S Corporations—Treatment of Tax and Nontax Matterssquare6The Conduit Concept.For most tax matters, S corporations are treated like partnerships. As in the partnership conduit concept, the taxable income of an S corporation flows through to the owners on a per-day and per-share basis. Income and losses are reported on Form 1120-S, allocated to each shareholder on a supporting K-1 schedule, and then transferred, via the K-1, to the individual owners’ 1040 returns. There, at the individual level, income is taxed and losses are deducted. square6The Entity Concept.The character of income and losses is determined at the entity level, not at the shareholder level. For example, a long-term capital gain reported by the S corporation remains long-term to the shareholder, even if his ownership in the S corporation had been held for a short-term period.Chapter 16, Exhibit 1a
S Corporations—Basissquare6Just like partners in a partnership, the shareholders of an S corporation are required to pay income tax on the corporation’s income regardless of whether and when the income is distributed.square6The shareholder is essentially paying tax on money he/she is not receiving. To ensure that the shareholder is not taxed twice on the same square6money, each time the shareholder of an S corporation pays tax on the S corporation’s income, the shareholder’s basis increases by the amount of income on which he/she has paid tax.square6When that income is eventually distributed, the shareholder’s basis is decreased.Chapter 16, Exhibit 1a
square6The biggest difference between S Corporations and partnerships is:square6Owner salaries and payroll taxes.Deductible by S corporations, not by partnerships.square6Example 1: Joe is a lawyer and a 50% partner in partnership A. A lawyer like Joe normally earns $60,000. Partnership A had a net income of $200,000 this year. square6Joe must pay income tax on $100,000. S Corporations vs. Partnershipssquare6Joe must pay self employment tax on $100,000. square6The same result would have been true if Joe was a sole proprietor.square6Example 2: Joe is a lawyer and a 50% shareholder in S Corporation A. A lawyer like Joe normally earns $60,000. S Corporation A had a net income of $200,000 this year. square6Joe must pay income tax on $100,000. square6Joe must pay self employment tax on $60,000.
square6Another difference between S Corporations and Partnerships is that S Corporations recognize gain on the distribution of appreciated property to their shareholders, while partnerships do not. rhombus6Example: An S Corporation has five equal shareholders. On December 31, the S Corporation distributes a piece of land with a FMV of $300,000 and an AB of $200,000 to Shareholder A. At the time of the distribution, Shareholder A has a basis in the S corporation of $290,000.