S-Corp Update

Kathy Herbig, Senior Manager – Crowe Horwath LLPKevin Powers, Partner – Crowe Horwath LLP

Disclaimer

The information provided herein is educational in nature and is based on authorities that are subject to change.

You should contact your tax adviser regarding application of the information provided to your specific facts and circumstances.

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Session Agenda

Net Investment Income Tax

Inadvertent S Corp Termination Relief

Stock Related Issues

Other Current Issues

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Net Investment Income Tax

Net Investment Income Tax

The 3.8% net investment income tax for individuals, estates, and trusts is imposed on:• Individuals with income more than $250,000 for joint returns or surviving

spouses, $125,000 for separate returns, and $200,000 in other cases• Trusts and estates with income AGI over the dollar amount at which the highest

estate and trust income tax bracket begins ($11,950 for 2013) Net investment income includes:

• Gains from the sale of property, including sales of passive activities• Interest• Dividends• Annuities• Royalties• Rents• Income from passive activities (within the meaning of section 469)• Income from a trade or business of trading in financial instruments

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Tax on Net Investment Income

Items generally excluded from net investment income:• Income from pass through entities that are not passive activities. However,

income resulting from the investment of working capital will be subject to the 3.8% tax even if the activity is not passive.

• Income of real estate professionals. New safe harbor added for rental income of real estate professionals.

• Gain from the sale of partnerships, LLCs, and S corporations that are not passive activities

• Self-employment income• Tax-exempt interest• Qualified retirement plan distributions and IRA distributions• Income from exercise of qualified stock options• Non-taxable portion of gain from the sale of a principal residence

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Tax on Net Investment Income – Estates and Trusts

Estates and trusts are subject to the 3.8% tax when 2013 AGI exceeds the dollar amount at which the highest estate and trust income tax bracket begins ($11,950 for 2013).

A simple trust generally pays tax only on capital gains and passes the rest of its income through to its beneficiaries. Simple trusts with capital gains income in excess of $11,950 will be subject to the 3.8%.

Estates and complex trusts will pay the 3.8% tax on investment income (other than capital gains) that is not distributed plus its capital gains in excess of $11,950.

Special rules apply to ESBTs Individuals are subject to the 3.8% tax when 2013 AGI exceeds

$250,000 for joint returns or surviving spouses, $125,000 for separate returns, and $200,000 in other cases.

If an estate or trust has net investment income in excess of $11,950 and the beneficiary has AGI below the threshold for application of the 3.8% tax, the 3.8% tax can be avoided by distributing the net investment income to the beneficiary.

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ESBTs and Net Investment Income (NII)

ESBTs compute NII under a multistep process: Step one: The S portion and non-S portion of the ESBT compute

undistributed NII as separate trusts and then combine these amounts to calculate the ESBT's undistributed NII.

Step two: The ESBT calculates its adjusted gross income. The ESBT's adjusted gross income is the non-S portion's adjusted gross income, increased or decreased by the net income or net loss of the S portion, after taking into account all deductions, carryovers, and loss limitations applicable to the S portion, as a single item of ordinary income or loss.

Step three: The ESBT’s NII is the lesser of: • The ESBT's total undistributed NII; or • The excess of the ESBT's adjusted gross income over the threshold

amount for the taxable year.

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ESBTs and Net Investment Income (NII)

In Year 1, the non-S portion of an ESBT has dividend income of $15,000, interest income of $10,000, and capital loss of $5,000. Trust's S portion has net rental income of $21,000 and a capital gain of $9,000. The Trustee’s annual fee of $1,000 is allocated 60% to the non-S portion and 40% to the S portion. Trust makes a distribution from income to a single beneficiary of $9,000.

Step one – Determine undistributed NII • S portion of ESBT has $27,600 of undistributed NII composed of:

• Rental income $21,000 • Capital gain $7,000 • Trustee Fee $(400)

• Non S portion of ESBT has $12,400 of undistributed NII composed of: • Dividend Income $15,000 • Interest Income $10,000 • Deductible Capital Loss $(3,000) • Trustee Annual Fee $(600) • Distributable net income distribution$(9,000)

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ESBTs and Net Investment Income (NII) Combined undistributed net investment income is $40,000 composed of:

• S portion’s undistributed net investment income $27,600 • Non-S portion’s undistributed net investment income $2,400

Step two – The ESBT’s adjusted gross income is calculated. The amount is $40,000, in this case the same as the undistributed net investment income, composed of:• Dividend Income $15,000 • Interest Income $10,000 • Deductible Capital Loss ($3,000) • Trustee Annual Fee ($600) • Distributable net income distribution ($9,000) • S Portion Income $27,600.

