Larry's Tax Law

I have feverishly been reporting about provisions of the One Big Beautiful Bill Act and have left my multi-part series on Subchapter S adrift at sea.  Accordingly, I want to sneak in one more article in this Subchapter S series before turning my attention back to the Act.

Single-Class-of-Stock Requirement

In accordance with Code § 1361(b)(1)(D), an S corporation may not have greater than one class of stock.  The key to only having one class of stock is generally to make sure that all outstanding shares have identical rights to distribution and liquidation proceeds.  That concept, however, may be easily said, but it may be difficult to fully grasp, implement and monitor.  In this blog post, I aim to synthesize the complexities of this monumental rule of Subchapter S into an understandable set of guidelines.

In this fifth installment of my multi-part series on the One Big Beautiful Bill Act, Steve Nofziger and I discuss a provision of the Act that impacts certain business owners who are contemplating a sale of their shares, Code Section 1202.[1]

Background

Code Section 1202 has a rich history.  It was originally enacted over three decades ago as part of the Revenue Reconciliation Act of 1993.  It was one of many provisions of that legislation aimed at stimulating the investment in closely held businesses.  Congress tinkered with Code Section 1202 over the following years, enhancing the benefits it offered small business owners.  In 2009, as part of the American Recovery and Reinvestment Act of 2009, Congress temporarily increased the amount of gain exclusion offered under this provision.  The next year, as part of the Small Business Jobs Act of 2010, Congress temporarily increased the gain exclusion in limited circumstances to 100%.  Impetus for that amendment to Code Section 1202 (increasing the benefit to 100%) was recognition by lawmakers that many taxpayers that otherwise qualified for gain exclusion under Code Section 1202 were not able to take advantage of it due to other provisions of the Code (e.g., the individual alternative minimum tax). The 100% exclusion, however, enhanced the benefit so that taxpayers subjected to the alternative minimum tax would see some benefit from the application of Code Section 1202.  Accordingly, as part of the Protecting Americans from Tax Hikes Act of 2015, Congress made the 100% exclusion permanent.  Consequently, the selling shareholders of a closely held corporation and their tax advisers today need to evaluate the application of Code Section 1202.            

The One Big Beautiful Bill Act (the “Act”), signed into law by President Trump on July 4, 2025, made several significant changes to the existing framework for the exclusion of capital gains from the sale of qualified small business stock (“QSBS”) under Code Section 1202.

Now that the scurrying around and worrying relative to developments impacting the Corporate Transparency Act (“CTA”) that were coming at us with laser speed are on a slow simmer, I can turn my attention back to my multi-part series on Subchapter S.  Don’t worry, I am not abandoning my coverage of the CTA.  I intend to report any future developments, earth-shattering or otherwise.  

INTRODUCTION

At the most fundamental level, corporations with an election in effect under Code Section 1362 are flowthrough entities.  Items of income, loss, deduction and credit pass through to the shareholders under Code Section 1366 on a pro-rata basis.  Likewise, all operating and liquidating distributions must be made to the shareholders in strict proportion to share ownership.  Unlike Subchapter K, which allows in certain circumstances special allocations of the pass-through items and disproportionate distributions, Subchapter S is not so forgiving. 

These concepts seem mundane.  Unfortunately, in practice, they can sometimes create havoc for the unwary.

In this Part XVI of my multi-part series on some of the not-so-obvious aspects of Subchapter S, I explore how the flowthrough of items of income, loss, deduction and credit are impacted when there are changes in the ownership of an S corporation during the taxable year.

In this Part XV of my multi-part series on some of the not-so-obvious aspects of Subchapter S, I explore a potential advantage that the S corporation has over the C corporation.

