Lots of goings on involving S corporations. As a reminder, the income of S firms flows through to their owners and is taxed at individual tax rates. And subject to limitations, owners are able to deduct their pro rata share of losses on their 1040 returns.
Start with changes made by tax reform: The 20% qualified business income deduction.
Self-employed people and owners of pass-through firms such as S corporations can take this popular break, subject to limitations that apply to high earners. The K-1s you get have new codes to reflect this change.
Also, the limitation on deducting business losses on individual returns. The amount of trade or business losses that exceeds a $500,000 threshold for couples and $250,000 for other filers is nondeductible, with the excess carried forward.
Keep an eye on a Senate bill’s simplifications for S corporations. Among the desired changes: Allowing banks to have IRAs as shareholders. And easing rules for corporations with retained profits that switch to S status. More of their income could be passive before a special penalty tax would apply. Currently, if over 25% of a former regular corporation’s gross receipts are passive, the S firm owes a 21% tax on the excess. And if this happens for three straight years, it can lose its S status. The bill would hike the 25% passive income threshold to 60% and would repeal the excessive passive income rule as an S-election termination event.
Boosting tax enforcement on the S corporation front is a goal of IRS. As shown by campaigns from its Large Business and International Division that focus on risk areas in which IRS has found taxpayer compliance to be lacking. One targets distributions by S corporations. Among some of the concerns: S firms that fail to report gain on distributions of appreciated property to shareholders. C corporations with accumulated earnings and profits that elect to switch to S status and later make distributions that should properly be treated as taxable dividends. Also, cash or property distributions by S firms to shareholders in excess of stock basis. A second, risk-focused compliance campaign involves the built-in-gains tax…the 21% levy paid by corporations that convert to S status on profits from sales of assets owned before the conversion and sold within five years after the switch.
Shareholder basis in S corporations is a third big enforcement priority. Owners of S corporations can deduct loses only up to their stock basis and loans that they make to the company. IRS know that compliance in this area is deficient. IRS is conducting audits in this area. Exams are at the shareholder level. Agents are checking to see whether shareholders are properly tracking their basis.
Many S firm owners must now include basis information with their 1040. Starting with 2018 returns, they must check a box on line 28 of Schedule E and attach a basis computation. This requirement applies to those who report a loss, dispose of their stock, or receive a distribution or loan repayment from the company.