4.9 S Corporation and LLC

1. Eligibility Requirements

1) Domestic corporation
2) Only one class of stock
3) Shareholders must individual, estate and qualified trust can be shareholders
4) No nonresident alien individual shareholders
5) 100 shareholders or less (family members are counted as one)

2. Election of S Corporation Status

All shareholders (voting and nonvoting) must consent to a valid election.
If the election is made at any time on or before the 15th day of the third month (March 15) of the election year, the election is effective on the first day of the tax year.

3. Effect of S Corporation Election on Corporation

1) No tax on S corporation
However, S corporation is subject to special taxes: the built-in gain tax, excessive passive investment income tax, and LIFO recapture tax.

2) A taxable year and the due date
S corporations file Form 1120S and must adopt the calendar year unless a valid business purpose for a different taxable year(fiscal year) is established.
The return is due by the 15th day of the third month (March 15) after the close of the tax year.

3) Pass-thru & Form 1120S
S corporations report both separately and non-separately stated items of income and/or loss. (see 3.3 Partnership Information Return)

(1) Fringe benefits
a) Deductible fringe benefits: employee owning 2% or less of the share
b) Non-deductible fringe benefits: for a more than 2% employee shareholder

(2) Mid-year change of ownership
Allocations to shareholders are per day, per-share basis

4. Effect of S Corporation Election on Shareholders

1) Loss limitation
At-risk: adjusted basis in stock + direct loans to the corporation

2) Shareholder's basis of stock
Original basis
+ Additional investment
+ All income
- All loss
- Distributions received
= Shareholder's adjusted basis

5. Taxability of Distributions to Shareholders

1) With NO C corporation earnings and profits
(a) Return of capital - nontaxable and reduces shareholder's stock basis
(b) Capital gain - taxable to extent distribution exceeds stock basis

2) With C corporation earnings and profits
(a) AAA (accumulated adjustment account) - nontaxable and reduces shareholder's stock basis
(b) AEP - taxable as a dividend and does NOT reduce shareholder's stock basis
(c) Return of capital - nontaxable and reduces shareholder's stock basis
(d) Capital gain - taxable to extent distribution exceeds stock basis

6. Termination of S Corporation

1) When S corporation status terminates
(1) The corporation fails to meet any eligibility requirements for S corporation status
(2) Greater than 50% of the shareholder consent to a revocation
(3) More than 25% of the corporation's gross receipts come from passive investment income for 3 consecutive years and the corporation had C corporation earnings and profits at the end of each year.

2) Re-electing: 5 years

7. Limited Liability Company

A single-member LLC: sole proprietorship
At least two owners: partnership or C corporation (Form 8832 Entity Classification Election)