "H#. Answer: 8
#age ef.: $:11%11J "xample $:11%/

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).) 6f an S corporation inadvertently terminates its election, the 6 S A) may permit the corporation to report as an S corporation even for the period that includes the termination date. 7) will not permit the corporation to restore its S election until the completion of a five%year waiting period. $) will permit restoration of the S election only if the event causing the termination was not within the control of the corporation. 8) will permit restoration of the S election if a majority of the shareholders consent to the reinstatement. Answer: A
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)0) 6dentify which of the following statements is false. A) A $ corporation short year income tax liability must be determined on an annuali<ed basis. 7) 6f the termination of an S election is considered to be inadvertent, then the election is permitted to continue in place as if the termination had never occurred. $) 6f an S election is terminated and the termination is not considered to be inadvertent, a ten%tax%year waiting period is re@uired before ma-ing a new election. 8) A corporation can obtain relief for a late S election if the 6 S consents. Answer: $
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)2) April $orporation4s Subchapter S election was voluntarily terminated for &''3. The first year that April would be eligible to re%elect S corporation status is A) &'1'. 7) &'11. $) &'1&. 8) &'1(. Answer: 8
#age ef.: $:11%1&

)/) 6dentify which of the following statements is true. A) An S corporation should have a buy%sell agreement to guard itself against an ill%advised sale of its stoc-. 7) The terms Asmall business corporationA and AS corporationA are synonymous. $) A regular corporation has common and preferred stoc- outstanding on Danuary 1. Cn Danuary &, the preferred stoc- is canceled in a recapitali<ation, leaving only common stocoutstanding. The corporation can ma-e an S election for this tax year. 8) All are false. Answer: A
#age ef.: $:11%1&

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)3) 6dentify which of the following statements is true. A) The natural business year for fiscal year election purposes is any tax year that ends within six months after the pea- period of business. 7) Section ((( permits an S corporation to elect to use a fiscal year other than a permitted year. $) A new corporation that is 1''B owned by Dohnny 7la-e, a cash method of accounting taxpayer, ma-es an S election for its initial tax year. The S corporation must also elect to use the cash method of accounting as its overall accounting method. 8) All are false. Answer: 7
#age ef.: $:11%1)

(') *or an S corporation to elect to use a fiscal year other than a permitted year, the fiscal year elected must have a maximum deferral period of A) one month. 7) two months. $) three months. 8) six months. Answer: $
#age ef.: $:11%1)

(1) 9hen a Sec. ((( fiscal year election is made, the S corporation ma-es re@uired payments to the 6 S in order to continue to use the fiscal year as its tax year. 9hich of the following statements about the tax year is correct: A) The Sec. ((( payment is deductible by the S corporation as an income tax. 7) The Sec. ((( payment is allocated ratably to each shareholder and claimed as a tax payment on their own tax return5s). $) The Sec. ((( payments are refundable if the S election is terminated. 8) The Sec. ((( payments must be made @uarterly on the same dates that the S corporation4s estimated tax payments are otherwise due. Answer: $
#age ef.: $:11%1)

(&) An S corporation is permitted to claim A) the dividends%received deduction. 7) a personal exemption. $) a deduction based on the amorti<ation of organi<ational expenditures. 8) a net operating loss. Answer: $
#age ef.: $:11%1.

()) 9hich of the following items is not separately stated for an S corporation: A) short%term capital gain 7) dividend income $) Section 1&(. income 8) charitable contribution Answer: $
#age ef.: $:11%1(, $:11%1.

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(() 6dentify which of the following statements is true. A) An election for an S corporation to use the Sec. 123 expensing election is made by the corporation and not by its shareholders. 7) The S corporation4s separately stated items are in general the same ones that apply in partnership taxation. $) An S corporation cannot claim a dividends%received deduction. 8) All are true. Answer: 8
#age ef.: $:11%1.

(.) 6dentify which of the following statements is true. A) #erry $orporation, an S corporation, receives K1',''' of dividends from a &.B%owned domestic corporation. #erry is allowed an /'B dividends%received deduction with respect to the distribution. 7) A ;C+ is incurred by a $ corporation in the current tax year. The $ corporation ma-es an S election for the following tax year. The entire $ corporation ;C+ carryover can be passed through to the S corporation4s shareholders at the end of the following tax year. $) Tax%exempt interest earned by an S corporation is not reported to its shareholders because it is excluded from the shareholders4 gross income. 8) All are false. Answer: 8
#age ef.: $:11%1.

(0) 6dentify which of the following statements is true. A) 7each $orporation, an S corporation, has gross receipts of K&(','''J taxable income of K1&','''J passive investment income of K1'','''J and expenses directly attributable to the passive investment income of K&','''. The corporation4s excess net passive income is K)&,'''. 7) The built%in gains tax applicable to S corporations can be avoided if the property is held for ten years. $) An S corporation generally will not owe the built%in gains tax if the corporation has never been a $ corporation. 8) All are true. Answer: 8
#age ef.: $:11%10, $:11%12

(2) Shanghai $orporation was organi<ed and elected S status in the current year. Fow much passive investment income can Shanghai earn and retain its S status: A) none 7) /'B of gross receipts $) .'B of gross receipts 8) no limit Answer: 8
#age ef.: $:11%10

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(/) The recognition period for the built%in gains tax extends for how many years after the S election ta-es effect: A) one year 7) three years $) five years 8) ten years Answer: 8
#age ef.: $:11%12

