S Corporation Taxation

Eligibility

Domestic · ≤ 100 shareholders (family = 1) · individuals (US), estates, certain trusts, exempt organizations · no partnerships, C corporations, or nonresident aliens · one class of stock (voting differences OK).

Election

• Form 2553, all shareholders consent; by March 15 for the current year.
• Revoke: > 50% of shares. Ineligible shareholder → terminates that day.
• Passive income > 25% for 3 years with earnings and profits → terminates. Wait 5 years to re-elect.

Pass-through

Per share, per day. Separately stated items. Reasonable salary for shareholder-employees.

Basis and losses

• Order: + income → − distributions → − nondeductible expenses → − losses.
• Losses: stock basis, then shareholder's own loans. No basis for third-party corporate debt.

Distributions

• No earnings and profits: tax-free to basis, then capital gain.
• With earnings and profits: accumulated adjustments account (AAA) → dividend → basis → gain.

Entity taxes

Built-in gains: 21% within 5 years of conversion. Excess passive income tax. Last-in, first-out (LIFO) recapture.

Exam traps

• Distributions above basis are capital gain; losses above basis are suspended and carried forward, not lost.
• Later income restores reduced loan basis before stock basis.
• Health insurance for a more-than-2% shareholder-employee is wages on the W-2, but the shareholder deducts it as self-employed health insurance.
• Termination mid-year creates two short tax years: one as an S corporation, one as a C corporation.