Step three – NIIT imposed on $28,050, the lesser of : • The combined undistributed NII of $40,000, or • The excess of the ESBT’s AGI $40,000 over the 2013 threshold amount ($11,950), or

$28,050

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Passive Loss Rules and Net Investment Income (NII)

Material Participation • Taxpayers are not subject to passive loss rules when they “materially participate” in an

activity’s operations on a regular, continuous, and substantial basis. • Includes participation by spouse in an activity.

Seven tests for establishing material participation: • Greater than 500 hours participation in the activity; • Substantially all participation by any individual; • Greater than 100 hours participation in the activity, but nobody participates more; • Materially participated in any 5 of last 10 years; • Activity is a personal service activity and individual materially participated in the activity

for any 3 prior tax years; • “Facts and circumstances” test; or • Activity is a “Significant Participation Activity:” taxpayer participates between 100 and 500

hours during the year, and participation in all “significant participation activities” is greater than 500 hours.

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Passive Loss Rules and Net Investment Income (NII)

Material Participation: Disqualified Activities

Work not customarily done by owners – disallowed from counting towards material participation where principal purpose of work is to meet material participation rules. • e.g. spouse working as receptionist

Investor activities – disallowed from counting towards material participation unless the individual is directly involved in day-to-day management or operations. Includes activities such as: • Studying and reviewing financial statements or reports on activity operations; • Preparing or compiling summaries or analyses of finances or operations for the

individual’s own use; and • Monitoring finances or operations in a non-managerial capacity. • Sidney C. Shaw, TC Memo 2002-35 – Taxpayer could not meet 500 hour requirement for

investor activities where he was not involved in day-to-day management.

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Tax on Net Investment Income

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S Corporation

ActiveShareholder

Passive Shareholder

50% 50%

Each shareholder’s K-1 reflects the following items:• Line 1, Ordinary Income

$1,000,000• Line 5, Portfolio Interest

Income $100,000 The portfolio income is income not

related to the trade or business of the S corporation.

The $100,000 of interest income will be investment income subject to the 3.8% tax for the active shareholder

The passive shareholder will have $1.1 million ($1 million ordinary income, $100,000 of portfolio interest) of investment income for purposes of the 3.8% tax

Tax on Net Investment Income

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S Corporation

ActiveShareholder

Passive Shareholder

50% 50%

At the beginning of business on Jan. 1, 2013 S corporation sells its business assets and reports the following items on each shareholder’s K-1:• Section 1231 Income

• $4 million• Long-Term Capital Gain

• $5 million The passive owner will be

subject to the 3.8% tax on the asset sale

The active owner will not be subject to the 3.8% tax on the asset sale

Tax on Net Investment Income

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S Corporation

ActiveShareholder

Passive Shareholder

50% 50%

At the beginning of business on Jan. 1, 2013 the active and passive owners sell their stock in a pass through entity

All assets of the S corporation are used in its trade or business. Each shareholder’s gain is $5 million

The shareholder’s stock basis is equal to the S corporation’s basis in its assets

The active owner will not be subject to the 3.8% tax

The passive owner will be subject to the 3.8% tax

Tax on Net Investment Income

The passive activity determination is made after taking into account the appropriate grouping of activities under Section 469

Regrouping is allowed under 469 if the following conditions are met:• The taxpayer is an individual, estate, or trust;• It is the taxpayer’s first taxable year beginning on or after Dec. 31, 2013

(although the taxpayer may elect to regroup activities for its tax year beginning in 2013 if IRC Sec. 1411 would apply); and

• The taxpayer’s modified adjusted gross income exceeds the threshold amount.

Once made, the regrouping election is binding on all future years S corporations CAN NOT REGROUP under this one time election

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Grouping Activities

Non passive shareholder where grouping is not permitted:• Taxpayer owns stock in ABC, Inc., an S corporation. ABC owns an interest

in XYZ, LLC. ABC and XYZ do not generate any interest, dividends or other items of investment income.

