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PRACTISING LAW INSTITUTE
TAX PLANNING FOR DOMESTIC & FOREIGN
PARTNERSHIPS, LLCs, JOINT VENTURES &
OTHER STRATEGIC ALLIANCES 2012PRACTISING LAW INSTITUTE
TAX STRATEGIES FOR CORPORATE ACQUISITIONS,
DISPOSITIONS, SPIN-OFFS, JOINT VENTURES,
FINANCINGS, REORGANIZATIONS AND
RESTRUCTURINGS 2012
______
THE S CORPORATION RULES AND THE USE OF S CORPORATIONS AS ACQUISITION VEHICLES
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May 2012December 2012
Mark J. Silverman
Steptoe & Johnson LLP
Washington, D.C.
AaronP.Nocjar
Steptoe & Johnson llp
Washington, D.C.
Copyright © 20132, Mark J. Silverman and Aaron P. Nocjar, All Rights Reserved.
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Internal Revenue Service Circular 230 Disclosure: As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein. .
I.INTRODUCTION
II.BECOMING AN S CORPORATION
A.Eligibility
1.Domestic Corporation
2.Ineligible Corporation
a.In General
b.Prior to the Small Business Act of 1996
(i)Affiliated Subsidiaries Not Permitted
(ii)Inactive Subsidiaries Permitted
(iii)Transitory Stock Ownership
(iv)Nonaffiliated Subsidiaries Permitted
3.Type of Shareholder
a.In General
b.Trusts as Shareholders
(i)In General
(ii)Qualified Subchapter S Trust
(iii)Electing Small Business Trust
(a)In General
(b)Beneficiaries
(c)Potential Current Beneficiaries
(d)Acquisition By Purchase
(e)ESBT Election
(f)Taxation of ESBTs
(g)Ceasing To Be an ESBT
c.ESOPs
d.Ineligible Shareholder Issues
(i)Transitory Ownership by Ineligible Shareholders
(ii)Incorporating a Partnership
4.Number of Shareholders
5.One Class of Stock Requirement
a.In General
b.Differences in Voting Rights
c.Identical Rights with Respect to Distribution and Liquidation Proceeds
(i)General Rule
(ii)Exceptions to General Rule
(a)State Law Requirements for Payment and Withholding of Income Tax
(b)Buy-Sell and Redemption Agreements
(c)Varying Interests
d.Stock Taken Into Account
(i)Restricted Stock
(ii)Deferred Compensation Plans
(iii)Straight Debt
e.Special Rules for Debt Instruments, Obligations, and Other Similar Arrangements
(i)In General
(ii)Debt Arrangements Treated as Equity under General Principles
(a)Short-Term Unwritten Advances
(b)Proportionately Held Obligations
(iii)Call Options, Warrants, or Other Similar Instruments
(a)Options Issued to Lenders
(b)Options Issued to Employees
(c)Call Option Safe Harbor Relief
(iv)Convertible Debt
(v)The Straight Debt Safe Harbor Rules
f.Miscellaneous Provisions
(i)Inadvertent Terminations
(ii)Effective Dates
6.Permitted Taxable Year
a.Current Guidance in General
b.Prior Guidance
(i)Pre-1983
(ii)1983-1986
c.Current Guidance in Detail
(i)Calendar Year or Business Purpose Year
(ii)Section 444 Fiscal Year
(iii)Grandfathered Fiscal Year
(iv)Procedural Requirements Relating to Permitted Taxable Years
(a)Treasury Regulations
(b)Other Guidance
d.Failure to Adopt, Change To, or Retain Permitted Year
(i)Validity of S Election
(ii)Termination of S Election
B.The S Election
1.Making the Election
a.Timing
b.Consent Required
c.Qualification as a Small Business Corporation
2.New Election After Termination
a.Five-Year Waiting Period
b.Successor Defined
c.New Election after Invalid Election or Retroactive Revocation of Election
III.EFFECTS OF AN S ELECTION
A.Pass-Through of S Corporation Items
1.In General
2.Operation of the Pass-Through Rules
3.Taxable Year of Inclusion
4.Allocation of Items
a.Per-Share Per-Day Rule