(3) Iing $orporation, a cash method taxpayer that uses the calendar year as its tax year, was incorporated on Dune 1, 13/(. The corporation made its initial S election on 8ecember 1 of last year, effective for the current tax year. "arnings and profits of K0',''' have been retained from $ corporation tax years. 9hich one of the following events results in the recognition of a built%in gain: A) $ollection of accounts receivable in the current year that resulted from services performed last year. 7) $ollection of interest income earned in the current year on bonds purchased on Danuary 1 of last year. $) $ollection of dividends declared on April . of the current year on stoc- purchased on *ebruary 1( of the current year. 8) ;one of the above are built%in gains. Answer: A
#age ef.: $:11%10, $:11%12

.') 6dentify which of the following statements is true. A) +ong%term capital gains may be subject to double taxation if the gains are subject to both the excess net passive income tax rules and the built%in gains tax rules. 7) Special allocations of ordinary income or loss and separately stated items that are available for partnerships are also permitted with S corporations. $) 9hen an S corporation4s shares are sold by a shareholder during a tax year, the transferee4s share of the earnings is reported from the day after the transfer date through the end of the tax year. 8) All are false. Answer: $
#age ef.: $:11%13

.1) Train $orporation is an S corporation that is owned e@ually by $arlos and 8iane at the beginning of the year. Cn April &1 5the one hundred and eleventh day of Train4s tax year) of the current year, $arlos sells all of his Train $orporation stoc- to Andre. Fow many days will be used when computing $arlos4s share of S corporation income for this year 5a non%leap year) assuming that a special income allocation election is not made: A) 11' 7) 111 $) &.( 8) &.. Answer: 7
#age ef.: $:11%13

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.&) $actus $orporation, an S $orporation, had accumulated earnings and profits of K1'',''' at the beginning of &''/. Tex and Shirley each own .'B of the stoc-. $actus does not ma-e any distributions during &''/, but had K&'',''' of ordinary income. 6n &''3, ordinary income was K1'',''' and distributions were K1'','''. 9hat is Tex4s ordinary income for &''/: A) K' 7) K.',''' $) K1'',''' 8) K&'',''' Answer: $
#age ef.: $:11%13, $:11%&'

.)) $actus $orporation, an S $orporation, had accumulated earnings and profits of K1'',''' at the beginning of &''/. Tex and Shirley each own .'B of the stoc-. $actus does not ma-e any distributions during &''/, but had K&'',''' of ordinary income. 6n &''3, ordinary income was K1'',''' and distributions were K1'','''. 9hat is Tex4s ordinary income for &''3: A) K' 7) K.',''' $) K1'',''' 8) K&'',''' Answer: 7
#age ef.: $:11%13, $:11%&'

.() $actus $orporation, an S $orporation, had accumulated earnings and profits of K1'',''' at he beginning of &''/. Tex and Shirley each own .'B of the stoc- and have a basis in their stoc- of K.',''' on Danuary 1, &''/. $actus does not ma-e any distributions during &''/, but had K&'',''' of ordinary income. 6n &''3, ordinary income was K1'',''' and distributions were K1'','''. 9hat is Tex4s basis at Danuary 1, &'1': A) K1'',''' 7) K1.',''' $) K&'',''' 8) K&.',''' Answer: 7
#age ef.: $:11%13, $:11%&'

..) 6dentify which of the following statements is true. A) The overall S corporation loss limitation e@uals the shareholder4s adjusted basis for his S corporation stoc- plus hisLher ratable share of all S corporation liabilities. 7) The loss pass%throughs from an S corporation may produce a net operating loss for the shareholder. $) An S corporation shareholder can increase the adjusted basis of hisLher stoc- by any indebtedness owed the shareholder by the S corporation. 8) All are false. Answer: 7
#age ef.: $:11%&'

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.0) An electing S corporation has a K)',''' ordinary loss for the non%leap year. Cn Danuary 1, 7everly and Sonya own e@ually all of the S corporation stoc-. Cn the 1(0th day of the year, 7everly gives her one%half of the S corporation stoc- to her daughter 7ec-y. Fow much of the K)',''' ordinary loss is allocated to 7everly: A) K&.,''' 7) K1.,''' $) K0,''' 8) K.,3.3 Answer: $ "xplanation: $) K)',''' M '..' M 51(0L)0.) N K0,'''
#age ef.: $:11%&', $:11%&1J "xample $:11%12

.2) An electing S corporation has a K)',''' ordinary loss for the non%leap year. Cn Danuary 1, 7everly and Sonya own e@ually all of the S corporation stoc-. Cn the 1(0th day of the year, 7everly gives her one%half of the S corporation stoc- to her daughter 7ec-y. Fow much of the K)',''' ordinary loss is allocated to Sonya: A) K&.,''' 7) K1.,''' $) K1',''' 8) K0,''' Answer: 7 "xplanation: 7) K)',''' M '..' N K1.,'''
#age ef.: $:11%&1

./) 9hich one of the following special loss limitations apply to an S corporation: A) at%ris- rules 7) passive activity limitation rules $) hobby loss rules 8) All of the above apply. Answer: 8
#age ef.: $:11%&&

.3) 8illey $orporation is an electing S corporation which uses a calendar year as its tax year. Cn Cctober )1, 8illey4s S election is terminated because of the ac@uisition of stoc- by an ineligible stoc-holder. 8illey $orporation shareholder Alan is allocated an S corporation loss for the year which cannot be used because of the basis limitation. Alan will lose the unused loss if not used by A) 8ecember )1 of this year. 7) 1arch 1. of next year. $) Cctober )1 of next year. 8) 8ecember )1 of next year. Answer: $
#age ef.: $:11%&)J "xample $:11%&'

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0') 6dentify which of the following statements is false. A) andy is a shareholder in an S corporation. Fis stoc- basis is K1',''' and his basis in a loan he made to the corporation is K),'''. andy4s share of the corporation4s ordinary loss for the current year is K11,'''. 6gnoring the at%ris- and passive activity limitations, andy can deduct the loss in full. 7) A shareholder4s S corporation stoc- basis will increase when the shareholder acts as guarantor on a corporate indebtedness. $) A shareholder4s ratable share of the S corporation4s ordinary loss reduces the adjusted basis of hisLher S corporation stoc-. Cnce the basis of the stoc- is reduced to <ero, any loss passthrough that remains reduces the basis of S corporation debts that are owed to the shareholder. 8) 8ebt basis is restored before stoc- basis. Answer: 7
#age ef.: $:11%&.