• Taxpayer actively participates in the activity of ABC but not XYZ. The activities of ABC and XYZ are not related and can’t be grouped as one activity under Section 469.

• Taxpayer will receive a K-1 with the following items:• ABC ordinary income of $400,000; • XYZ ordinary income of $600,000.

• Taxpayer will report the ABC income of $400,000 as non passive income and this income will not be NII.

• Taxpayer will report the XYZ income of $600,000 as passive income and this income will be NII.

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Tax on Net Investment Income

If the S corporation intends for its tax distributions to cover the tax on NII, the shareholder agreements should be reviewed to determine if this is allowable.• Disproportionate distributions are not allowed, so even shareholders not

subject to NII on the S corporation income would have to receive the increased tax distribution amount.

Pay particular attention to sale of S corporation stock and impact on reporting for passive shareholders.

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Inadvertent S Corp Termination Relief

Schedule B-1

New for 2013 S Corp tax returns Information on individual or entity responsible for reporting Sch. K-1

income/deduction items with respect to disregarded entities, trusts and estates

Has brought some additional awareness to ownership by trust / estate shareholders and whether proper elections are in place (e.g., QSST, ESBT)

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Schedule B-1 (form)

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Grantor Trust

Qualifications: Revocable trust is most common, but any grantor trust

(even if irrevocable) qualifies U.S. citizen or resident is the deemed owner of the entire

trust Qualifies while the deemed owner is alive

• Continues to qualify as an eligible shareholder for 2-year period following grantor’s death, however can extend to entire period of estate administration if trustee makes a Code §645 election

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Grantor Trust (cont’d)

Pitfalls: Cannot be a foreign trust S Corp shares held for more than 2 years after grantor’s

death• Unless a Code §645 election is made

Becomes an irrevocable trust• However, may qualify as an ESBT or QSST if election timely made

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Electing Small Business Trust

Qualifications: Trust can only have individuals, estates, or qualified

exempt organizations as beneficiaries No interest in the trust acquired by purchase Cannot be a charitable remainder trust Election must be made to treat as ESBT

• If shareholder at time of S election, ESBT election must be filed within 2½ months after earlier of 1) date on which S election filed or 2) effective date of the S election

• If S election was effective before corporate stock was transferred to trust, then ESBT election must be filed within 2½ months after date of transfer

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Electing Small Business Trust (cont’d)

Pitfalls: Cannot be a foreign trust ESBT election not filed, or not filed in a timely fashion Trust has a disqualified beneficiary Interest in trust acquired by gift or will Every “Potential Current Beneficiary” counts as a

separate shareholder 100% of S Corp earnings are taxed at the trust level, at

the maximum income tax rate

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Qualified Subchapter S Trust

Qualifications: Trust can only have one income beneficiary during the

current income beneficiary’s life The current income beneficiary must be a U.S. citizen or

resident Beneficiary’s income interest in the trust must terminate

on earlier of death of beneficiary or termination of the trust If trust terminates during beneficiary’s life, all trust assets

must be distributed to that beneficiary

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Qualified Subchapter S Trust (cont’d)

Qualifications: Trust income must either be:

(A) Required to be distributed to beneficiary, OR(B) Actually distributed to beneficiary…at least annually Any trust assets distributed during the life of the current

income beneficiary can only be distributed to such beneficiary Election must be made to treat as QSST

• If shareholder at time of S election, QSST election must be filed within 2½ months after earlier of 1) date on which S election filed or 2) effective date of the S election

• If S election was effective before corporate stock was transferred to trust, then QSST election must be filed within 2½ months after date of transfer

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Qualified Subchapter S Trust (cont’d)

Pitfalls: Cannot be a foreign trust QSST election not filed, or not filed in a timely fashion Trust has more than one current income beneficiary Trust has a disqualified beneficiary Trust improperly administered – for example, trustee fails

to actually distribute income

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Revenue Procedure 2013-30

Consolidates several earlier Revenue Procedures that provided relief for certain late elections, including:1. S Corp elections;2. ESBT elections;3. QSST elections;4. QSub elections; and5. Corporate classification elections (in conjunction with S Corp elections)

New procedures are in lieu of letter ruling process, so no user fees

Extends relief period in most circumstances

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What are the Normal Election Procedures?

