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S Corporation Tax Laws
The American Jobs Creation Act of 2004 has dramatic updates to the S Corporation rules. The last major modifications of the S Corporation rules were made with the Small Business Job Protection Act of 1996. This is a highlight of both tax law Acts. Please see your tax adviser for the specifics.
- The number of S Corporation Shareholders has been increased 100. In addition members of a family are treated as one shareholder. Members of a family are defined as, "the common ancestor, lineal descendants of the common ancestor, and the spouses (or former spouses) of lineal descendants or common ancestor."
- The types of trusts allowed to be shareholders of S Corporations have been liberalized. So-called "electing small business trusts" can be S Corporation shareholders. These are trusts in which the beneficiaries are individuals, estates or charities which hold a contingent remainder interest in the trust and which do not hold any present interest in income or principal. The rules for determining the current beneficiaries of these trusts have been eased.
- An IRA or Roth IRA is now allowed to be a shareholder of a bank that is an S corporation.
- Some exempt organizations may now be S Corporation shareholders. Certain qualified pension, profit-sharing and stock bonus plans which are tax exempt under the Internal Revenue Code may now be shareholders of S Corporations.
- Greater than 80% Rule. An S Corporation may now own 80% or more of the stock of a C Corporation. Before the 1996 Act, S shareholders could only own another corporation's stock where such ownership was less than 80%.
- Estate Administration Eased. The 1996 Act expands the time that a testamentary trust may be an S Corporation shareholder from 60 days to 2 years where the transfer of the S Corporation stock is to a trust incorporated in a will.
- Validation of Inadvertent Elections. The IRS will have the authority, for post-1982 tax years, to validate defective S Corporation elections just as it now has the authority to validate terminations; in both instances, the election or termination must have been "inadvertent." Late S Corporation elections may also be treated by the IRS as timely and thus made in the current year rather than in the next year so long as the Service finds that there was reasonable cause for the late election. Even further relief given in the 2004 Act.
- Affected Shareholders. Should any shareholder terminate his interest in the S Corporation, that shareholder and not all shareholders will be impacted. "Affected shareholders" includes any shareholder whose interest has ended or successor shareholders who have received the affected shares.
- Distributions by S Corporations during loss years are treated the same as are distributions from partnerships during loss years. A suspended loss or deduction can be transferred with the stock to the shareholder's spouse or to a divorced spouse.
- S Corporations may be eligible now for capital gains treatment with respect to subdivided real estate. A capital gain presumption is accorded S Corporations as it is accorded to individuals with respect to the sale of real estate from a subdivided single tract of land. Check with your adviser as to the details.
- Reelection of S Corporation Status. Pre-January 1, 1997 terminations of S Corporation status will be ignored by the Service. This means that any termination within the 5-year period before the date of the Act may now reelect S Corporation status without the consent of the IRS.
- An S Corporation that maintains an employee stock ownership plan can now use distributions to repay certain loans.
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