b.Election To Close the Books
(i)Termination of Shareholder’s Interest
(ii)Dispositions of Substantial Amounts of Stock
c.Allocation in an S Termination Year
d.Special Allocations
5.Limitations on Deductibility of Losses
a.Allocation of Loss Items
b.Section 1366(d)
(i)In General
(ii)Basis Adjustments
(iii)Carryover of Disallowed Losses
c.At-Risk Limitation – Section 465
d.Passive Loss Limitation – Section 469
B.Basis Adjustments
1.Stock
a.Increases
b.Decreases
2.Debt
a.Decreases
b.Increases (or Restoration)
3.Timing of Adjustments
a.Stock
b.Debt
4.Ordering Rules for Basis Adjustments
a.Stock
(i)General Rules
(a)Taxable Years Beginning Before January 1, 1997 (i.e., Prior to the Small Business Act of 1996)
(b)Taxable Years Beginning on or after January 1, 1997, and Before August 18, 1998
(c)Taxable Years Beginning on or after August 18, 1998
(ii)Elective Ordering Rule
(iii)Effects of Change to Stock Basis Adjustment Rules
(iv)Comparison to Partnership Interest Basis Adjustment Rules
b.Debt
C.Distributions
1.Corporate-Level Effects
a.Appreciated Property
b.Depreciated Property
c.Other Corporate-Level Effects
2.Shareholder Effects
a.Most S Corporation Distribution Rules Apply to Section 301(c) Distributions Only
b.S Corporation Having No Earnings and Profits
c.S Corporation Having Earnings and Profits
(i)First Layer
(ii)Second Layer
(iii)Third Layer
(iv)S Corporations with Previously Taxed Income
(v)The Accumulated Adjustments Account
(a)Increases to the AAA
(b)Decreases to the AAA
i)Items Other Than Distributions
ii)For Distributions
iii)For Distributions in Excess of the AAA
iv)Distributions of Money and Loss Property
(c)Effect of Debt Basis Adjustments
(d)Ordering Rules for Adjustments to the AAA
(e)Adjustments to AAA for Redemptions, Reorganizations, Divisions, and Year Terminations
i)Redemptions
ii)Reorganizations
iii)Corporate Divisions under Section 368(a)(1)(D)
iv)Year Terminations
(f)Which S Corporations Must (Should) Maintain an AAA?
(vi)Elections Relating to AAA Distribution Rules
(a)Election to Distribute Earnings and Profits First
(b)Election to Make a Deemed Dividend
(c)Election to Forego PTI
(vii)Planning Issue for S Corporation Having Earnings and Profits and Insufficient AAA
d.Special Elections
(i)Termination of Shareholder’s Interest
(ii)Dispositions of Substantial Amounts of Stock
D.Structuring Financing
1.Maximizing Basis
a.Contributions from Shareholders
b.Loans from Shareholders
(i)Taxation of Shareholder S Corporation Debt
(ii)Contribution of Shareholder S Corporation Debt
c.Back-to-Back Loans
d.Shareholder Guarantees
e.Sales Financing
2.Creating Priority for Investors
E.Special Effects of an S Election
1.Cancellation of Indebtedness Income and Sections 108 and 1366
2.Passive Activity Losses Under Section 469
3.Determination of Alternative Minimum Taxable Income
4.Charitable Contributions of Appreciated Property
F.Coordination with Subchapter C of the Code
G.Treatment of S Corporations as Shareholders of C Corporations
1.General Tax Treatment of S Corporations as Shareholders
2.S Corporations as Owners of 80 Percent-Owned Subsidiaries
H.Qualified Subchapter S Subsidiaries
1.Introduction
2.Electing QSub Status
a.IRS Notice 97-4 – Pre-October 10, 2000 Elections
b.Final QSub Regulations and Form 8869
c.Extensions to Elect QSub Status
d.Subsequent QSub Election Apparently Not Prohibited
3.The Effect of a QSub Election
4.Termination of a QSub Election
5.QSubs and Tax-Free Reorganizations
