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Table of Contents
-
List of Forms by Chapter - Chapter 1 — Considerations In Electing S Corporation Status
- Chapter Summary
-
I. General Principles in Selecting the Proper Form of Business Organization - II. Nontax Considerations in Selecting a Form of Business Organization
- III. [1.13] Basic Tax Characteristics
- [1.14] Proprietorships and Single-Member Limited Liability Companies
- [1.15] Partnerships and Limited Liability Companies with More than One Member
- C Corporations
- [1.16] Double Tax
- [1.17] Reducing the Impact of the Double Tax: Opportunities and Restrictions
- [1.18] Retirement Income and Fringe Benefits for Shareholder-Employees
- [1.19] Tax-Qualified Retirement Plans
- [1.20] Medical Benefits
- [1.21] Group Term Life Insurance
- [1.22] Employee Stock Plans
- S Corporations
- [1.23] Eligibility, Election, Operational, and Termination Rules Governing S Corporations
- [1.24] No More than 100 Shareholders
- [1.25] Only Qualified Shareholders
- [1.26] One Class of Stock
- [1.27] Shareholder Consent
- [1.28] Qualified Entities
- [1.29] Limitation of Passive Income
- [1.30] Tax on Built-In Gains
- [1.31] Treatment of S Corporation Income and Losses to Shareholders in General
- [1.32] Treatment of Corporate Distributions to Shareholders in General
- [1.33] Issues Affecting Exit Strategy
- IV. Using the Subchapter S Election or a Limited Liability Company as a Tax-Saving Device
- [1.34] Pass-Through of Losses
- [1.35] Capital Gain Conversion Potential
- [1.36] Retirement Income and Fringe Benefits for Owner-Shareholders
- [1.37] Accounting Methods
- [1.38] First-Level Tax Savings
- [1.39] Eliminating the Second Tax on Dividend Distributions
- [1.40] Sale or Liquidation of the Business
- [1.41] Elimination of Accumulated-Earnings Problems
- [1.42] Maximizing Investment Return on Corporate Earnings
- [1.43] Elimination of Unreasonable Compensation Issue
- [1.44] Income Splitting
- [1.45] Income Deferral in Year of Election if Corporation Has a Fiscal Tax Year
- V. Conclusion
- Chapter 2 — Electing S Corporation Status
- Chapter Summary
- I. Introduction
- II. Requirements To Elect S Status
- In General
- [2.6] A Small Business Corporation
- [2.7] No Disqualified Non-Individual Shareholders
- [2.8] Unissued Stock Does Not Count as a Second Class of Stock
- [2.9] Restricted Bank Director Stock
- [2.10] Deferred Compensation Plan with Currently Taxed Compensation Is Not Outstanding Stock
- [2.11] Deferred Compensation Non-Stock Buy-Sell Plans
- [2.12] Size of Operations and Activities
- [2.13] Domestic Corporation
- [2.14] Ineligible Corporations
- [2.15] No More than 100 Shareholders
- [2.16] Spouses
- [2.17] Family Members
- Shareholders Must Be Individuals, Estates, Certain Trusts, Tax-Exempt Charitable Organizations, or Qualified Retirement Plans
- [2.18] Individuals
- [2.19] Estates and Testamentary Trusts
- [2.20] Grantor Trusts
- [2.21] Voting Trusts
- [2.22] Qualified Subchapter S Trusts
- [2.23] Requirements To Be a Qualified Subchapter S Trust
- [2.24] The Qualified Subchapter S Trust Election
- [2.25] Electing Small Business Trusts
- [2.26] Election Process
- [2.27] Conversion to a Qualified Subchapter S Trust
- [2.28] Termination of an Electing Small Business Trust
- [2.29] An Electing Small Business Trust as Shareholder and Taxes Imposed
- [2.30] Individual Retirement Accounts Owning Stock in a Bank
- [2.31] Tax-Exempt Organizations
- [2.32] Qualified Retirement Plans
- [2.33] Shareholder May Not Be a Nonresident Alien
- [2.34] No More than One Class of Stock
- [2.35] Buy-Sell and Redemption Agreements
- [2.36] Obligations Designated as Debt
- [2.37] Call Options, Warrants, and Similar Instruments
- [2.38] Straight Debt Safe Harbor
- Nonvoting And Voting Shares Allowed Within One Class of Stock
- [2.39] General Rule
- [2.40] Family Estate Planning Opportunity with Nonvoting and Voting Stock in a Sub S Corporation
- [2.41] Qualified Subchapter S Subsidiaries
- [2.42] The Election
- [2.43] Late Qualified Subchapter S Subsidiaries Election
- [2.44] Termination of a Qualified Subchapter S Subsidiaries Election
- Maintaining the Subchapter S Election
- [2.45] Inadvertent Terminations
- [2.46] Election After Termination
- III. The Process of Electing S Status
- [2.47] The Election and Form 2553 Filing Requirements
- [2.48] Shareholder Consents
- [2.49] Late Elections
- [2.50] Procedure According to Tax Return Filing
- [2.51] Additional Documents Under Rev.Proc. 2003-43
- [2.52] Automatic Relief
- [2.53] Extensions of Time To File Consents
- [2.54] Newly Organized Corporations
- [2.55] Multi-State S Corporation Registration (Doing Business in Other States with State Income Tax S Corporation Statutes)
