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Please Don't shoot the messenger here ....
But yes, a partnership is a non-qualifying shareholder
As to the WHY?: The limitations on who can be an S corp shareholder derive from the manner in which taxes are imposed on the corporation. The IRS permits shareholders of this type of entity to report what is called "flow-through" income and losses on their individual personal tax returns. Taxes are not assessed at the corporate level when an S corp election is made with the IRS.
If S corp shares are issued to a prohibited entity--another corporation, ( or a partnership)for example--the entire S corp election can be declared null and void by the IRS. In other words, the income of the entity will be taxed not only at the corporate level but in regard to individual shareholders as well. The double taxation an S corp is designed to avoid is enforced by the IRS
Here's an excellent article on the things that cause an involuntary termination of S-Corp election: http://smallbusiness.chron.com/events-cause-termination-s-corporation-64249.html
I know the S election terminates, that was stated in the original question. The question was and is - "Is the termination a taxable event"? If so why is it taxable?
I said yes it is
Further, I said ....As to the WHY?: The limitations on who can be an S corp shareholder derive from the manner in which taxes are imposed on the corporation. The IRS permits shareholders of this type of entity to report what is called "flow-through" income and losses on their individual personal tax returns. Taxes are not assessed at the corporate level when an S corp election is made with the IRS.
Not only is it taxable ... as I have already told you............"-the entire S corp election can be declared null and void by the IRS. In other words, the income of the entity will be taxed not only at the corporate level but in regard to individual shareholders as well. "
You're trying to have you proverbial cak and eat it too
S corporations are required under Sec. 1361(b) to meet the following criteria to qualify as a small business corporation:
Sir or mama, your telling me that the s-corp election ends. The question is "is the termination of the s-election a taxable event"? I know who can and cannot be members of an S-corp. If your missing the questions, you can call me. The question has nothing to do with the tax on the entity going forward, it's about the termination itself.
the income of the entity will be taxed not only at the corporate level but in regard to individual shareholders as well.
in the year of termination
that is the taxable event
We are not communicating. So if I sell 40% of my stock to the partnership, do I calculate a gain or loss on 40% of the assets of the S-Corp? Do I calculate what 100% of the sale price would have been and use that as selling price and calculate a gain or loss based on the FMV of the assets?
It's not that simple
You essentially will be taxed twice
hang on a sec... I have an excellent example for you
Sorry, I lost ya there for a few... another expert locked on while I was looking ... Did't find the article which discussed it in Layman's terms, so I'll just give you IRS guidance... essentially you have to upon loss of status do a short year return wher part of the year you are taxes as a c_corp
The part of the Stermination year ending on the date before theeffective date of the termination is an 1120S(S corporation) short tax year. The part of theS termination year beginning on the first dayon which the termination is effective is an1120 (C corporation) short tax year.
So, you don't really have the typical TRANSACTION based event, you have to allocate between an S-Corp and C-Corp taxation for that year
After the S termination year is divided intoan 1120S short year and an 1120 short year,the separately stated items of income, loss,credit, and deduction, and the amount of thenonseparately stated income or loss must bedivided between the periods. There are twomethods that can be used to make this divi-sion. They are:1) A pro rata allocation, or2) An allocation based on normal tax ac-counting rules.
After the separately stated items and thenonseparately stated income or loss are di-vided, one set of amounts is used for the1120S short year and the other set of amountsis used for the 1120 short year.The corporation will have to file two returnsto cover the S termination year. One coversthe 1120S short year and one covers the 1120short year. The S termination year will countonly as one tax year for figuring carrybacksand carryovers, even though two returns arefiled for the year.
The pro rata allocation cannot be made to any item that results from a corporation’s elec- tion to treat a stock purchase as an asset purchase. The pro rata allocation cannot be made if 50% or more of the corporation’s stock is sold or exchanged during the S termination year.
See page 18 of IRS publication 589
Hope this helps
Here's the code: from http://www.law.cornell.edu/uscode/text/26/1362
(e) Treatment of S termination year
Essentially, (from a colleague here: "
There is a deemed "year end" at the time of termination. The assets are deemed to be sold and then contributed to the new corporation. So any gain or loss on the assets at the time of termination are reported, and the new entity gets to increase basis by the amount of gain that was taxed."
THe "event, " if you will, is the deemed year end and conversion to a C Corp
I think the very last statement "the assets are deemed to be sold and contributed to the Corporation" is what I was trying to get to. Does it have to be a new Corporation? Can I file an 8832 election and be taxed as a partnership as well after the sale?