Vol. 8, No. 4, Pg. 32. Recent Changes to S Corporation Rules.

• Author: By James F. McCrackin

South Carolina Lawyer

1997.

Vol. 8, No. 4, Pg. 32.

Recent Changes to S Corporation Rules

32Recent Changes to S Corporation RulesBy James F. McCrackinOn August 20, President Bill Clinton signed the Small Business Job Protection Act of 1996 (SBJPA). The SBJPA provides for numerous changes to the Internal Revenue Code (IRC). Included in these changes are various amendments regarding the eligibility and operation of a corporation under Subchapter S of the IRC.

Some changes are intended to eliminate the disadvantages previously associated with the choice of an S corporation as a business entity, while other changes clarify areas of confusion.

Limitations on the Number of Shareholders Increased

The SBJPA amends IRC § 1361 (b)(1)(A) to provide that an S corporation may have up to 75 shareholders. S corporations were previously limited to 35 shareholders. The rule that a husband and wife, and their estates, are treated as a single shareholder remains unchanged. This change in the number of eligible shareholders should make it easier for some corporations to qualify under Subchapter S.

S Corporations May Have Subsidiaries

Under previous law, an S corporation could not have a C corporation as an 80 percent or more subsidiary (except for an inactive subsidiary), because an S corporation was not allowed to be a member of an affiliated group as defined in IRC § 1504. IRC § 1361 (b)(2)(A). An S corporation

33was prohibited from having another S corporation as a subsidiary because a corporation was not an eligible shareholder of an S corporation. IRC §1361 (b)(1)(B).

The SBJPA eliminates the affiliated group prohibition and allows an S corporation to own 80 percent or more of the stock of a C corporation. However, an S corporation still may not be included in a consolidated return. IRC § 1504 (b)(8).

Dividends received by an S corporation from an 80 percent-or-more-owned C corporation shall not be treated as "Passive Investment Income" for purposes of: 1) the tax imposed when the passive investment income of an S corporation with subchapter C earnings and profits exceeds 25 percent of gross receipts under IRC § 1375; and 2) the rule that terminates the S corporation status of S corporations with subchapter C earnings and profits where passive investment income exceeds 25 percent of gross receipts for three consecutive years under IRC § 1362(d)(3).

The rule that an S corporation may not have a corporate shareholder remains unchanged. However, an S corporation will be allowed to own the stock of a "qualified Subchapter S subsidiary." A qualified Subchapter S subsidiary includes any domestic corporation that would otherwise be eligible as an S corporation if: 1) the corporation is 100 percent owned by an S corporation parent; and 2) the S corporation elects to treat the subsidiary as a qualified Subchapter S subsidiary. IRC §§ 1361 (b)(3)(B)(i) and (ii). A qualified Subchapter S subsidiary will not be treated as a separate corporation, and its assets, liabilities and items of income, deduction and credit are...