- IV. Termination of S Election
- [2.56] In General
- [2.57] Revocation of the S Election
- [2.58] Termination by Ceasing To Be a Small Business Corporation
- [2.59] Termination Due to Excess Passive Income
- [2.60] S Termination Year
- [2.61] Other Consequences of S Termination Year
- [2.62] Inadvertent Terminations
- [2.63] Inadvertent Defective Election
- [2.64] No Election Until Five Years After Termination
- V. Organizing and Capitalizing the S Corporation
- [2.65] In General
- Selecting Classes of Common Stock
- [2.66] Corporate Factors
- [2.67] Tax Factors
- The Debt-Equity Mix
- [2.68] In General
- [2.69] Comparison of Debt and Equity in an S Corporation
- Transferring Property to the Corporation
- [2.70] Nonrecognition of Gain
- [2.71] Receipt of Boot
- [2.72] Basis for Stock
- [2.73] Assumption of Liabilities
- [2.74] Last-In, First-Out Recapture
- [2.75] Nonrecognition of Built-In Gains After Five Years
- Selection of a Fiscal Year
- [2.76] Permitted Taxable Year
- [2.77] Internal Revenue Code §444 Election
- [2.78] Internal Revenue Code §7519 Payments
- [2.79] Comprehensive Example
- [2.80] Selection of Accounting Method
- [2.81] Shareholders’ Agreements
- VI. Appendix — Forms
- Chapter 3 — Operating and Maintaining the S Corporation
- Chapter Summary
- I. [3.1] Scope of Chapter
- II. Tax Consequences at the Corporate Level
- [3.2] Effect of Election
- [3.3] Computation of Taxable Income
- [3.4] Elections of the S Corporation
- [3.5] Expenses Owed to Shareholders and Related Taxpayers
- [3.6] Earnings and Profits of S Corporations
- [3.7] Distributions of Appreciated Property
- [3.8] No Investment Tax Credit Recapture on Election
- [3.9] Carryforwards and Carrybacks
- [3.10] S Corporation as Shareholder of Regular Corporations
- [3.11] Certain Taxes Imposed at the Corporate Level
- [3.12] Passive Investment Income Rule and the “Sting” Tax
- [3.13] Corporations without accumulated earnings and profits
- [3.14] Corporations with accumulated earnings and profits
- [3.15] Tax Imposed by Internal Revenue Code §1374
- [3.16] Last-in, First-Out Recapture Tax
- [3.17] Information Returns and Tax Audits
- III. The S Corporation as a Conduit — Tax Consequences at the Shareholder Level
- [3.18] Conduit Aspects
- The Taxation Scheme of Subchapter S
- [3.19] Determination, Characterization, and Allocation of Shareholder Tax Items
- [3.20] “Taken into Account” and “Pro Rata Share”
- [3.21] The Mechanism for Passing Through the Character of Tax Items
- [3.22] Adjustments to Basis of Stock and Loans from Shareholders
- [3.23] Stock Basis Rules
- [3.24] Indebtedness Basis Rules
- [3.25] Deductibility of Deductions and Losses by Shareholder
- [3.26] Treatment of Distributions
- [3.27] Corporations Without Accumulated Earnings and Profits
- [3.28] Corporations with Accumulated Earnings and Profits
- [3.29] Elections Relating to the Source of Distributions
- [3.30] In-Kind Distributions
- IV. [3.31] Maximizing Use of Deductions and Losses
- V. [3.37] Distribution Planning
- VI. [3.40] Changes in Ownership
- VII. [3.44] Reorganizations Involving S Corporations
- VIII. [3.51] Compensating Employees of S Corporations
- IX. [3.54] Qualified Subchapter S Subsidiaries
- X. [3.55] Conclusion
- Chapter 4 — Passive Loss Rules: Application to an S Corporation and Its Shareholders
- Chapter Summary
- I. [4.1] Introduction
- II. [4.2] Background
- III. [4.3] Applying the Regulations
- [4.4] What the Taxpayer Is Trying To Determine
- [4.5] Passive Activity Losses Checklist
- [4.6] Step One — Determine Whether the Taxpayer Is Subject to Internal Revenue Code §469
- [4.7] Step Two — Determine the Separate Activities of the Taxpayer
- [4.8] General Activity Rules
- [4.9] Grouping Activities
- [4.10] Limitations on Grouping Rental Activities
- [4.11] Activities of Certain Limited Partners and Limited Entrepreneurs
- [4.12] Activities Conducted Through Entities
- [4.13] Certain Trading Activities
- [4.14] Consistency Requirements
- [4.15] Grouping by the Internal Revenue Service To Prevent Tax Avoidance
- [4.16] Reporting Groupings
- [4.17] Step Three — Determine Whether the Taxpayer Materially Participates
- [4.18] Participation
- [4.19] Material Participation Tests
- [4.20] Significant Participation
- [4.21] Personal Service Activity
- [4.22] Facts and Circumstances Test
- [4.23] Step Four — Determine Whether the Activity Is a Rental Activity
- [4.24] Exceptions to General Rule
- [4.25] Average period of customer use
- [4.26] Average customer use of seven days or less
- [4.27] Average customer use of 30 days or less with significant personal services
- [4.28] Extraordinary personal services are provided