IV.ADDITIONAL EFFECTS OF CONVERTING TO AN S CORPORATION
A.Corporate Level Tax on Built-In Gains – Section 1374
1.Purpose
2.General Rule
3.Computation of Tax
4.Recognized Built-In Gain
5.Recognized Built-In Loss
6.Limitation – Net Unrealized Built-In Gain
a.In General
b.Subsequent Adjustments to NUBIG
7.Scope of Provision
a.S Corporations Covered
b.Assets Covered
8.NOL Carryovers , Capital Loss Carryovers, and other Loss and Deduction Carryovers
9.Installment Sales
10.Partnership Interests
a.Overview
b.Look-Through Rules: (Treas. Reg. § 1.1374-4(i)(1))
c.Disposition of a Partnership Interest: (Treas. Reg. § 1.1374-4(i)(3))
d.Special Rules
(i)Section 704(c) Gain or Loss
(ii)Disposition of Distributed Property (Treas. Reg. § 1.1374-4(i)(7))
11.Effective Date of Section 1374
12.Regulations Cover Additional Issues
13.Recordkeeping Issues
14.Additional Planning Issues
15.Old Capital Gains Tax
B.Corporate Level Tax on Passive Investment Income - Section 1375
1.In General
2.Definitions
3.Rules Relating to C Corporation Subsidiaries
4.Special Rules Relating to QSubs
5.Waiver of Section 1375 Tax
6.Planning To Avoid Section 1375 Tax
C.LIFO Recapture
D.Investment Credit Recapture
E.Estimated Taxes
V.CEASING TO BE AN S CORPORATION
A.Terminating the S Election
1.Revocation
2.Generating Passive Investment Income
a.Gross Receipts
(i)Sale or Exchange of Capital Assets
(ii)Exclusions and Deferrals
b.Passive Investment Income
(i)Royalties
(ii)Rents
(iii)Dividends
(a)In General
(b)Dividends from Affiliated Subsidiaries
(iv)Interest
(v)Annuities
(vi)Sale of “Stock or Securities”
(vii)Special Rules for Dealers and Patrons
c.Accumulated Earnings and Profits
d.Effective Date of Termination for Passive Income
e.Planning To Avoid Termination for Passive Income
3.By Ceasing To Be a Small Business Corporation
B.What Is Not a Termination
C.Inadvertent Terminations
D.Treatment of S Termination Years
1.Definition
2.Effect
E.Post-Termination Distributions
VI.SUMMARY OF OTHER RELEVANT PROVISIONS
A.Investment Interest Deduction Limitation – Section 163(d)
B.Acquisitions to Avoid Tax – Section 269
C.Limitation on the Use of the Cash Method of Accounting – Section 448
D.Reduction of Paperwork Burden on Certain S Corporations
VII.COMPARISON OF S CORPORATIONS WITH OTHER ENTITIES AS ACQUISITION VEHICLES
A.Factors That Encourage the Use of S Corporations
1.Repeal of the “General Utilities” Doctrine
2.Noncorporate Rate Compared to the Corporate Rate
a.Ordinary Income Rates
b.Capital Gains Rates
c.Reduction of the Double Tax on C Corporation Earnings
3.Former C Corporations Taxed on Built-In Gain
4.The Alternative Minimum Tax
B.Types of Pass-Through Entities
C.Advantages of S Corporations
1.Compared with C Corporations
2.Compared with Partnerships
D.Disadvantages of S Corporations
VIII.ACQUIRING AND CONVERTING C CORPORATIONS TO S CORPORATION STATUS
A.Making a C Corporation Eligible
1.Purchase of Stock
2.Recapitalization
3.Divisive D Reorganization
B.Changing Taxable Years To Obtain Maximum Benefit
1.New Corporations
2.Existing Corporations
3.Acquisition of Existing C Corporation
C.Effect of Conversion on the Corporation
IX.S CORPORATION AS AN ACQUISITION VEHICLE
A.Special Concerns with S Corporations
1.Newly-Formed S Corporation
2.Avoiding Termination
3.Other Considerations
B.Particular Transaction Structures Involving S Corporations
1.Asset Acquisitions by S Corporations
a.Taxable Asset Acquisitions
b.Tax-Free Asset Acquisitions
(i)Effect on Election