01) An S corporation reports ordinary income of K1&',''' after deducting K&',''' for *red4s salary. *red and his three children own the S corporation e@ually. The 6 S determines *red4s stoc- transfer to his three children is not bona fide. easonable compensation for *red is K(','''. Fow much of the S corporation4s K1(',''' pre%salary income must be reported by *red: A) K1(',''' 7) K1'',''' $) K.',''' 8) K(',''' Answer: A
#age ef.: $:11%&(, "xample $:11%&1

0&) 6dentify which of the following statements is false. A) The AAA balance can be negative, but the shareholder4s basis in the S corporation stoccannot be less than <ero. 7) The AAA represents the cumulative incomeLloss recogni<ed in post%13/& S corporation years. $) ;onmoney property distributions made by an S corporation having accumulated "H# are treated differently when determining the corporate level gain recogni<ed under Sec. )11 than are property distributions made by an S corporation without accumulated "H#. 8) Tax exempt income does not increase the AAA but increases the basis of the S corporation stoc-. Answer: $
#age ef.: $:11%&2%$:11%&3

0)) #ressley $orporation was incorporated on Danuary 1, 133(. The corporation made its S election on 1arch 1, 133/. The corporation retains an "H# balance from its $ corporation days. 8uring the current year, it made a cash distribution to its sole shareholder obert #ressley. 9hat is the proper se@uence reducing the corporate earnings accounts for the distribution: A) AAAJ "H# 7) AAAJ CAAJ "H# $) "H#J AAA 8) AAAJ #T6J "H# Answer: A "xplanation: A) The CAA is not a separate accumulated earnings account even though it is reported on page ( of the *orm 11&'S. The tax%exempt income otherwise included in CAA becomes part of the S corporation4s stoc- basis for distribution purposes
#age ef.: $:11%&/

0() 8ixon $orporation was incorporated on Danuary 1, 133.. The corporation made its S election on April 1, 133/. The corporation retains an "H# balance from its $ corporation 13 Copyright 2011 Pearson Education, Inc.

days. 9hich one of the following current year income and expense items is not included in 8ixon $orporation4s Accumulated Adjustments Account: A) ordinary income or loss 7) tax%exempt bond interest income $) long%term capital gains and losses 8) amorti<ation of organi<ational expenditures Answer: 7 "xplanation: 7) The tax%exempt bond interest income is included in the Cther Adjustments Account
#age ef.: $:11%&3

0.) 6dentify which of the following statements is true. A) An S corporation may be subject to the corporate alternative minimum tax. 7) Allocation of tax preference items for A1T generally occurs on a daily basis. $) An S corporation may be subject to the corporate alternative minimum tax when the corporation has accumulated "H# from prior $ corporation tax years. 8) All are false. Answer: 7
#age ef.: $:11%))

00) 6dentify which of the following statements is true. A) *ringe benefits limited by the more%than%&B%shareholder rule include stoc- options, group term life insurance premiums and medical insurance premiums. 7) A shareholder owning &B or more of an S corporation4s stoc-, who is also an employee of the corporation, must include all statutory fringe benefits in gross income on hisLher individual return. $) Section )1/ stoc- attribution rules are used to define &B or more shareholders of S corporation4s stoc-. 8) All are false. Answer: 7
#age ef.: $:11%)), $:11%)(

02) An S corporation is not treated as a corporate taxpayer with respect to which one of the following fringe benefits: A) stoc- options 7) @ualified retirement plans $) group term life insurance premiums 8) non@ualified deferred compensation Answer: $
#age ef.: $:11%)(

0/) 6dentify which of the following statements is false. A) The election form can be signed by a person authori<ed to sign the S corporation tax return. 7) An S election is filed by the corporation by using *orm &..) on or before the due date 5without regard to any extensions) for the corporate tax return for the tax year in @uestion. $) An S corporation must file a tax return for any year in which the S corporation is in existence. 8) The 6 S can grant extensions of time of filing shareholder consents to the S election. Answer: 7
#age ef.: $:11%)2

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03) 6dentify which of the following statements is false. A) An S corporation files a *orm 11&'S corporate income tax return on or before the 1.th day of the fourth month following the close of its tax year. 7) An S corporation4s ordinary income or loss is reported by an individual shareholder on Schedule " of *orm 1'('. $) An S corporation that owes the built%in gains tax or the excess net passive income tax must ma-e @uarterly estimated tax payments. 8) An S corporation cannot use the prior year tax liability exception when determining the re@uired payment to be made with respect to the built in gains tax. Answer: A
#age ef.: $:11%)2, $:11%)/

2') 1ashburn $orporation is an S corporation that uses a fiscal year ending Dune )' as its tax year. 9hen is 1ashburn $orporation4s income tax return due: A) Duly 1. 7) September 1. $) Cctober 1. 8) 1arch 1. of the next year Answer: 7
#age ef.: $:11%)2

21) An S corporation is permitted an automatic extension of time for filing its tax return. The automatic extension period is A) one month. 7) two months. $) three months. 8) six months. Answer: 8
#age ef.: $:11%)2

2&) 9hich of the following tax levies imposed on an S corporation are re@uired to be paid by using estimated tax payments: A) built%in gains tax 7) excess net passive income tax $) both A and 7 8) none of the above Answer: $
#age ef.: $:11%)/

