1. Subchapter S Corporations
Robert R. Oliva, Ph.D., LL.M.(Tax), J.D., CPA
University of Arkansas at Little Rock

2. Introduction (Class 1) Cooordination between Subchapter C and S
Definition of an S Corporation
One class of stock
Definition: all “outstanding shares” must confer identical rights
“outstanding shares”
“identical rights” / ”binding agreements”
straight debt safe harbor

3. Introduction (p. 2) Eligible shareholders
Permissible entities
Not permissible
Election of Subchapter S treatment
Effective date
Consents necessary

4. Introduction (p. 3) Termination of Subchapter S treatment Voluntary
Involuntary
Failure to meet requirements
EPII
Inadvertent terminations
Re-elections

5. IRC Structure USC Title 26 Subtittles A: Income Taxes
Chapter 1: Normal taxes and surtaxes
Subchapter A: Tax Liability: IRC 1-60
Subchapter B: Taxable Income: IRC
Subchapter C: Corporations and Shareholders: IRC
Subchapter S: IRC

6. Coordination between Subchapters C and S
“. . . except when inconsistent with S, C applies ”
Previously: S to be treated as an individual when it is a C shahareholder.
Current version:
80% owned C may be liquidated into S shareholder
IRC 338 election permissible when acquiring C
However, IRC 243 still not available.

7. Definition of an S Corporation: IRC 1361(a)
small business domestic corporation
effective election for the year

8. Small Business Domestic Corporation:
IRC 1361(b)(2): It must NOT
be an ineligible corporation
have more than 100 shareholders
have more than one class of stock
be an ineligible entity
be owned by a NRA

9. AN S cannot be an ineligible corporation
No insurance company
Exception: Some casualty insurance companies
No 936 corporation
No DISC or former DISC
No financial institution that uses a reserve method of accounting for bad debts

10. An S cannot have more than 100 shareholders
Attribution:
H & W = 1, whether owned separately or as H and W.
Ancestors and descendants – see textbook
A & B as joint tenants = 2, even if H and W.
C, D, and E as beneficiaries of a voting trust = 3

11. AN S cannot have more than one class of stock
Shareholders of “outstanding stock” must have “identical rights” to distribution and liquidation
“Identical rights”: as provided by charter, bylaws, state law, or “binding agreements”.
1361(c)(4): OK to have different voting rights

12. Some stock is not considered “Outstanding stock”
substantially nonvested options
restricted stock

13. “Binding Agreements”
May be an attempt to circumvent 1 class of stock requirements.
If so, then it creates a different class of stock.

14. Most “binding agreements” are OK
commercial contracts
agreements to redeem stock if death, disability, termination
unwritten shareholders’ advances < $10,000
reclassifiable debt, held proportionally to equity

15. All others arrangements may be reclassified as equity if
not in debt “safe harbor”
equity” under general principles of tax law
principal purpose was to circumvent requirements on
“identical rights” and
#/type of shareholders

16. Debt “safe harbor” unconditional promise to pay
interest. not contingent on profits
Except active/regular creditors
not convertible into equity

17. Permissible Shareholders
Individuals (No NRA)
Some non-individuals
Qualified Subchapter S Trust: QSST
Electing Small Business Trust: ESMBT
Estates of individuals
Death estates
If transferred to a trust (pour overs) for < 2 years
Bankruptcy estates
Domestic grantor trusts: For < 2 years
Voting trusts
Not-for-profit: IRC 501(c)(3)
Retirement plans under IRC 401(b) but not IRA’s’s

18. No NRA’s Exception: Beware of community property states
election
married to US citizen or reside
Beware of community property states
Beware of common law marriages

19. Prohibited non-individuals shareholders
partnerships
corporations
Exception: Qualified Subchapter S Subsidiary
Note: An S may own a C
> 80% of a C: dividends from EP from active trade not considered PII:IRC 1362(d)(3)(E)

20. Qualified Subchapter S Trust: QSST
1 income beneficiary
US citizen or resident
May have >1 potential successive beneficiaries
100% of income must be distributed
At death of current beneficiary
Successor beneficiary must refuse to consent to S election.
If > 1 beneficiary at death,
QSST continues to qualify for < 2 years
QSST may continue if only 1 beneficiary

21. Electing Small Business Trust: ESBT
Any eligible S shareholder
Unlike the QSST, income may be accumulated.
May have many beneficiaries
May have different present and future beneficiaries, including charities.

22. S elections: IRC 1362 Form 2553 Effective date? Who consents?
If reasonable cause, IRS may treat an election to be timely
even if no election ever filed
retroactive to 1/1/83

23. When effective: If done > 15th of 3rd month, effective next year
If done < 15th of 3d month:
retroactive to beginning of year.
postponed to next year.

24. Who consents? all must consent
beware of pre-election date shareholders
cotenants must consent

25. Tax Year
Y/E December 31
Other Y/E of establishes a business purpose

26. Termination
Voluntary: If shareholders holding > 50% of outstanding (voting and nonvoting) shares desire termination
Involuntary
Failed to meet requirements
Excess Passive Investment Income

27. Excess Passive Investment Income
C’s EP at EOY
EPII = PII > 25% of gross receipts, for 3 consecutive years
S terminates on the first day of the year after the 3rd consecutive year with EPII

28. Gross Receipts dividends, interest, royalties
But not div. from 80% owned C corp where EP from active trade
s/e of stocks/secs: only gains
But not receipts in liquidation of >50% subsidiary
s/e of capital assets: only capital gains net income

29. Inadvertent Terminations
Failure was “inadvertent”
to qualify
missing consents
EPII
Steps taken to correct problems
S and shareholders agree to adjustments.

30. Year of termination S short/C short
Last day of S short year = day before termination event
First day of C short year = day of termination event

31. Measuring income in termination year
If all shareholders do not elect: Books are not closed until EOY; items computed as if no termination; then daily prorata.
If all shareholders elect: Books closed at end of short S year and C short year, report actual results of operation for short S and short C
“all shareholders”
All who were S shareholders in short year
All shareholders on 1s day as C

32. Re-election after Termination
Wait 5 years unless IRS permits it sooner