Federal Taxation of Entities
Core concepts
Entity taxation covers partnerships, S corporations, and C corporations. Partnerships are pass-through: income, deductions, and credits flow to partners, and distributions generally do not trigger gain unless cash exceeds outside basis. S corporations also pass through income but have eligibility limits (100 shareholders, eligible individuals, one class of stock) and payroll requirements for shareholder-employees. C corporations are separate taxpayers subject to the corporate rate, with potential double taxation of dividends.
Basis and distributions
Partner's outside basis increases with contributions and share of income, decreases with distributions and share of losses. Losses are limited to basis. S corporation shareholder basis works similarly but excludes entity-level debt.
Traps
Questions test whether an entity qualifies as an S corporation, the tax treatment of distributions (return of basis vs. gain), and the built-in gains tax. Watch for the distinction between partnership and S corporation treatment of liabilities and the corporate alternative minimum tax considerations.
Worked rule of thumb
Example: Partner contributes $20,000 cash and property with basis $10,000 (FMV $15,000). Outside basis = $20,000 + $10,000 = $30,000 (no gain on contribution). If the partnership distributes $35,000 cash, the partner recognizes $5,000 gain (cash exceeds basis).
Key points
- Partnerships and S corporations are pass-through entities.
- Partner basis increases with income, decreases with losses/distributions.
- S corporation limits: 100 shareholders, one class of stock.
- C corporations face double taxation on dividends.
- Distributions in excess of basis trigger gain.