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2)) $onnie4s estaurant has been an S corporation since it was formed in 1330. 6ts results for the previous year are as follows: Sales K&'',''' Supplies 3',''' Salaries .',''' 8epreciation .,''' 6nterest on business loan 1,''' $haritable contributions ),''' Advertising (,''' !tilities expense 0,''' #roperty taxes 1,''' >ain on the sale of investment land 5long%term) /,''' 9hat are $onnie4s separately%stated items: 9hat is the S corporation4s ordinary income: Answer: The separately%stated items, other than ordinary income, are the long%term capital gain of K/,''' and the charitable contributions. The S corporation ordinary income is calculated as follows: Sales Supplies Salaries 5employees) 8epreciation 6nterest on business loan Advertising !tilities expense #roperty taxes Crdinary income
#age

3',''' .',''' .,''' 1,''' (,''' 0,''' 1,'''

K&'','''

ef.: $:11%1(, $:11%1.

1.2,''' K(),'''

2() #ower $orporation reports the following results: Service income 5not passive income) 8ividend income 6nterest income #assive income%related expenses Cther expenses K(',''' )',''' 0',''' &',''' .','''

At the end of the year, #ower4s Subchapter $ "H# is K.','''. 9hat is #ower $orporation4s excess net passive income and its excess net passive income tax for the year: Answer: The excess net passive income is: OPK)',''' Q K0',''' % K&','''R M PK3',''' % 5'.&. M K1)',''')RLK3','''RS N K((,2&&. The excess net passive income tax is: K((,2&& M '.). N K1.,0.).
#age ef.: $:11%10

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2.) $huc- $orporation reports the following results for this year: Service 5non%passive) income 8ividend income 6nterest income #assive income%related expenses Cther expenses K12,.'' 1/,.'' 1(,''' .,''' 1&,.''

At the end of this year, $huc-4s "H# for its $ corporation tax years amount to K)','''. $ompute $huc- $orporation4s excess net passive income. Answer: "xcess net N ;et passive M #assive investment income%&.B of gross receipts passive income 6ncome #assive investment income K10,3&) % 5K)&,.'' % K.,''') M
#age ef.: $:11%10
K)&,.'' % &.B5K.','' ') K)& ,.'''

20) #otter $orporation reports the following results for the current year: Cperating income 8ividend income 6nterest income Cther expenses #assive income%related expenses K(',''' ).,''' &.,''' &.,''' &','''

At the end of the year, #otter4s Subchapter $ "H# is K.','''. 9hat is the amount of #otter4s excess net passive income: Answer: K).,''' 8ividends &.,''' 6nterest K0',''' >ross passive income 5 &',''') 1inus: elated expenses K(',''' ;et passive income "xcess net passive income N K0',''' % 5'.&. M K1'',''') M K(',''' N K&),))).)) K0','''
#age ef.: $:11%10

22) 7oxer $orporation, a $ corporation, elects on Dune )' of last year to ma-e an S election for the current year. The net unreali<ed built%in gains at the beginning of the current year are K)'','''. The net recogni<ed built%in gains in the current year are K11','''. 9hat is 7oxer4s built%in gains tax for the current year: Answer: K11',''' M '.). N K)/,.''
#age ef.: $:11%12

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2/) >ofer $orporation, an S corporation, is owned e@ually by 1ahmoud and Iwame. The corporation had long%term capital gains of K1'',''' and ordinary income of K3',''' for the current year and made no distributions. 9hat is the amount of ordinary income from S corporation activities that 1ahmoud must report: Answer: K3',''' M '..' N K(.,'''
#age ef.: $:11%13

23) *or the calendar year, "l- $orporation, an S corporation, has boo- income of K..,''', which includes K(.,''' from operations and a K1',''' net long%term capital gain. 8uring the year, K&&,.'' is distributed to "l-4s three e@ual shareholders, all of who are calendar year taxpayers. 9hat are "l-4s total ordinary income and capital gain pass%throughs for the year: Answer: Crdinary income is K(.,''' and long%term capital gain income is K1','''.
#age ef.: $:11%13

/') The ?anity $orporation organi<ed and began operations in Danuary. The corporation4s ten e@ual shareholders elect to have ?anity taxed as an S corporation, and the election and necessary consents are filed in a timely manner. *or its first tax year ended 8ecember )1, ?anity has ordinary income of K0(,''' and short%term capital gains of K10,'''. 8uring the year, it distributes K)',''' in cash e@ually to its ten shareholders. *or the year, how much income should each shareholder report and how should it be characteri<ed: Answer: Crdinary income, K0,('' 5'.1' M K0(,'''). Short%term capital gain, K1,0'' 5'.1' M K10,'''). The distribution does not result in any income or gain being recogni<ed since it does not exceed any shareholder4s basis for their stoc-.
#age ef.: $:11%13%$:11%&(

/1) Arnie is a .'B shareholder in "nergy $orporation which is an S corporation. The S corporation had an K/',''' ordinary loss last year and K1',''' of ordinary income this year. 7efore accounting for last year4s losses, Arnie4s basis in his "nergy stoc- is K)&,''' and "nergy owed Arnie K(,''' 5an unsecured note having a basis of K(,''') at the end of last year. 6n addition, "nergy had K1'',''' of other liabilities owed to creditors other than Arnie at the end of last year. 9hat income and loss must Arnie report on his current return as a result of owning the "nergy stoc- 5ignoring the at%ris- and passive activity limitations): Answer: Fe must report K.,''' ordinary income and K(,''' ordinary loss.