(a)Merger
(b)Consolidation
(c)C Reorganization
(d)Acquisitive D Reorganization
(ii)Allocation of Income or Loss in the Acquisition Year
(iii)Carryover of Corporate Attributes
(iv)Pre-Reorganization Distributions
(v)Distributions Pursuant to the Merger
(vi)Post-Reorganization Distributions
(vii)LIFO Recapture
2.Stock Acquisitions by S Corporations
a.Taxable Stock Acquisitions
(i)Effect on Election Prior to the Small Business Act of 1996
(ii)Effect on Election Pursuant to the Small Business Act of 1996
(iii)Allocation of Income or Loss in the Acquisition Year
b.Tax-Free Stock Acquisitions
(i)Availability of Tax-Free Treatment
(ii)Effect on Election
(iii)Pre-Reorganization Distributions
(iv)Distributions Contemporaneously with the Reorganization
(v)Post-Reorganization Distributions
c.Alternatives to S Corporation Acquiring Stock of Target
(i)Brother “S” – Sister “C” Merger
(a)Subchapter C Issues
(b)Subchapter S Issues
(ii)Brother “S” – Sister “S” Structure
X.S CORPORATION AS A TARGET
A.Asset Dispositions
1.Taxable Asset Dispositions – Direct Sale of Assets
2.Taxable Asset Dispositions – Taxable Merger
a.Installment Sale Issues
b.Effect on Election
c.Allocation of Income (Loss) in Year of Disposition
3.Deemed Asset Dispositions – Section 338(h)(10)
a.The Election
b.Consequences of the Election
c.Effective Dates
d.Deemed Ownership of Stock Held by a QSST
4.Tax-Free Asset Dispositions
a.Availability of Reorganization Provisions
b.Effect on Election
c.Allocation of Income (Loss) in Year of Disposition
d.Carryovers
e.Suspended Losses
f.Pre-Reorganization Distributions
g.Distributions Pursuant to the Reorganization
h.Post-Reorganization Distributions
B.Stock Dispositions
1.Sales of Stock
a.Effect on Election
b.Allocation of Income (Loss) Items in the Year
c.Amount and Character of Gain or Loss on the Sale
d.Pre-Sale Distributions
e.Post-Sale Distributions
f.Section 338(g) Election
g.Section 1411 Net Investment Income Tax......
2.Redemptions
a.Effect on Election
b.Allocation of Income or Loss in the Year
c.Distributions
(i)Section 302(a) Redemptions
(ii)Section 302(d) Redemptions
C.Complete Liquidation
1.General Tax Consequences
2.Effect on Election
3.Allocation of Income and Loss in Year of Liquidation
I.INTRODUCTION...... 1
II.BECOMING AN S CORPORATION...... 4
A.Eligibility...... 4
1.Domestic Corporation...... 5
2.Ineligible Corporation...... 6
a.In General...... 6
b.Prior to the Small Business Act of 1996...... 7
(i)Affiliated Subsidiaries Not Permitted...... 7
(ii)Inactive Subsidiaries Permitted...... 7
(iii)Transitory Stock Ownership...... 8
(iv)Nonaffiliated Subsidiaries Permitted...... 8
3.Type of Shareholder...... 8
a.In General...... 8
b.Trusts as Shareholders...... 10
(i)In General...... 10
(ii)Qualified Subchapter S Trust...... 11
(iii)Electing Small Business Trust...... 13
(a)In General...... 13
(b)Beneficiaries...... 14
(c)Potential Current Beneficiaries...... 14
(d)Acquisition By Purchase...... 17
(e)ESBT Election...... 17
(f)Taxation of ESBTs...... 18
(g)Ceasing To Be an ESBT...... 19
c.ESOPs...... 19
d.Ineligible Shareholder Issues...... 20
(i)Transitory Ownership by Ineligible Shareholders...... 20
(ii)Incorporating a Partnership...... 21
4.Number of Shareholders...... 22
5.One Class of Stock Requirement...... 25
a.In General...... 25
b.Differences in Voting Rights...... 25
c.Identical Rights with Respect to Distribution and Liquidation Proceeds 25
(i)General Rule...... 25
(ii)Exceptions to General Rule...... 27