S Corp Elections• Form 2553, Election by a Small Business Corporation• File election at any time during the preceding taxable year OR on or before

the 15th day of the 3rd month of the current taxable year

ESBT Elections• Trustee files an election statement with the applicable IRS Service Center• Due within the 16-day-and-2-month period beginning on the day that the S

Corp stock is transferred to the trust

QSST Elections• Beneficiary files an election statement with the applicable IRS Service

Center• Due within the 16-day-and-2-month period beginning on the day that the S

Corp stock is transferred to the trust

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What are the Normal Election Procedures? (cont’d)

QSub Elections• Form 8869, Qualified Subchapter S Subsidiary Election• Must be filed no later than 2 months and 15 days after, but no earlier than

12 months before, the effective date

Corporate Classification Elections• Form 8832, Entity Classification Election• Must be filed no later than 75 days after, but no earlier than 12 months

before, the effective date• A domestic eligible entity that timely elects to be an S Corp is treated as

having made an election to be classified as an association

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General Requirements for Relief

Relief must be requested within 3 years and 75 days after the intended effective date of the applicable election

Failure to qualify as an S Corp, ESBT, QSST or QSub was due solely to failure to comply with the normal election procedures

For late S Corp or QSub elections, the corporation must have reasonable cause for its failure to timely file and act diligently to correct the mistake upon its discovery

For late ESBT or QSST elections, the failure to timely file must have been inadvertent, and the S Corp and the person/entity seeking relief must act diligently to correct the mistake upon its discovery

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Filing Procedures

Submit applicable election form (e.g., Form 2553) directly to the applicable IRS Service Center with supporting documentation as described in the Rev. Proc., including the reasonable cause/ inadvertence statement as discussed on the previous slide

The applicable election form must state at the top of the document: “Filed Pursuant to Rev. Proc. 2013-30”

Supporting statements must each be signed under Penalties of Perjury

If multiple failures with respect to a single S Corp, all of the applicable election forms can be filed at the same time, but each application for relief must independently comply with the procedural requirements

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Filing Procedures (cont’d)

If the S Corp has filed all Forms 1120S for tax years between the intended effective date of the applicable election and the current tax year, the applicable election form can be attached to the current year Form 1120S, so long as the current year Form 1120S is filed within 3 years and 75 days after the intended effective date of the applicable election

• An extension of time to file the current year Form 1120S is disregarded for this purpose

• Form 1120S must state at the top: “Includes Late Election Filed Pursuant to Rev. Proc. 2013-30”

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Filing Procedures (cont’d)

If the S Corp has not filed Forms 1120S (or any other income tax return or information return) for the tax year including the intended effective date of the applicable election, or any year thereafter, the election form may be attached to the Form 1120S for the year including the intended effective date of the applicable election, so long as:

1. The Form 1120S for the tax year including the intended effective date of the applicable election is filed within 3 years and 75 days after the intended effective date of the applicable election, AND

2. All other delinquent Forms 1120S are filed simultaneously and consistently with the requested relief

Form 1120S must state at the top: “Includes Late Election Filed Pursuant to Rev. Proc. 2013-30”

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Relief for Late S Corp Elections

Form 2553 must be signed by all persons who were shareholders at any time during the period that begins on the first day of the taxable year for which the election is to be effective and ends on the day the completed form is filed

Form 2553 must include statements from all shareholders that they have reported their income on all affected tax returns consistent with the S Corp election for the year the election should have been filed and for all subsequent years

See Rev. Proc. for additional materials for late corporate classification election intended to be on the same date the S Corp election was intended to be effective

Requirement to file request for relief within 3 years and 75 days after the intended effective date of the applicable election generally does not apply where all corporate and shareholder returns have been filed consistent with S Corp status (see Rev. Proc. for additional conditions)

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Relief for Late ESBT and QSST Elections

In the case of an ESBT, the applicable election form must include a statement from the trustee that all potential current beneficiaries meet the general S Corp shareholder requirements and that the trust satisfies the general requirements to qualify as an ESBT

In the case of a QSST, the applicable election form must include a statement from the trustee that the general requirements to qualify as a QSST have been satisfied and that the income distribution requirements have been and will continue to be met

The completed election form must also include statements from all shareholders, during the period between the date the S Corp election was to have become effective and the date the completed election form is filed, that they have reported their income on all affected tax returns consistent with the S Corp election for the year the election should have been made and for all subsequent years