- [4.29] Rental incidental to non-rental activities
- [4.30] Property customarily made available for nonexclusive use by various customers
- [4.31] Property provided to partnership or S corporation in which taxpayer owns an interest
- [4.32] Exception for Rental Real Estate Activities of Real Estate Professionals
- [4.33] Limited Exception for Active Participation in Rental Real Estate
- [4.34] Step Five — Eliminate Nonpassive Income
- [4.35] Portfolio Income
- [4.36] Personal Service Income
- [4.37] Self-Charged Items
- [4.38] Gross Income from Oil and Gas Properties
- [4.39] Additional Exclusions from Passive Activity Gross Income
- [4.40] Step Six — Determine Applicability of Recharacterization Rules
- [4.41] Significant Participation
- [4.42] Non-Depreciable Rental Property
- [4.43] Interest Income from Passive Equity-Financed Lending Activity
- [4.44] Income from Property Rented Incidental to Development Activity
- [4.45] Self-Rented Property
- [4.46] Pass-Through Entities Licensing Intangible Property
- [4.47] Additional Situations Subject to Recharacterization
- [4.48] Substantially appreciated property formerly used in nonpassive activity
- [4.49] Qualified working interests in oil and gas
- [4.50] Active participation rental real estate
- [4.51] Step Seven — Calculate the Passive Loss
- [4.52] Calculate Passive Activity Deductions
- [4.53] Calculate Passive Activity Gross Income
- [4.54] Gain from disposition of an interest in an activity or an interest in property used in an activity
- [4.55] Income from Internal Revenue Code §481 adjustments
- [4.56] Overall Net Loss
- [4.57] Net Loss for Each Activity
- [4.58] Loss Carryover
- [4.59] Step Eight — Apply Passive Activity Losses Following Disposition of an Activity
- [4.60] Sales
- [4.61] Gifts
- [4.62] Inheritance
- [4.63] Former Passive Activities
- [4.64] Partial Dispositions
- [4.65] Installment Sales
- [4.66] Disposition of Interest in Pass-Through Entity
- [4.67] Conversion of C Corporation to S Corporation
- [4.68] Treatment of Passive Activity Credits
- IV. [4.69] Conclusion
Authors
- Janelle N. Darnell
Janelle N. Darnell
Janelle N. Darnell is an Associate at McGuireWoods LLP, in Chicago, where she focuses her practice on taxation and mergers and acquisitions, and she will be a Partner as of January 1, 2026. Darnell is a member of the Illinois State Bar Association and the American Bar Association, and she was recognized as a Nolan Fellow by the American Bar Association’s Tax Section for the 2023 – 2024 fiscal year. She currently serves as Vice-Chair of the ABA Tax Section’s S Corporations Committee, and she is the incoming Chair of the Committee for the 2026 – 2027 fiscal year. Darnell received a B.A. from California Polytechnic State University, an M.B.A. from San Diego State University, a J.D. from the University of San Diego School of Law, and an LL.M. from the Northwestern University Pritzker School of Law.
- Paul S. Drizner
Paul S. Drizner
Paul S. Drizner is a Partner in the Chicago office of Seyfarth Shaw LLP, where he concentrates his practice in taxation. Drizner is a member of the American Bar Association. He received his B.S. from the University of Illinois and his J.D. from Loyola University Chicago School of Law, where he served as an editor on the Loyola University Chicago Law Journal.
- Anthony J. Jacob
Anthony J. Jacob
Anthony J. Jacob is a Partner at Hinshaw & Culbertson LLP, in Chicago, and concentrates his practice in business law, banking and commercial finance law, real estate law, and election law. In 2013 and 2014, respectively, Jacob was appointed as a member of the investment committee for the board of trustees at the University of Illinois Chicago School of Law (formerly known as the John Marshall Law School) and as a board member at the Institute of Illinois Business Law at Chicago-Kent College of Law. He has previously chaired the Business and Securities Law Section Council of the Illinois State Bar Association. Jacob received his B.A. at Northern Illinois University and both his LL.M. and J.D. from the University of Illinois Chicago School of Law, where he was Student Publications Editor of the UIC Law Review and a member of the moot court team.
- Alexander Loftus
Alexander Loftus
Alexander Loftus is a Partner at Loftus & Eisenberg, Ltd., in Chicago, where he focuses his practice on business litigation. Loftus has been named a Super Lawyer and is a member of the Illinois Trial Lawyer’s Association, the Illinois State Bar Association, and the Small Business Advisory Counsel. He received his J.D. from DePaul College of Law.
S Corporations 2026 Edition
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