(a)State Law Requirements for Payment and Withholding of Income Tax 27
(b)Buy-Sell and Redemption Agreements...... 28
(c)Varying Interests...... 28
d.Stock Taken Into Account...... 28
(i)Restricted Stock...... 29
(ii)Deferred Compensation Plans...... 29
(iii)Straight Debt...... 30
e.Special Rules for Debt Instruments, Obligations, and Other Similar Arrangements 30
(i)In General...... 30
(ii)Debt Arrangements Treated as Equity under General Principles 30
(a)Short-Term Unwritten Advances...... 30
(b)Proportionately Held Obligations...... 31
(iii)Call Options, Warrants, or Other Similar Instruments...31
(a)Options Issued to Lenders...... 31
(b)Options Issued to Employees...... 32
(c)Call Option Safe Harbor Relief...... 32
(iv)Convertible Debt...... 32
(v)The Straight Debt Safe Harbor Rules...... 32
f.Miscellaneous Provisions...... 33
(i)Inadvertent Terminations...... 33
(ii)Effective Dates...... 34
6.Permitted Taxable Year...... 34
a.Current Guidance in General...... 34
b.Prior Guidance...... 34
(i)Pre-1983...... 34
(ii)1983-1986...... 34
c.Current Guidance in Detail...... 35
(i)Calendar Year or Business Purpose Year...... 35
(ii)Section 444 Fiscal Year...... 35
(iii)Grandfathered Fiscal Year...... 36
(iv)Procedural Requirements Relating to Permitted Taxable Years 37
(a)Treasury Regulations...... 37
(b)Other Guidance...... 37
d.Failure to Adopt, Change To, or Retain Permitted Year...... 38
(i)Validity of S Election...... 38
(ii)Termination of S Election...... 39
B.The S Election...... 40
1.Making the Election...... 40
a.Timing...... 40
b.Consent Required...... 41
c.Qualification as a Small Business Corporation...... 42
2.New Election After Termination...... 43
a.Five-Year Waiting Period...... 43
b.Successor Defined...... 44
c.New Election after Invalid Election or Retroactive Revocation of Election 45
III.EFFECTS OF AN S ELECTION...... 45
A.Pass-Through of S Corporation Items...... 45
1.In General...... 45
2.Operation of the Pass-Through Rules...... 46
3.Taxable Year of Inclusion...... 48
4.Allocation of Items...... 48
a.Per-Share Per-Day Rule...... 48
b.Election To Close the Books...... 49
(i)Termination of Shareholder’s Interest...... 49
(ii)Dispositions of Substantial Amounts of Stock...... 50
c.Allocation in an S Termination Year...... 51
d.Special Allocations...... 51
5.Limitations on Deductibility of Losses...... 51
a.Allocation of Loss Items...... 52
b.Section 1366(d)...... 52
(i)In General...... 52
(ii)Basis Adjustments...... 52
(iii)Carryover of Disallowed Losses...... 53
c.At-Risk Limitation – Section 465...... 55
d.Passive Loss Limitation – Section 469...... 55
B.Basis Adjustments...... 57
1.Stock...... 57
a.Increases...... 57
b.Decreases...... 58
2.Debt...... 59
a.Decreases...... 59
b.Increases (or Restoration)...... 60
3.Timing of Adjustments...... 61
a.Stock...... 61
b.Debt...... 62
4.Ordering Rules for Basis Adjustments...... 62
a.Stock...... 62
(i)General Rules...... 62
(a)Taxable Years Beginning Before January 1, 1997 (i.e., Prior to the Small Business Act of 1996) 62
(b)Taxable Years Beginning on or after January 1, 1997, and Before August 18, 1998 63
(c)Taxable Years Beginning on or after August 18, 1998 63
(ii)Elective Ordering Rule...... 64
(iii)Effects of Change to Stock Basis Adjustment Rules....64
(iv)Comparison to Partnership Interest Basis Adjustment Rules 64
b.Debt...... 65
C.Distributions...... 65
1.Corporate-Level Effects...... 65
a.Appreciated Property...... 65
