Printer Friendly

S Corporation passive income.

This item examines the excess net passive income (ENPI) of S corporations. The ENPI tax is an easily overlooked concern with former C corporations that have elected S status. Under Sec. 1375(a), S corporations with accumulated earnings and profits (E&P) and net passive investment income (PII) greater than 25% of gross receipts are subject to an income tax. The tax is calculated by multiplying the ENPI by the highest corporate income tax rate. Further, S corporations that fall into this category at the close of three consecutive tax years will automatically have their S status terminated at the beginning of the next tax year.

PII

PII is defined in Sec. 1362(d)(3)(c)(i) as gross receipts derived from royalties, rents, dividends, interest, annuities and sales or exchanges of stock or securities (only to the extent of any gains derived therefrom). The term does not include interest collected on installment sales of inventory or other obligations acquired in the ordinary course of business.

Rental Income

Rents are generally deemed passive income. However, Regs. Sec. 1.1362-2(c)(5)(B)(2) allows an exclusion if the corporation provides significant services and incurs substantial costs in the rental business. The definitions of "significant services" and "substantial costs" are not necessarily clear and are determined by taking all the facts and circumstances surrounding the corporation's active trade or business into account.

In two recent letter rulings (Letter Rulings 200425037 and 200425039), the IRS ruled that rents received by two S corporations were not PII. The active business of both corporations was real estate renting and management, presumably a major factor for the favorable ruling. It may be advisable for a corporation to obtain a letter ruling if rents are a risk to PII exposure.

Gross Receipts

The term "gross receipts" is defined in Kegs. Sec. 1.1362-2(c)(4)(i) as the total amount received or accrued under the accounting method used by the corporation in computing its taxable income, not reduced by returns and allowances, cost of goods sold or deductions. If an S corporation is a member of a partnership or limited liability company, the gross receipts from that entity retain their character.

In Rev. Rul. 71-455, the IRS ruled that a corporation had to include in its gross receipts its distributive share of gross receipts from a passthrough entity, rather than its distributive share of ordinary income (or loss). The ability to use the distributive share of gross receipts, rather than gross income, can be sufficient to exempt the corporation from the ENPI tax. Conversely, the corporation's distributive share of PII may potentially trigger the tax.

Corporations with E&P considering electing S status should be sure to undertake a PII assessment before making the election. As with other concerns as to electing S status, it is better to be aware of potential problems beforehand.

LAURA J. LIEWEN, CPA, HAMMEL COMPANY, P.C., TUCSON, AZ
COPYRIGHT 2004 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2004, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
Printer friendly Cite/link Email Feedback
Author:Liewen, Laura J.
Publication:The Tax Adviser
Date:Dec 1, 2004
Words:488
Previous Article:Federal tax implications of same-sex marriage.
Next Article:S Corporations, CGES and Sec. 179.
Topics:


Related Articles
Determining the deductibility of S corporation passive losses.
Rental real estate and sec. 1375.
Deducting suspended losses on disposition of S stock.
Convert C corporation to S corporation at retirement for passive income.
Avoiding involuntary termination of S status from excess passive investment income.
Suspended PALs from C years could be deducted in S election year.
Passive loss carryovers - a reversal.
S corporation can deduct suspended PALs incurred while a C corporation.
PALs carried forward from C to S Corporation.
Avoiding the 25% passive gross receipts problem by using a stock redemption to remove excess investments.

Terms of use | Privacy policy | Copyright © 2021 Farlex, Inc. | Feedback | For webmasters |