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Relief for Late QSub Elections

Form 8869 must include a statement that the subsidiary corporation satisfies the general QSub requirements and that all assets, liabilities, and items of income, deduction, and credit of the QSub have been treated as assets, liabilities, and items of income, deduction, and credit of the S Corp on all affected returns consistent with the QSubelection for the year the election was intended to be effective and for all subsequent years

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Effective Date

Rev. Proc. 2013-30 was effective as of September 3, 2013

Transition rule allows for an entity to withdraw a prior letter ruling request and receive a refund of its user fee, if entity contacted IRS National Office no later than October 18, 2013

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Stock Related Issues

One Class of Stock

S Corporations can only have one class of stock• All classes of stock must participate equally in dividend distributions and

liquidating distributions• Differences in voting rights are disregarded

Preferred Stock is not allowed Considerations on structuring of debt agreements

• Ensure debt obligation does not resemble equity with different distribution and liquidation rights from common stock

Single class of stock applies to all outstanding stock• Restricted stock is not considered outstanding stock, so long as forfeiture

risk remains and a §83(b) election has not been made• Phantom stock plans not considered second class of stock

(see PLRs 9803023 and 9803008)

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Debt Considerations

Straight Debt Safe Harbor Provisions – §1361(c)(5)• Must be in writing• Must be an unconditional promise to pay a sum certain in money on a

specified date or on demand• The interest rate and interest payment dates must not be contingent on the

borrower’s profits, the borrower’s discretion, or similar factors• The debt must not be convertible directly or indirectly into stock• The debt must be owned by a creditor that either (1) is a permitted S

corporation shareholder or (2) is actively and regularly engaged in the business of lending money

Convertible Debt does not meet safe harbor provisions• Considered a second class of stock under Reg. §1.1361-1(l)(4)(iv) if meets

a two-fold test in the regulations

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Disproportionate Distributions

Disproportionate distributions by an S corporation could be treated by the IRS as a second class of stock• Equalizing distributions must be paid within a reasonable time period

Impact of shareholder transfers• Shareholder A transfers all shares held to Shareholder B on 1/1/2015• On 1/10/2015, S Corp pays a dividend intended to allow shareholders to

pay tax on 2014 distributable S Corp income• Which shareholder receives the dividend?• Does this scenario create disproportionate distributions?

• See Reg. §1.1361-1(l)(2)(iv) Nonresident withholding – State tax payments

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Election to Terminate Year

Reg. §1.1377-1(b) provides that if a shareholder’s entire interest in the S corporation terminates, the S corporation can elect to treat the taxable year as two separate taxable years.• All affected shareholders must consent to the election.• The taxable year is treated as separate taxable years for all affected

shareholders for purposes of allocating items of income, loss, deduction, and credit, making adjustments to AAA, earnings and profits, and basis; and determining the tax effect of a distribution.

• The first taxable year closes on the day on which the shareholder’s interest terminated.

• The election does not affect the due date of the S corporation’s return.• Election can not be made if the termination of the shareholder’s interest

occurs in a transaction that results in a termination of S Corp status.

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Election to Terminate Year (cont’d)

Reg. §1.1368-1(g) provides that if a qualifying disposition occurs, the S corporation can elect to treat the taxable year as two separate taxable years.• Each shareholder who held stock in the corporation during the taxable year

must consent to the election.• Cannot be made if a Reg. §1.1377-1(b) election is made.• The taxable year is treated as separate taxable years for purposes of

allocating items of income and loss, making adjustments to AAA, earnings and profits, and basis; and determining the tax effect of distributions under §1368(b) and (c).

• The first taxable year closes on the day on which the qualifying disposition occurs.

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Election to Terminate Year (cont’d)

Qualifying Dispositions –• A disposition by a shareholder of 20 percent or more of the outstanding

stock of the corporation during any thirty-day period during the taxable year.

• A redemption treated as exchange under §302(a) or §303(a) of 20 percent or more of the outstanding stock of the corporation from a shareholder during any thirty-day period during the taxable year.

• An issuance of an amount of stock equal to or greater than 25 percent of the previously outstanding stock to one or more new shareholders during any thirty-day period during the corporation’s taxable year.

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S Corporation Termination Year

CCA 201433014 highlights a frequently overlooked rule for computing income in an S corporation termination year under §1362(e)(2).