b.Depreciated Property...... 66
c.Other Corporate-Level Effects...... 66
2.Shareholder Effects...... 67
a.Most S Corporation Distribution Rules Apply to Section 301(c) Distributions Only 68
b.S Corporation Having No Earnings and Profits...... 68
c.S Corporation Having Earnings and Profits...... 68
(i)First Layer...... 68
(ii)Second Layer...... 69
(iii)Third Layer...... 69
(iv)S Corporations with Previously Taxed Income...... 69
(v)The Accumulated Adjustments Account...... 70
(a)Increases to the AAA...... 70
(b)Decreases to the AAA...... 71
i)Items Other Than Distributions...... 71
ii)For Distributions...... 71
iii)For Distributions in Excess of the AAA..72
iv)Distributions of Money and Loss Property72
(c)Effect of Debt Basis Adjustments...... 72
(d)Ordering Rules for Adjustments to the AAA....72
(e)Adjustments to AAA for Redemptions, Reorganizations, Divisions, and Year Terminations 74
i)Redemptions...... 74
ii)Reorganizations...... 74
iii)Corporate Divisions under Section 368(a)(1)(D) 74
iv)Year Terminations...... 74
(f)Which S Corporations Must (Should) Maintain an AAA? 75
(vi)Elections Relating to AAA Distribution Rules...... 75
(a)Election to Distribute Earnings and Profits First.75
(b)Election to Make a Deemed Dividend...... 75
(c)Election to Forego PTI...... 76
(vii)Planning Issue for S Corporation Having Earnings and Profits and Insufficient AAA 76
d.Special Elections...... 76
(i)Termination of Shareholder’s Interest...... 76
(ii)Dispositions of Substantial Amounts of Stock...... 76
D.Structuring Financing...... 76
1.Maximizing Basis...... 76
a.Contributions from Shareholders...... 77
b.Loans from Shareholders...... 77
(i)Taxation of Shareholder S Corporation Debt...... 78
(ii)Contribution of Shareholder S Corporation Debt...... 80
c.Back-to-Back Loans...... 81
d.Shareholder Guarantees...... 82
e.Sales Financing...... 82
2.Creating Priority for Investors...... 83
E.Special Effects of an S Election...... 83
1.Cancellation of Indebtedness Income and Sections 108 and 1366...... 83
2.Passive Activity Losses Under Section 469...... 87
3.Determination of Alternative Minimum Taxable Income...... 88
4.Charitable Contributions of Appreciated Property...... 89
F.Coordination with Subchapter C of the Code...... 90
G.Treatment of S Corporations as Shareholders of C Corporations...... 91
1.General Tax Treatment of S Corporations as Shareholders...... 91
2.S Corporations as Owners of 80 Percent-Owned Subsidiaries...... 92
H.Qualified Subchapter S Subsidiaries...... 93
1.Introduction...... 93
2.Electing QSub Status...... 94
a.IRS Notice 97-4 – Pre-October 10, 2000 Elections...... 94
b.Final QSub Regulations and Form 8869...... 95
c.Extensions to Elect QSub Status...... 95
d.Subsequent QSub Election Apparently Not Prohibited...... 95
3.The Effect of a QSub Election...... 96
4.Termination of a QSub Election...... 100
5.QSubs and Tax-Free Reorganizations...... 103
IV.ADDITIONAL EFFECTS OF CONVERTING TO AN S CORPORATION...... 104
A.Corporate Level Tax on Built-In Gains – Section 1374...... 104
1.Purpose...... 104
2.General Rule...... 105
3.Computation of Tax...... 105
4.Recognized Built-In Gain...... 106
5.Recognized Built-In Loss...... 107
6.Limitation – Net Unrealized Built-In Gain...... 108
a.In General...... 108
b.Subsequent Adjustments to NUBIG...... 109
7.Scope of Provision...... 113
a.S Corporations Covered...... 113
b.Assets Covered...... 113
8.NOL Carryovers , Capital Loss Carryovers, and other Loss and Deduction Carryovers 116
