1. Corporate & Partner Tax Instructor: Dwight Drake S Corp Eligibility Requirements 1.Eligible Corps – no banks or insurance companies, affiliated group member only if “Qualified Subchapter S Subsidiary” – 100% owned by S corp and election to disregard QSSS as tax entity. 2.Shareholder number: 100 max. Married couple count one. If fiduciary holds, look thru to beneficiaries. Families can elect to one – six generations deep. 3.Eligible shareholders: No corps, partnerships, nonresident aliens, and ineligible trust. Estate’s, qualified pension trusts and some charitable trusts OK. 4.One Class of Stock. Voting differences only allowed.

2. Corporate & Partner Tax Instructor: Dwight Drake Trusts That Work With S Election 1.Voting trusts 2.Grantor trusts 3.Testamentary trusts that were grantor trusts – for 2 years following death of grantor. 4.Testamentary trusts that receive S corp stock under will – but only for 2 years following death. 5.“QSST” - Qualified Subchapter S Trusts. Requires: Only one beneficiary; all income distributed annually to US citizen or resident; Elect QSST status and treated as owner of S corp stock for tax purposes. QTIP Trust classic example. 6.“ESBT” – Electing Small Business Trust. Requires: All beneficiaries qualified S corp shareholders; all interests received by gift or bequest, not purchase; trust S corp income taxed at highest individual marginal rates. Advantage: allows multiple Bs and income sprinkling.

3. Corporate & Partner Tax Instructor: Dwight Drake Straight Debt Huge Safe Harbor 1361(c)(5) 1.Unconditional promise to pay on demand or at specified time. 2.Interest rate and payments not contingent on profits or discretion. 3.No convertibility 4.Creditor actively and regularly engaged in lending money or is individual, estate or trust that would be eligible S corp shareholder. Note: If safe harbor met, excess interest may still not be treated as interest for tax purposes.

4. Corporate & Partner Tax Instructor: Dwight Drake Problem 888 (a)Z Corp 120 shares outstanding. 99 each own 1 share and A & B (brothers) own 21 shares as joint tenants. Family exception limits to 100 shareholders. S Corp allowed. (b)Same, except A & B are married and own shares different ways. S allowed because spouses treated only as one shareholder no matter how owned per 1361(c)(1). Both spouses must file consents. (c)Same as (b). Z Makes S election, B dies and leaves to friend Z. While in estate, S election good. When go to Z, have 101 and S terminates on that day and have S short year and C short year.

5. Corporate & Partner Tax Instructor: Dwight Drake Problem 888 (d)Same as (a), but last 21 shares held by voting trust with 3 beneficiaries. Voting trust permissible shareholder, but count now is 102 - so no S election. (e)Same as (a), but 21 shares owned by revocable living trust. Since grantor trust and only one person, count only 100 and S election permitted. (f)QTIP trust may qualify as “qualified subchapter S trust” under 1361(d) if beneficiary makes election under 1361(d)(2). (g) Z has 100 shareholders and forms partnership with two other corps, each with 100 shareholders. Partnership is only business. S election permitted per Rev. Rule 94-43. Rationale: 100 limit was for administrative simplicity, which is not adversely effected by partnership.

6. Corporate & Partner Tax Instructor: Dwight Drake Problem 888 (h)Z has voting and non-voting common stock, which is only outstanding stock. Has authorized, unissued preferred stock. Z may make S election. Voting and nonvoting still considered one class per 1361(c)(4). Preferred would kill if issued, but no effect if it unissued. (i)Same as (h), but agreement gives shareholders with large tax burden larger distributions. Two classes of stock per Reg. 1.1361-1(l)(2)(v). No S election. (j)Bonds issued to shareholders proportionately at 25-to-1 debt/ equity ratio with interest at prime plus 3%. Clearly bonds may be equity, but not kill S if “straight debt” per 1361(c)(5)(A). Neither subordination nor high rate prevent “straight debt”, but excess interest may not be deductible as interest.

7. Corporate & Partner Tax Instructor: Dwight Drake Problem 893 Basic Facts: Snowshoe Inc. - A owns 300 share voting common. - B, C & D own 100 shares nonvoting common - Operations began October 3 (a)Who must consent to S? All shareholders, including nonvoting. 1362(a)(2). If B sold to G, both B & G would need to consent because both shareholders during first year. If B refused, then election good for second year. If B partnership which transfer to individual, election not good for first year because B (ineligible shareholder) owned for part of first year. Election good for year 2.

8. Corporate & Partner Tax Instructor: Dwight Drake Problem 893 Basic Facts: Snowshoe Inc. - A owns 300 share voting common. - B, C & D own 100 shares nonvoting common - Operations began October 3 (b)When election required? By 15 th day of third month. 1362(b)(1)(B). Begin Oct 3, so election due by Dec 17. New corp year begins when corp has shareholders, acquires assets or begins business, whichever is first. (c)What taxable year allowed? “Permitted year” is calendar year or natural business year. 25% last two month gross reciepts test of Rev. Proc. 87-32. Also, 444 election and 7519 deposit game allowed. Since ski resort, should meet 25% test.

9. Corporate & Partner Tax Instructor: Dwight Drake Problem 893 Basic Facts: Snowshoe Inc. - A owns 300 share voting common. - B, C & D own 100 shares nonvoting common - Operations began October 3 (d) Who can revoke? Those owning more than half all stock outstanding, including non-voting. Reg. 1.1362-2(a). A would need one additional shareholder. If revocation by 15 th day of 3 rd month, effective on first day of year. Otherwise, effective for next year. 1362(d)(1)(C). (e) C sells to nonresident alien? S termination immediately. 1362(b)(1)(C). Current year divided into short S year and short C year. 1362(d)(2)(B) & 1362(e).

10. Corporate & Partner Tax Instructor: Dwight Drake Problem 893 Basic Facts: Snowshoe Inc. - A owns 300 share voting common. - B, C & D own 100 shares nonvoting common - Operations began October 3 (f) Only 5 shares to Olga and C had no knowledge? 1362(f) permits cure for inadvertent termination. Olga’s sale would need to be rescinded and C recognizes income otherwise allocable to Olga. “Inadvertent” burden of proof on corporation. Fact that corp had no knowledge of sale “tends to establish” proof of “inadvertence”. Reg. 1.1362-4(b) and -5.

11. Corporate & Partner Tax Instructor: Dwight Drake Problem 893 Basic Facts: Snowshoe Inc. - A owns 300 share voting common. - B, C & D own 100 shares nonvoting common - Operations began October 3 (g) What if 45% gross receipts from rentals, dividends and interest? No problem with S election because no C corp earnings and profits – 1362(d)(3) termination for 25% passive income not apply. Before ’82, there was 20% lid on passive income for all S corps, but no more. Now passive termination threat exists only if C corp E & P, which will never exist for corp that has always been S corp.