Last year: 7asis of stoc7asis of debt Total basis 1inus: +oss utili<ed 7asis of stoc- and debt +oss carryover to current year
#age ef.: $:11%&1

Current year: K)&,''' (,''' K)0,''' 5 )0,''') %'% K (,'''

Crdinary income earned +oss carryover from last year

K.,''' 5(,''')

/&) "agle $orporation has always been an S corporation. "agle is 1''B%owned by Iaty. Iaty4s adjusted basis in the "agle stoc- is K1'',''' on Danuary 1 of the current year. 8uring the current year, "agle distributes TUG stoc- 5a capital asset) to Iaty. The TUG stoc- has a K.',''' *1? and a K(',''' adjusted basis on "agle4s boo-s. The TUG stoc- has been held as an investment for four years by "agle. "agle $orporation reports K(',''' of ordinary income in the current year. 9hat is Iaty4s basis in the "agle stoc- at the beginning of the next year: 1 Copyright 2011 Pearson Education, Inc.

Answer: 1L1 7asis #lus: >ain on distribution Crdinary income #re%distribution basis 1inus: 8istribution 1&L)1 7asis
#age ef.: $:11%&(

K1'',''' 1',''' (',''' K1.',''' 5 .',''') K1'','''

/)) obert "l- paid K1'',''' for all of the single class of stoc- of "l-om $orporation, an electing S corporation, when incorporated in Danuary, &''2. "l-om4s operating results and dividend distribution are as follows: Tax Year Ending &''2 &''/ &''3 Ordinary Income 5K(',''') 0',''' )','''

istri!ution

K&',''' 53L)')

9hat is "l-4s basis for his "l-om stoc- on 8ecember )1 of &''2: Answer: K1'',''' % K(',''' Q 5K0',''' % K&',''') Q K)',''' N K1)','''. +ast year4s distribution is tax%free since "l-4s basis for his stoc- is K1&',''' 5K1'',''' % K(',''' Q K0',''') at the end of last year before any reduction for the distribution.
#age ef.: $:11%&(, $:11%&.

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/() Iing $orporation, an electing S corporation, is 1''B owned by $rystal. Cn Danuary 1 of the current year her adjusted basis in the Iing stoc- is K)','''. 8uring the year, Iing reports an ordinary loss of K)',''', tax%exempt municipal bond income of K1.,''', dividend income from domestic corporations of K.,''', a long%term capital loss of K&',''' and a short%term capital loss of K)','''. 9hat is $rystal4s basis for the Iing stoc- at the end of the year: Answer: 1L1 Adjusted basis K )',''' #lus: 8ividend income .,''' Tax%exempt income 1.,''' K .',''' 1inus: Crdinary loss 5 )',''') +T$+ 5 &',''') ST$+ 5 )',''') 1&L)1 Tentative basis 5K)',''') Cnly K.',''' of the K/',''' total loss can be used, and stoc- basis goes to K'. A K)',''' carryover is composed of ratable portions of each of the three types of losses.
#age ef.: $:11%&.

/.) 8avid owns &.B of an S corporation4s stoc- 5a capital asset) for the first three months of the S corporation4s tax year. 8uring the year the S corporation has K10,''' of ordinary income and K)&,''' of long%term capital gain. 8avid starts the year with a basis of K.',''' in his S corporation stoc- and sells the stoc- for K.0,''' on April 1 of the year. Assuming all months have )' days, how much gainLloss does 8avid report on the sale of the stoc- and what is its character: Answer: PK.',''' Q 5K10,''' M '.&. M 3'L)0') Q 5K)&,''' M '.&. M 3'L)0')R N K.),'''. Amount reali<ed K.0,''' 1inus: Adjusted basis 5 .),''') ecogni<ed gain 5long%term capital gain) K ),'''
#age ef.: $:11%&., "xample $:11%&)

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/0) Deff owns .'B of an S corporation4s stoc- with a basis in his stoc- of K.',''' on Danuary 1. 6n addition, the S corporation owes Deff K)',''' on Danuary 1. The debt has a basis of K)',''' and is evidenced by a note. The S corporation reports an ordinary loss of K1.',''' for the current year. The next year it reports ordinary income of K&','''. Cn Danuary 1 of the third year, the note is repaid. 8ue to the repayment of the note, Deff must report: Answer: Stoc" 1L1 7asis 1inus: Uear 1 loss 1&L)1 7asis #lus: Uear & income 1&L)1 7asis Amount reali<ed 1inus: Adjusted basis $apital gain
#age ef.: $:11%&., $:11%&0

e!t K)',''' 5 &.,''') K .,''' 1',''' K1.,''' K)',''' 5 1.,''') K1.,'''

K.',''' 5 .',''') %'% %'% %'%

21 Copyright 2011 Pearson Education, Inc.

/2)

oc-y $orporation, an S corporation, reports the following results for the current year K2',''' &',''' 1',''' 0,''' 10,'''

Crdinary income +ong%term capital gain 1unicipal bond interest income 8omestic corporate dividends $haritable contributions

oc-y4s AAA and accumulated "H# balances at the beginning of the year are K/',''' and K.',''', respectively. oc-y ma-es a K1'',''' cash distribution to its sole shareholder on Dune 1 and a second K1'',''' cash distribution on 8ecember 1. The shareholder4s basis for oc-y stoc- on Danuary 1 was K1&','''. 8iscuss the tax conse@uences of these transactions. Answer: The basis of the shareholder4s stoc- is increased to K&1',''' 5K1&',''' Q K2',''' Q K&',''' Q K1',''' Q K0,''' % K10,''') by oc-y4s current year operations. oc-y4s AAA balance before any current year distributions is K10',''' 5K/',''' Q K2',''' Q K&',''' Q K0,''' % K10,'''). K/',''' OPK1'','''L5K1'',''' Q K1'',''')R M K10',''' N K/','''S of each distribution comes from oc-y4s AAA and is tax%free because the K10',''' amount coming from AAA is less than the K&1',''' basis of the oc-y stoc-. The remaining K&',''' of each distribution comes from oc-y4s accumulated "H# and is a taxable dividend. This portion of the distribution does not reduce the basis of the stoc-. The year%end accumulated "H# is K1','''. 6n addition, oc-y has a K1',''' balance in its Cther Adjustments Account from the current year tax%exempt income. This amount is not a separate earnings pool for distribution purposes, but is reflected in the shareholder4s stoc- basis. The basis of the
#age ef.: $:11%&., $:11%&/

oc-y stoc- is K.',''' at year%end 5K&1',''' % K10',''').