9.Installment Sales...... 117
10.Partnership Interests...... 118
a.Overview...... 118
b.Look-Through Rules: (Treas. Reg. § 1.1374-4(i)(1))...... 119
c.Disposition of a Partnership Interest: (Treas. Reg. § 1.1374-4(i)(3)) 120
d.Special Rules...... 121
(i)Section 704(c) Gain or Loss...... 121
(ii)Disposition of Distributed Property (Treas. Reg. § 1.1374-4(i)(7)) 121
11.Effective Date of Section 1374...... 122
12.Regulations Cover Additional Issues...... 123
13.Recordkeeping Issues...... 124
14.Additional Planning Issues...... 124
15.Old Capital Gains Tax...... 125
B.Corporate Level Tax on Passive Investment Income - Section 1375...... 126
1.In General...... 126
2.Definitions...... 127
3.Rules Relating to C Corporation Subsidiaries...... 127
4.Special Rules Relating to QSubs...... 128
5.Waiver of Section 1375 Tax...... 128
6.Planning To Avoid Section 1375 Tax...... 128
C.LIFO Recapture...... 128
D.Investment Credit Recapture...... 132
E.Estimated Taxes...... 132
V.CEASING TO BE AN S CORPORATION...... 132
A.Terminating the S Election...... 132
1.Revocation...... 132
2.Generating Passive Investment Income...... 133
a.Gross Receipts...... 133
(i)Sale or Exchange of Capital Assets...... 134
(ii)Exclusions and Deferrals...... 135
b.Passive Investment Income...... 135
(i)Royalties...... 135
(ii)Rents...... 136
(iii)Dividends...... 136
(a)In General...... 136
(b)Dividends from Affiliated Subsidiaries...... 136
(iv)Interest...... 138
(v)Annuities...... 138
(vi)Sale of “Stock or Securities”...... 138
(vii)Special Rules for Dealers and Patrons...... 138
c.Accumulated Earnings and Profits...... 139
d.Effective Date of Termination for Passive Income...... 140
e.Planning To Avoid Termination for Passive Income...... 140
3.By Ceasing To Be a Small Business Corporation...... 140
B.What Is Not a Termination...... 141
C.Inadvertent Terminations...... 142
D.Treatment of S Termination Years...... 143
1.Definition...... 143
2.Effect...... 143
E.Post-Termination Distributions...... 144
VI.SUMMARY OF OTHER RELEVANT PROVISIONS...... 145
A.Investment Interest Deduction Limitation – Section 163(d)...... 146
B.Acquisitions to Avoid Tax – Section 269...... 146
C.Limitation on the Use of the Cash Method of Accounting – Section 448.....147
D.Reduction of Paperwork Burden on Certain S Corporations...... 147
VII.COMPARISON OF S CORPORATIONS WITH OTHER ENTITIES AS ACQUISITION VEHICLES 147
A.Factors That Encourage the Use of S Corporations...... 147
1.Repeal of the “General Utilities” Doctrine...... 147
2.Noncorporate Rate Compared to the Corporate Rate...... 148
a.Ordinary Income Rates...... 148
b.Capital Gains Rates...... 148
c.Reduction of the Double Tax on C Corporation Earnings.....148
3.Former C Corporations Taxed on Built-In Gain...... 149
4.The Alternative Minimum Tax...... 149
B.Types of Pass-Through Entities...... 150
C.Advantages of S Corporations...... 151
1.Compared with C Corporations...... 151
2.Compared with Partnerships...... 152
D.Disadvantages of S Corporations...... 153
VIII.ACQUIRING AND CONVERTING C CORPORATIONS TO S CORPORATION STATUS 154
A.Making a C Corporation Eligible...... 154
1.Purchase of Stock...... 154
2.Recapitalization...... 154
3.Divisive D Reorganization...... 155
B.Changing Taxable Years To Obtain Maximum Benefit...... 156
1.New Corporations...... 156
2.Existing Corporations...... 156
3.Acquisition of Existing C Corporation...... 156
C.Effect of Conversion on the Corporation...... 157