580 MODULE 36 TAXES: CORPORATE

for the period January 1 through March 31, and a C corporation tax return (Form 1120)for the period April 1
through December 31,2009. Both tax returns would be due by March 15,2010.
3. Passive investment income exceeding 25% of gross receipts for three consecutive taxable
years if
the corporation has subchapter C earnings and profits at the end of each of those years.
(1) Subchapter C earnings and profits are earnings and profits accumulated during a taxable year
for which the corporation was a C corporation.
(2) Termination is effective as of the first day of the taxable year beginning after the third con-
secutive year of passive investment income in excess of 25% of gross receipts.
EXAMPLE: An S corporation with subchapter C earnings and profits had passive investment income in ex-
, cess of25% of its gross receipts for its calendar years 2007,2008 and 2009. Its S corporation status would
terminate 111110. .
4. Generally once terminated, S corporation status can be reelected only after five non-S
corporation
years.
(1) The corporation can requestIRS for an earlier reelection.
(2) IRS may treat an inadvertent termination as if it never occurred.
5. An S corporation generally pays no federal income taxes, but may have to pay a tax on its built-in
gain, or on its excess passive investment income if certain conditions are met (see page 584).
6. The S corporation is treated as a pass-through entity; the character of any item of income, ex-
pense, gain, loss, or credit is determined at the corporate level, and passes through to shareholders,
retaining its identity.
7. An S corporation must recognize gain on the distribution of appreciated property (other than
its
own obligations) to its shareholders. Gain is recognized in the same manner as if the property had
been sold to the distributee at its FMV.
EXAMPLE: An S corporation distributes property with a FMV of $900 and an adjusted basis of $100 to its sole
shareholder, Gain of $800 will be recognized by the corporation. The character of the gain will be determined at
the corporate level, and passed through and reported by its shareholder. The shareholder is treated as receiving a
$900 distribution, subject to the distribution rules discussed on page 582 ..
8. Expenses and interest owed to any cash-method shareholder are deductible by an accrual-
method
S corporation only when paid.
, ,
EXAMPLE: An accrual-method calendar-year S corporation accrues $2,000 of salary to a cash-method employee
(a 1% shareholder) during 2008, but does not make payment until February 2009, The $2,000 will be deductible
by the corporation in 2009, and reported by the shareholder-employee as income in 2009.
9. An S corporation will not generate any earnings and profits. All items are reflected in
adjustments
to the basis of shareholders' stock and/or debt.
10. S corporations must make estimated tax payments for the tax liability attributable to the
built-in
gains tax, excess passive investment income 'tax, and the tax due to investment credit recapture ..
11. The provisions of subchapter C apply to an S corporation, except where inconsistent with
sub-
chapter S. For example, an S corporation can use Secs. 332 and 337 to liquidate an acquired sub-
sidiary, and can make a Sec. 338 election if otherwise qualified.
12. A shareholder of an S corporation must separately take into account (for the shareholder's taxable
year in which the taxable year of the S corporation ends) (1) the shareholder's pro rata share of the
corporation's items of income (including tax-exempt income), loss, deduction, or credit the separate
treatment Of which could affect the tax liability of any shareholder, plus (2) the shareholder's pro rata
share of all remaining items which are netted together into "ordinary income (loss) from trade or busi-
ness activity."
13. Some of the items which must be separately passed through to retain their identity
include
(1) Net long-term capital gain (loss)
(2) al gain (loss)
N (3) Net.gain (loss) from Sec. 1231 casualty or theft
s (4) Net gain (loss) from other Sec. 1231 transactions
-te (5) Tax-exempt interest
c (6) Charitable contributions
(7) ~oreign income taxes