TCP, Tax Compliance and Planning
Sources for S Corporation Compliance: Built-In Gains, the AAA, and Basis Ordering
Last reviewed
The standards and authorities behind PocketCPA's TCP lessons on S Corporation Compliance: Built-In Gains, the AAA, and Basis Ordering. The topic rests on IRC Sec. 1361 / 1362 / 1366 / 1367 / 1368 / 1371 / 1374 / 1375 / 1377.
About this topic
Subchapter S is a set of ordering rules wearing a tax return. Almost nothing in this lesson turns on knowing an obscure provision. It turns on running the steps in the order the Code and the regulations put them in, because in every one of these computations a different order produces a defensible-looking number that is wrong.
Five statutes carry the load, and it helps to know what each one does before the details arrive. Sec. 1366 decides what passes through and how much loss a shareholder may deduct. Sec. 1367 moves stock and debt basis. Sec. 1368 decides what a distribution costs. Sec. 1374 taxes a former C corporation's old appreciation at the entity level. Sec. 1362 starts and ends the election, and Sec. 1375 taxes a former C corporation's passive receipts while the election survives.
Key points
- S corporation status requires no more than 100 shareholders, one class of stock, and only eligible shareholders.
- The built-in gains tax applies for five years after a C-to-S conversion on gains that were built in at the time of election.
- The accumulated adjustments account (AAA) tracks post-election undistributed income and determines whether distributions are tax-free.
- Shareholder basis is increased by income and decreased by losses and distributions, and limits loss deductions.
What the lessons cover
- Built-in gains tax
- The AAA and distributions with E and P
- Basis ordering and loss limits
- Termination
- Eligibility: who may hold S corporation stock
- Pass-through mechanics: per-share, per-day allocation and character
- Debt basis: creating it, using it, and restoring it
- Suspended losses and the post-termination transition period
- The excess net passive income tax
- The compliance sequence, end to end
Authoritative references
Eligibility and election:
- Sec. 1361(b)(1) and (c), the small business corporation and who may hold its stock: the family aggregation at (c)(1), the permitted trust and estate shareholders at (c)(2), and the straight debt safe harbor at (c)(5); the full list of conditions is in the references for the S corporation eligibility unit.
- Sec. 1362(a), (b) and (c), the election, its timing and the late election rules, and the consent of shareholders.
Termination:
- Sec. 1362(d)(1) through (d)(3), termination by revocation, by ceasing to be a small business corporation, and by excess passive investment income for three consecutive years where there are earnings and profits.
- Sec. 1362(e), the S termination year and the allocation of items between the S short year and the C short year, including the pro rata election at (e)(3) and the closing-of-the-books rules at (e)(6).
- Sec. 1362(f), relief for an inadvertent invalid election or termination.
- Sec. 1371(b), no carryover of losses between a C year and an S year, Sec. 1371(c), the effect on earnings and profits, Sec. 1371(d), the cash distributions during the post-termination transition period, and Sec. 1371(e), the post-termination distributions of money from the accumulated adjustments account.
Pass-through and basis:
- Sec. 1366(a)(1) and (a)(2), the pro rata share of items of income, loss, deduction, and credit, with character determined at the corporate level.
- Sec. 1377(a)(1) and (a)(2), the per-share, per-day allocation and the election to terminate the taxable year on a termination of the shareholder's interest.
- Sec. 1367(a)(1) and (a)(2), the increases and decreases in stock basis, and Sec. 1367(b)(2), the reduction and restoration of debt basis.
- Sec. 1366(d)(1) through (d)(3), the loss limit by stock basis and debt basis, the carryforward of the disallowed loss, and the post-termination transition period.
- Sec. 1366(e) and (f), family member services and the reduction in pass-through for tax imposed under Sec. 1374 and Sec. 1375.
Distributions:
- Sec. 1368(a) through (c), distributions from a corporation with no earnings and profits and from one with them, in the order of the accumulated adjustments account, accumulated earnings and profits, and basis.
- Sec. 1368(e)(1) through (e)(3), the accumulated adjustments account and its adjustments, including distributions during the post-termination transition period.
- Sec. 1371(a) and Sec. 301(c), the application of subchapter C rules to the distributions of a corporation with earnings and profits.
Corporate-level taxes:
- Sec. 1374(a), (b) and (d), the tax on net recognized built-in gain, the 21 percent rate and the taxable income limit, the net unrealized built-in gain at (d)(1), the recognized built-in gain and loss at (d)(3) and (d)(4), the recognition period at (d)(7), and the carryover basis assets at (d)(8).
- Sec. 1375(a) and (b), the tax on excess net passive income, with the limit at 25 percent of passive investment income over taxable income, and the waiver at Sec. 1375(d).
- Sec. 11(b), the corporate rate applied in the built-in gains computation.
How PocketCPA uses these sources
Every lesson is written in original words and cites the paragraph each rule comes from. No standard's text is reproduced. How lessons and questions are written and checked is set out in our methodology.