The Patient Protection and Affordable Care Act, as modified by the Health Care and Education Reconciliation Act of 2010, effective January 1, 2013, imposes a three and eight-tenths percent (3.80%) Medicare tax (the “Net Investment Income Tax” or the “NIIT”) under Code § 1411 on the lesser of:

In this Part XIV of my multi-part series on some of the not-so-obvious aspects of Subchapter S, I explore a narrow aspect of Subchapter S that is often ignored or forgotten.  An S corporation is not always a mere extension of its shareholders.

Because of the pass-through nature of Subchapter S, taxpayers and their advisers often conclude that an S corporation is a mere extension of its shareholders.  That is not always the case.  A 2012 decision of the U.S. Tax Court provides a good illustration of this point.

Basic Rules

IRC § 6501(a) generally requires the IRS to assess tax within three (3) years after a tax return is filed by the taxpayer. 

There are two (2) notable exceptions to this rule under IRC § 6501(c) and (e), namely:

1. Under IRC § 6501(c), an unlimited assessment period exists in the case of a false or fraudulent return where the taxpayer has the intent to evade tax; and
2. Under IRC § 6501(e), a six (6) year period for assessment exists in the case where the taxpayer understates gross income by more than 25 percent, unless there is adequate disclosure on the taxpayer’s original tax return.

In the case of a shareholder of an S corporation, the analysis is generally conducted at the shareholder level.  In other words, the focus is on the shareholder’s tax return, and the issue is whether there is a problem with that return that would extend the limitation period for assessment.

As we know from the basic rules, absent fraud or an undisclosed substantial understatement of gross income, the limitation period for assessment is three (3) years.  Likewise, absent fraud, an undisclosed substantial understatement of gross income extends the limitation period for assessment to six (6) years.

In this Part XI of my multi-part series on some of the not-so-obvious aspects of S corporations, I explore a topic that should be obvious but which appears to be ignored by many taxpayers and their tax advisers – accurate computation of shareholder basis for purposes of taking losses flowing through from the S corporation is important.

Background

In 2005, the Internal Revenue Service launched a study to assess the reporting compliance of S corporations.  The study, carried out under the National Research Program (“NRP”), involved the examination of roughly 4,800 randomly selected S corporation returns from tax years 2003-2004.  Based upon the portions of the study disclosed by the Service to the public, six major areas of noncompliance in the S corporation arena were detected:

Introduction

When considering converting a C corporation to an S corporation, tax advisers and taxpayers need to pay careful attention to the many perils that exist.  Failure to pay close attention to the road in this area could result in a disaster.  This Part X of my multi-part series on Subchapter S is designed to illuminate some of the road hazards that exist along the roadway traveling from Subchapter C to Subchapter S. 

Before converting an existing C corporation to an S corporation, an analysis of several matters should be undertaken, including the impact of the election on the shareholders and the corporation.  These matters include, but are not limited to, the topics briefly discussed below.

This fifth installment of my multi-part series on Subchapter S is focused on married individuals who own shares of an S corporation.  While the rules relating to shareholder eligibility seem straightforward, their application relative to spouses may create traps for unwary taxpayers and their tax advisers.

BACKGROUND

Number of Shareholders Limitation

Prior to 1996, an S corporation could have no more than 35 shareholders.  The Small Business Job Protection Act of 1996 (“SBJPA”) amended Code Section 1361(b)(1)(A), increasing the maximum number of permitted shareholders of an S corporation to 75.  In 2004, Congress enacted the American Jobs Creation Act (“AJCA”). The AJCA further amended Code Section 1361(b)(1)(A), increasing the maximum number of permitted shareholders of an S corporation to 100.  This change was effective for tax years beginning in 2005.  Today, the maximum number of permitted shareholders of an S corporation remains at 100.

This fourth installment of my multi-part series on Subchapter S is focused on suspended losses of an S corporation.  While the rules seem straightforward, their application can be tricky, especially given legislative changes made in recent years.

Background

In general, S corporation shareholders, like the owners of entities taxed as partnerships, are allocated their share of the entity’s losses for the taxable year.  A number of rules, however, may limit the ability of the owners to deduct these losses.