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Sales or Exchanges of Stock or Securities
A sale or exchange of stock or securities is included in gross receipts only to the extent of the gain. Losses on sales or exchanges are not a part of gross receipts. Nor are they offset against gains on sales or exchanges when figuring gross receipts. This applies even if the S corporation is a regular dealer in stocks and securities. However, amounts received in exchange for stock in a corporate liquidation are not included in gross receipts if the S corporation owned more than 50% of each class of the liquidating corporation’s stock on the date of the first distribution concerning the liquidation. This 50% requirement applies to a class of stock whether or not the class of stock has voting rights. For this requirement, shares of stock of the liquidating corporation held by an S corporation shareholder are not treated as held by the S corporation.
Questions and Answers on the Net Investment Income Tax
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Passive Investment Income
Passive investment income includes gross receipts from royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities. The amount included in passive investment income for sales or exchanges of stock or securities for an S corporation that is not an “options dealer” or “commodities dealer” is specially figured as explained above. If the S corporation is an “options dealer” or a “commodities dealer,” any gains or losses from section 1256 contracts (regulated futures contracts, foreign currency contracts, nonequity options, and dealer equity options) or property related to such contracts are not included when the computations are made.
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Royalties include mineral, oil, and gas royalties, and amounts the S corporation receives for the use of patents, copyrights, secret processes, formulas, goodwill, trademarks, trade brands, franchises, and other like property. Rents are amounts the S corporation receives for the use of, or the right to use its real or personal property. Rents do not include payments for the use or occupancy of property if significant services are also provided to the occupant. Examples of payments not treated as rents include payments for the use or occupancy of rooms or other quarters in hotels, boarding houses, apartment houses that provide hotel services, tourist homes, motor courts, or motels. Significant services are considered provided to the occupant if they are primarily for the occupant’s convenience and are not usually or customarily provided in the rental of rooms or other space for occupancy only. For example, providing maid service is considered significant service to the occupant. Heat and light, cleaning public entrances, exits, stairways, and lobbies, collecting trash, etc., are not considered significant services. Payments for parking cars usually are not rents. Payments for warehousing of goods or the use of personal property are not rents if significant services are provided with the payments.
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Interest is an amount received for the use of money, including tax-exempt interest and unstated interest. Unstated interest includes amounts considered interest on notes or obligations received in installment sales, obligations issued for property, and below-market loans when the contract does not contain a stated rate of interest, or the stated rate is below the appropriate federal rate. However, interest on obligations acquired in the ordinary course of the S corporation’s trade or business from the performance of services or the sale of inventory or property held primarily for sale to customers is excluded from passive investment income.
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Precalculating the Tax on Excess Net Passive Income
An S corporation is liable for a tax at a rate of 35%, on excess net passive income if its passive investment income is more than 25% of gross receipts. And if at the end of the tax year it has earnings and profits from any tax year in which the corporation was not an S corporation. Net Passive Income Net passive income is passive investment income, described above, and reduced by deductions directly connected with the production of passive investment income. This does not include net operating losses and dividends-received deductions allowed to corporations that are not S corporations. Investment-related deductions allowable in figuring net passive income include brokerage fees, interest expenses, safe deposit box rentals, and investment advisory fees.
Determining the Taxability of S Corporation Distributions: Part I
Excess Net Passive Income
Excess net passive income for the tax year is the amount that has the same ratio to net passive income as the amount of passive investment income that exceeds 25% of gross receipts has to total passive investment income. Therefore, to figure excess net passive income, multiple net passive incomes by a fraction consisting of passive investment income minus 25% of gross receipts over passive investment income.
An S corporation (with subchapter C earnings and profits) has gross receipts of $10,000. Of this amount, $4,000 is passive investment income. After subtracting applicable deductions, net passive investment income is $3,000. Excess passive investment income equals $1,125 ($3,000 x $1,500/$4,000). The corporation must pay corporate income tax on $1,125. If the situation continues for three years, the S-election is revoked.Determining the Taxability of S Corporation Distributions: Part I
Determining the Taxability of S Corporation Distributions: Part II
Excess net passive income cannot be more than the S corporation’s taxable income for the year.
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The only credit that can be used by the S corporation to offset this tax is the credit figured on Form 4136, Credit for Federal Tax on Fuels. If any gain is used to figure both the tax on excess net passive income and the tax on capital gains, the amount of gain subject to the capital gains tax
is reduced. The total of passive investment income for purposes of figuring the tax on excess passive income is determined by not taking into account any recognized built-in gain or loss of the corporation. If the S corporation is subject to the tax on excess net passive income, it must reduce the items of passive income passed through to the shareholders.
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Next Blog will tell you more about S Corporation.