Federal Taxation of Entities
Federal Taxation of Entities
This domain tests entity classification and the tax consequences of formation, operations, distributions, and liquidation for C corporations, S corporations, and partnerships, including owner basis and owner-level reporting.
Core rules
- C corp: entity-level tax; dividends to shareholders taxed again (qualified dividends at preferential rates); corporate dividends-received deduction for eligible dividends; E&P measures dividend vs return of capital. Accumulated earnings tax and personal holding company tax are backstops.
- S corp: flow-through; eligibility (100 shareholders, eligible individuals, one class of stock, domestic); election Form 2553; shareholder basis increased by income and direct loans, decreased by distributions then losses; distributions in excess of basis are gain. Built-in gains tax applies to former C corps.
- Partnership: flow-through; §721 formation; partnership basis (outside) vs inside basis; §704(b) substantial economic effect; §704(c) built-in gain allocation; guaranteed payments ordinary income; §754 election steps up inside basis.
- Liquidations: C corp §331/§332; S corp §331; partnership §731/§732.
Worked example
A owns 100% of an S corporation with stock basis $20,000 at the start of the year. The corporation has no C-corp E&P, earns $8,000 ordinary income, and distributes $30,000 cash. Basis first increases to $28,000; the distribution reduces basis to $0 and the excess $2,000 is long-term capital gain (assuming stock held >1 year). A later $10,000 loss is suspended because basis is zero. If A had loaned the corporation $10,000 directly, basis would increase by that loan and more loss would be allowed; a shareholder guarantee alone does not create basis.
Traps
Treating S distributions as dividends; forgetting basis ordering; using partnership rules for S corp debt; ignoring §704(c) on contributed appreciated property; missing the S corp reasonable-compensation issue; overlooking §754; assuming check-the-box applies to corporations.