//) Gebra $orporation has always been an S corporation and is 1''B owned by #aul. #aul has a basis of K(',''' in his Gebra stoc- at the beginning of the year. 8uring the year, Gebra has an ordinary loss of K&',''' and a long%term capital gain of K1','''. 6n addition, Gebra $orporation distributed K..,''' in cash to #aul on 8ecember 1. 9ill the distribution cause #aul to recogni<e a gain: 6f so, what is its amount and character: Answer: 7asis adjustments for distributions made by an S corporation during the tax year are ta-en into account before applying the loss limitation. 8istributions reduce the adjusted basis for determining the allowable loss, but the loss does not reduce the adjusted basis for determining the tax status of distributions. 7asis +ong%term capital gain 1inus: 8istribution #ost%distribution basis V8istributions cannot reduce basis below <ero. The K.,''' capital gain.
#age ef.: $:11%&2

K(',''' 1',''' 5.',''')V K %'% excess distribution is a long%term

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/3) $aravan $orporation has always been an S corporation. $aravan $orporation is 1''B% owned by Alan 1erten. Cn Danuary 1, Alan has an adjusted basis of K.',''' in his $aravan stoc-. 8uring the year $aravan reports ordinary income of K0',''', a long%term capital gain of K1',''', and a charitable contribution of K.,'''. Alan receives a K&',''' cash distribution from $aravan on 8ecember 1. 9hat income does Alan recogni<e from the distribution, and what is his basis in the $aravan stoc- at year%end: Answer: 7asis N K.',''' Q K0',''' Q K1',''' % K.,''' % K&',''' N K3.,'''. The distribution is tax%free since the K11.,''' predistribution basis exceeds the amount distributed.
#age ef.: $:11%&2

3') +ist and discuss five advantages and five disadvantages of electing to be taxed as an S corporation over a $ corporation or a partnership. Answer: Some of the advantages and disadvantages which might be included in the answer are: Advantages: W The corporation4s income is exempt from the corporate income tax. W The corporation4s losses are passed through to the shareholders. W !ndistributed income that has been taxed to the shareholder is not taxed again when subse@uently distributed. W $apital gains dividends and tax%exempt income are separately stated and pass through to the shareholders. W 8eductions, losses and tax credits are separately stated and passed through to the shareholders. W S corporations are not subject to the alternative minimum tax. W S corporations are not subject to the personal holding company tax. W S corporations are not subject to the accumulated earnings tax. W S corporations may split income between family members. 8isadvantages: W A $ corporation is treated as a separate tax entity and can use the 1.B tax brac-et. W S corporation earnings are taxed to the shareholder even if not distributed. W S corporations are subject to an excess net passive income tax, +6*C recapture tax, and built%in gains tax. W 8ividends received by the S corporation are not eligible for the dividends%received deduction. W Allocation of income and loss is based on stoc- owned on each day of the tax year. Special allocations are not permitted. W The loss limitation is smaller for an S corporation than a partnership because of the treatment of general debts incurred by the S corporation. W An S corporation and its shareholders are subject to the at ris-, passive activity, and hobby loss limitations with respect to their loss and deduction passthroughs. W An S corporation is restricted in the type and number of shareholders allowed and types of investments that can be made. W S corporations are generally restricted to using a calendar year as their tax year.
#age ef.: $:11%), $:11%(

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31) 1artha, a !.S. citi<en, owns ('B of the stoc- of >eorge $orporation, an electing S corporation. At the time of her death this year, the >eorge stoc- passes to her estate. The stoc- is subse@uently transferred to a trust provided for in 1artha4s will. $an the testamentary trust hold the >eorge stoc- for a two%year period before the S election is terminated: Answer: The trust can hold the S corporation stoc- for an indefinite period of time only if the trust4s income beneficiary ma-es an election to have it treated as a =SST or small business trust. Ctherwise, the S election will be terminated at the end of the two%year period.
#age ef.: $:11%., "xample $:11%1

3&) Shamroc- $orporation has two classes of common stoc- outstanding. The $lass A and $lass 7 common stoc- give the shareholders identical rights and interests in the profits and assets of the corporation. $lass A has one vote per share. $lass 7 is nonvoting. $an Shamroc- $orporation ma-e an S corporation election: Answer: Ues, since Shamroc- $orporation is treated as having only one class of stocoutstanding.
#age ef.: $:11%0, "xample $:11%&

3)) >arret and Fans own all the stoc- of >F $orporation. >arret sells all his >F stoc- to Clga on *ebruary 1&. The next day >F ma-es an S election. *or the election to apply to the current year, who must consent to the election: Answer: Clga, >arret, and Fans must consent to the election. 6f Clga refuses to consent to the election, the election will not begin until next year.
#age ef.: $:11%/, "xample $:11%(

3() Swamp $orporation, a calendar year taxpayer, has been an S corporation for several years. Fowever, the corporation has become @uite profitable, and management feels that it would be advantageous to ma-e a public stoc- offering. 9hat are Swamp $orporation4s options concerning the date of revocation of the S election: Answer: 6f Swamp revo-es its S election before 1arch 10 of the current year and has the election terminated at the close of business on 8ecember )1 of the previous year. 6f the revocation election is made after 1arch 1. of the current year, it does not ta-e effect until Danuary 1 of next year. Swamp may also specify a prospective current year revocation date as long as the date specified is on or after the date the revocation is made.
#age ef.: $:11%1', "xample $:11%.