If an S election terminates on a date other than the first day of a taxable year of the corporation, the S corporation will have two tax years:1. An S Corp year from the beginning of the tax year through the day PRIOR

to the S Corp termination date; and2. A C Corp year from the date of termination through the end of the

corporation's taxable year. In an S termination year, the amount of each item of income,

deduction, loss, or credit is determined for the entire year and then allocated throughout the year on a daily basis unless an election is made to close the books of the S corporation upon the termination.

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S Corporation Termination Year (cont’d)

There are situations, however, where the general pro-rata allocation rule will not apply:• A sale or exchange of 50% or more of the corporation's stock during the S

termination year; a gift is not a sale or exchange for these purposes.• Where an acquiring corporation makes a §338 election (and presumably a

§336(e) election) after a corporation's S status terminates, the pro rata allocation rule will not apply to the gain under §338 or §336(e).• This could happen if the S election terminates in one year but the 80% QSP is not

achieved until the subsequent year.• When the former S corporation joins a consolidated group.

The shareholders may elect to allocate profit or loss between the S Corp and the C Corp years under a closing of the books election.

All persons who have held stock at any time during the short S year, as well as those persons who are shareholders on the first day of the short C year, must unanimously consent to such election.

The requirements for the election statement are found in Reg. §1.1362-6(a)(5)

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Other Current Issues

Shareholder Basis in Debt

Final regulations published on July 23, 2014

S Corp shareholders have basis in debt only to the extent of “bona fide” indebtedness of the S Corp that runs directly to the shareholder• Code Sec. 1366(d)(1) provides that shareholders can deduct losses to the

extent of stock basis and debt basis

Reg. Sec. 1.1366-2(a)(2) applicable to debt between an S Corp and its shareholder resulting from any transaction occurring on or after July 23, 2014• However, the final regulations can be relied on for any debt transaction that

occurred in a tax year for which the period of limitations on the assessment of tax had not expired before July 23, 2014

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Shareholder Basis in Debt (cont’d)

Bona fide indebtedness to a shareholder is determined under general Federal tax principles and depends upon all facts and circumstances

A shareholder does not obtain basis in debt merely by guaranteeing a loan or acting as a surety, accommodation party, or in any similar capacity relating to a loan• Shareholder may increase their debt basis only to the extent of actual

payments made on bona fide indebtedness of the S Corp for which the shareholder acts as guarantor (or in a similar capacity)

• See Reg. Sec. 1.1366-2(a)(2)(iii), Example 4

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Shareholder Basis in Debt (cont’d)

In the past, some courts have held that bona fide debt exists only where a shareholder makes an economic outlay and is thus made “poorer in a material sense” as a result of the transaction

The final regulations provide that back-to-back loan transactions through related S Corps can result in bona fide debt, thus allowing the shareholder to increase their debt basis• For example, A is the sole shareholder of S1 and S2; S1 loans $200k to A,

who then loans $200k to S2; assuming A’s loan to S2 constitutes bona fide debt, A increases the debt basis in S2 by $200k

• See Reg. Sec. 1.1366-2(a)(2)(iii), Example 2

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Inadvertent S Corp Termination Relief

Numerous PLRs issued throughout the year on inadvertent S Corp terminations involving:• S Corp elections;• ESBT elections;• QSST elections;• QSub elections; and• Corporate classification elections (in conjunction with S Corp elections)

Taxpayers had to establish reasonable cause and show that granting relief would not prejudice government interests

Due to issuance of Rev. Proc. 2013-30, expect a significantly reduced number of PLR requests by taxpayers on inadvertent S Corp terminations

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Ineligible Shareholders

Rulings on ineligible shareholders will not be impacted by Rev. Proc. 2013-30, nor will rulings on the “one class of stock” rule

PLRs 201418044, 201420005, 201426011 and 201432001• An ineligible shareholder became an owner of stock after the S election

date• Within a reasonable period of time after discovery of the ineligible

shareholder, S Corp took corrective action• Relief conditioned upon the eligible shareholders including the ineligible

person’s allocable income/deduction items on their tax returns

PLR 201430011• Complex set of facts involving potential second class of stock

See Code Sec. 1362(f)

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Controlled Groups & Sec. 179 Expense

