Post mortem: issues to consider after death of an S corp shareholder.

• Author: Malekhedayat, Julie
• Position: EstatePlanning

There are several issues an estate's executors and advisers must consider when an S corporation shareholder dies. Three of the most common are income tax reporting in the year of death, income lax basis of the decedent's stock passing to heirs and protecting live company's S corp status during estate administration.

Subchapter S of the Internal Revenue Code allows the shareholders of an eligible small-business corporation to make an election to (ax the corporation as a pass-through entity, an S corp. thereby avoiding the double taxation of income inherent in regular C corporation income.

For example, a C corp pays tax on its income al the entity level, then the shareholders pay tax on the income again when it's paid out as dividends. An S corp, though, typically does not pay tax at the entity level, but taxable income is reportable on the individual shareholders' tax returns directly thereby bypassing the entity-level tax. This is a tremendous break for (he shareholders, and it's critical that executors and advisers handle S corps appropriately and protect the S election status.

Tax Reporting in the Year of Death

Scorp income is prorated on a per-share-per-day basis among shareholders. When a shareholder dies, income allocable to that person's shares is prorated between the individual lax return and the estate. Alternatively, if all affected shareholders agree, the books may be closed at the date of death and post-death and post-death income allocated among shareholders accordingly. An analysis of the impact of this election will need to be done in lime for filing any affected tax returns or extensions of lime lo file those returns, and may impact shareholders* current year estimated tax payments.

[ILLUSTRATION OMITTED]

Tax Basis of Inherited Stock

Following normal lax rules, S corp stock held as the separate property of the decedent will receive a See. 1014-step-up in basis lo date-of-death or alternate-valuation-dale fair market value. Stock held as community property will also receive a basis step-up as to both the decedent's and surviving spouse's community properly shares. For 2010 deaths only an election out of the estate lax regime to modified carryover basis treatment is available, in which case a new set of laws will apply that are beyond the scope of this article.

If S corp stock was used to fund a marital trust or bypass trust was the death of the first spouse, then care should be taken at the second death because only the stock owned by the marital trust will receive a stepped-up basis al the second death...