3.) Ginc $orporation is created in the current year and promptly ma-es an S election. Fow much passive income can it earn this year without fear of losing its S corporation status or being subject to the Sec. 1)2. tax on excess net passive income: Answer: Ginc can earn an unlimited amount of passive income during a tax year because it has never been taxed as a $ corporation and has no Subchapter $ "H#.
#age ef.: $:11%1', "xample $:11%0

30) 7ellows $orporation, a calendar year taxpayer has been an S corporation for ten years. +ast year, Dohn sold all the 7ellows stoc- to 1ic-y. #ayments for the stoc- are to be made over a five%year period. 6n 1arch of next year, 1ic-y fails to ma-e the necessary payments and Dohn repossesses the stoc-. 8uring the time 1ic-y holds the stoc-, 7ellows $orporation revo-es its S election. $an 7ellows $orporation reelect S status: Answer: Ues, 7ellows $orporation can immediately apply for reelection of S corporation status because more than .'B ownership change has occurred since the date of termination.
#age ef.: $:11%1&, "xample $:11%3

32) 9hat is a permitted year: Answer: A permitted year is defined as a taxable year ending on 8ecember )1 5including a .&%.) wee- year) or any fiscal year for which the corporation established a business purpose. 24 Copyright 2011 Pearson Education, Inc.

#age

ef.: $:11%1)

3/) $an loss or credit carry forwards from a previous $ corporation tax year help reduce the built%in gains tax: Answer: Ues. 7oth ;C+ and capital loss carryforwards reduce the amount of recogni<ed built%in gains taxed under Sec. 1)2(. The general business and minimum tax credit carryforwards reduce the actual built%in gains.
#age ef.: $:11%12

33) 6f losses are suspended due to the lac- of basis in S corporation stoc-, do the losses expire when the S election terminates: Answer: ;o. These loss carryovers may be deducted in the post%termination transition period if the shareholder creates additional stoc- basis in that period of time.
#age ef.: $:11%&&

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1'') ?D $orporation is to be owned e@ually by ?ic and Doe. The corporation will be formed by exchanging the assets and liabilities of the ? H D 1anufacturing #artnership for all the corporation4s stoc- on September 1 of the current year. 7oth shareholders use the calendar year as their tax year and desire to ma-e an S election. 9hat tax issues should ?ic and Doe consider with respect to the incorporation: Answer: W 8oes the incorporation transaction @ualify as tax%free under Sec. ).1: W Are advantages to be gained by transferring the partnership4s assets to the corporation in exchange for its stoc- and then li@uidating the partnership: W Are advantages to be gained by first li@uidating the partnership and then transferring the assets to the corporation in exchange for its stoc-: W 9hat is the amount and character of the gain or loss recogni<ed on the incorporation by the partnership: The S corporation: The partners: W 9hat is the basis of the assets to the S corporation: W 9hat is the basis of the S corporation stoc- to each shareholder: W 9hen does the holding period start for the assets: The S corporation4s stoc-: W 9hat tax year should the corporation elect: 8oes this tax year have to be the same tax year used by the partnership: W 9hat accounting methods should the corporation elect: 8o these accounting methods have to be the same accounting methods used by the partnership: W 9hat procedures must be followed to ma-e an S election: W 7y what date must the corporation ma-e the election: W 9hat format does the election ta-e: W 9hat consents are re@uired of the shareholders: Cne underlying @uestion that might be brought up is: Should the tax practitioner and the transferor consider using an ++$ instead of an S corporation: The method of incorporation does matter. 6n fact, the entity ma-ing the selection does not have to be a corporation. !nder the chec-%the%box regulations, a noncorporate entity can elect to be taxed as a corporation and then ma-e a selection. The tax conse@uences 5gain recogni<ed, basis amounts, etc.) can be different depending on which of the three basic methods are used to terminate the partnership and transfer the assets to the corporation. The three methods are: 51) the partnership transfers assets to the corporation in exchange for stoc-, and the partnership transfers the stoc- to its partners in li@uidationJ 5&) the partnership transfers assets to its partners in li@uidation, and the former partners transfer the assets to the corporation in exchange for stoc-J and 5)) the partners transfer their partnership interests to the corporation in exchange for stoc-, and the partnership transfers the assets to the corporation in li@uidation. 9ithout further information, the gain and basis amounts cannot be determined, nor can we say which of the three ways are better. The S corporation can use a tax year different from the partnership, but it does have to be a re@uired year. +i-ewise, the S corporation can elect any accounting method that it chooses, without regard to the method employed by the partnership. The corporation must file an S election 5*orm &..)) in a timely manner and the appropriate consents must be obtained from the shareholders. A transfer of assets from a partnership to an ++$ is covered by rules different from a corporate formation 5see $hapter $1').
#age ef.: $:11%&%$:11%/, $:11%1&, $:11%1), $:11%&), $:11%&(, $:11%)., $:11%)0