IRS Information Letter 2013-0016• Two or more S Corps can be part of a brother-sister controlled group

• A brother-sister controlled group has 2 or more corporations with 5 or fewer shareholders that are individuals, estates, or trusts owning more than 50% of the total combined voting power / value of all classes of stock in the corporation, taking into account each person’s stock ownership only to the extent it is identical for each corporation

• However, Reg. Sec. 1.1563-1(b)(2)(ii)(C) specifically excludes S Corps from being component members of a controlled group

• In practice, many taxpayers have erroneously applied controlled group limitations to the Sec. 179 deduction for S Corps in a controlled group

• The Sec. 179 deduction is determined for an S Corp as if it is an independent entity and not attributed to the other members of the controlled group

• Also remember that the Sec. 179 deduction claimed by the S Corp is subject to the maximum dollar amount limitation at the S Corp level and then again at the shareholder level

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Sec. 265 Interest Expense Disallowance

Sept. 2014 Tax Adviser• Code Sec. 1363(b)(4) provides that the Sec. 291 TEFRA interest expense

disallowance applies to S Corps/QSubs only for the first 3 years after conversion from C Corp status• Sec. 291 TEFRA disallowance would also not apply to a bank that has been an

S Corp/QSub since inception

• However, the Sec. 291 exemption only applies in the context of bank-qualified obligations

• Non-bank-qualified obligations will continue to be subject to disallowance of 100% of allocable interest expense under Code Sec. 265(b)

• To avoid uncertainty, banks should obtain a copy of the issuer’s IRS Form 8038-G or 8038-GC, which is a mandatory filing for issuers of tax-exempt obligations

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2% Shareholder-Employee Fringe Benefits

CCA 201228037

• Not necessarily a new development, but a good reminder

• 2% shareholder-employees are allowed to take an “above the line” deduction for all health insurance premiums paid or reimbursed by the S Corp, if the premiums are reported as wages on the shareholder-employee’s W-2 and reported as gross income on his/her tax return

• S Corp is also permitted to deduct these premiums as employee compensation on the 1120S

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Basel III Capital Conservation Buffer

Financial Institutions Letter (“FIL”) 40-2014

• Issued by FDIC on July 21, 2014

• Describes how the FDIC will consider requests from S Corp banks to pay dividends to shareholders to cover taxes on their pass-thru share of the bank’s earnings, when those dividends would otherwise not be permitted under the capital conservation buffer requirements

• Restrictions imposed by the buffer not fully effective until January 1, 2019

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Basel III Capital Conservation Buffer (cont’d)

Financial Institutions Letter (“FIL”) 40-2014

• The FDIC will consider the following 4 factors in evaluating requests

1. Is the S Corp requesting a dividend of no more than 40% of net income?

2. Does the requesting S Corp believe the dividend payment is necessary to allow the shareholders of the bank to pay income taxes associated with their pass-thru share of the bank’s earnings?

3. Is the requesting S Corp bank rated 1 or 2 under the Uniform Financial Institutions Rating System and not subject to a written supervisory directive?

4. Is the requesting S Corp bank at least adequately capitalized, and would it remain adequately capitalized after the requested dividend?

• If S Corp satisfies each of these factors, the requested dividend generally would be approved absent significant safety-and-soundness concerns

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Flow-Thru Tax Credits to Shareholders

Low-Income Housing

• Passive shareholder can generally claim credits without limitation, assuming shareholder has adequate net passive income from all sources

• Active shareholder may be limited by tax-equivalent $25k rental real estate loss, assuming no other sources of passive income and $25k limit not already used against allocable losses from LIHTC project

• Available credits can offset AMT for post-2007 projects

Rehabilitation

• Is the rehab associated with rental real estate?

• YES – Apply same rules as low-income housing

• NO – General passive/active participation rules apply

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Pending Legislation

Extension of reduced 10-year BIG Tax recognition period?

Extension of special shareholder basis adjustment rule for charitable contributions of appreciate property?

As of the date this presentation was submitted, Congress had yet to act on a comprehensive extenders bill

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For more information, contact:

Kathy Herbig, Senior ManagerCrowe Horwath LLPDirect 502.420.4501kathy.herbig@crowehorwath.com

Kevin Powers, PartnerCrowe Horwath LLPDirect 630.586.5140kevin.powers@crowehorwath.com

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Questions??