26 Copyright 2011 Pearson Education, Inc.

1'1) 9oods $orporation has operated as a $ corporation for the last seven years. The corporation has assets with a K.'',''' adjusted basis and a K2'',''' *1?. +iabilities are K&'','''. 9olf 9oods, a calendar year taxpayer, owns all of the 9oods $orporation stoc-. The corporation has a Dune )' year%end and uses the accrual method of accounting. 6n order to reduce his total combined corporate and personal federal income tax liability, 9olf4s $#A has told him to convert the corporation to S corporation status. 9olf would li-e to complete the conversion on the last day of the corporation4s tax year. 9hat tax issues should 9olf and his $#A consider with respect to the S election: Answer: The @uestions listed below are based on the presumption that an S election is going to be advantageous and that the S corporation is in fact the best entity choice for the corporation. W 9hat procedures must be followed to ma-e an S election: W 7y what date must the corporation ma-e the election: W 9hat format does the election ta-e: W 9hat consents are re@uired of the shareholders: W 9hat tax year should the S corporation elect: 8oes this tax year have to be the same tax year used by the $ corporation: W 9hat accounting methods should the S corporation elect: 8o these accounting methods have to be the same accounting methods used by the $ corporation: W 9hat possible built%in gains tax liability will be incurred while an S corporation: W Should the corporation obtain an appraisal of the assets as of the first day of the S election: W 9hat tax attributes 5e.g., ;C+s and capital losses) will be suspended as a result of ma-ing the S election: W 9hat possible excess net passive income tax liability will the S corporation incur: W Should the corporation consider distributing its Subchapter $ "H# to eliminate this tax liability: W 9hat possible +6*C recapture tax liability will the corporation incur in its final $ corporation tax year: The corporation must file an S election 5*orm &..)) in a timely manner, and the appropriate consents must be obtained from the shareholders. The S corporation cannot automatically use a tax year different from the $ corporation, but it may have to change to a re@uired tax year. The S corporation must continue to use the accounting methods the $ corporation has used. A built%in gains tax liability will be imposed on asset dispositions occurring within ten years of the first day of the S election period. An appraisal is suggested to establish the amount of the built%in gains and losses to minimi<e the built%in gains tax liability. $ $orporation ;C+s and net capital losses can reduce the built%in gains tax liability but cannot pass through to the shareholders. 6n addition, if the S corporation has Subchapter $ "H#, it may incur the excess net passive income tax liability if it earns a substantial amount of passive income. Also, the S corporation may incur the +6*C recapture tax if it used the +6*C inventory method in its final $ corporation tax year.
#age ef.: $:11%2, $:11%/, $:11%1&%$:11%1/, $:11%)., $:11%)0

27 Copyright 2011 Pearson Education, Inc.

1'&) Troy owns .'B of 8ot.$om, an e%commerce company. Fis S corporation stoc- basis at the beginning of the year is K)'','''. 8ot.$om has not done well this year and will report an ordinary loss of K/2.,'''. Troy4s marginal tax rate for the current year is ).B. 9hat tax issues should Troy consider with respect to the loss: Answer: W 9hat is Troy4s allocable share of the 8ot.$om ordinary loss: W 9hat portion of the loss is limited by the basis of the S corporation stoc- and debt: The at risrules: The passive activity loss rules: The hobby loss rules: W 6f his use of the loss is limited only by the basis of the S corporation stoc- and debt, should Troy invest additional amounts before year%end to increase the basis of the stoc- andLor debt: 9hen should such an investment be made: 7efore year%end: After year%end: Should he not ma-e an additional investment and use the loss against future profits: Troy should anticipate a K()2,.'' ordinary loss pass%through, which exceeds his K)'',''' basis for the 8ot.$om stoc-. The additional investment should be made only if it is economically wise. "ven if Troy ma-es the additional investment, he still might not be able to deduct the loss. The passive activity loss rules may deny the loss until Troy has passive income from this or another activity or until he completely disposes of his investment. The tax year to ma-e the additional investment, and deduct the loss, will be the year in which Troy anticipates the highest marginal tax rate 5discounted for the time value of money.)
#age ef.: $:11%1/%$:11%&), $:11%)), $:11%)(

1')) $oo-4s Cutlet has been an S corporation since its inception six years ago. Cn Danuary 1 of the current year, the corporation4s two e@ual shareholders, 8avis and 8ane, had adjusted bases of K1.',''' and K12.,''' respectively, for their S corporation4s stoc-. The shareholders plan to have the corporation distribute land with a K.',''' adjusted basis and a K&'',''' *1? in the current year. Crdinary income is expected to be K1/',''' in the current year. 9hat tax issues should 8avis and 8ane consider with respect to the distribution: Answer: W 9hat gain or loss does $oo-4s Cutlet recogni<e on ma-ing the distribution: 8oes the gain or loss trigger any built%in gains tax liability: "xcess net passive income tax liability: W 9hat is each shareholder4s basis for the $oo-4s Cutlet4 stoc- immediately preceding the distribution: W 9hat basis reduction does the distribution cause for each shareholder: 8oes the basis reduction trigger the recognition of any income by the shareholder 5e.g., if the distribution reduces the shareholder4s basis to <ero). W 9hat is each shareholder4s basis for the $oo-4s Cutlet stoc- immediately following the distribution: W 9hat is each shareholder4s basis and holding period for the land received: $oo-4s Cutlet will recogni<e a K1.',''' 5K&'',''' % K.',''') gain on the distribution. This gain may be subject to the Sec. 1)2( or Sec. 1)2. tax, but insufficient facts are provided to ma-e such a determination. This gain and $oo-4s Cutlet4 ordinary income from operations will flow through to the shareholders and increase their stoc- bases. 8avis and 8ane ta-e K)1.,''' 5K1.',''' Q K2.,''' Q K3',''') and K)(',''' 5K12.,''' Q K2.,''' Q K3',''') bases, respectively, assuming no corporate level taxes are imposed. "ach shareholder will reduce his basis by K1'',''' 5'..' M K&'',''') for the distribution.
#age ef.: $:11%1.%$:11%12, $:11%&0%$:11%)'

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