S corporation compliance topics covering elections, basis, distributions, built-in gains, and midyear ownership changes.
This chapter covers the compliance rules that make S corporations distinct from both C corporations and partnerships. TCP questions in this area often turn on election validity, shareholder basis tracking, the residue of prior C corporation history, and the allocation of tax items when ownership changes during the year.
S corporation compliance questions should be solved in sequence. First confirm that S status is valid, then trace shareholder stock basis, debt basis, AAA, accumulated earnings and profits, distributions, and any ownership-change allocation. A favorable pass-through answer can be wrong if eligibility was lost or if basis does not support the deduction or distribution treatment.
| Compliance issue | What controls the answer | Common TCP trap |
|---|---|---|
| Eligibility and election | Shareholder type, share class, timing, consent, and termination rules. | Computing S corporation treatment before confirming valid S status. |
| Stock and debt basis | Contributions, income, losses, distributions, and direct shareholder loans. | Using corporate debt as shareholder debt basis without the required relationship. |
| AAA and distributions | Account ordering, basis reduction, and possible dividend treatment. | Treating every distribution as tax-free because the entity is an S corporation. |
| Built-in gains and C corporation history | Prior C corporation attributes can create entity-level tax or dividend effects. | Ignoring accumulated E&P after a C-to-S conversion. |
| Ownership changes | Allocation method and timing determine each shareholder’s share of annual items. | Allocating the full year by ending ownership when a midyear change matters. |
| Step | Compliance task | Why it controls the answer |
|---|---|---|
| 1. Validate S status | Confirm eligible shareholders, one class of stock, domestic corporation status, consent, and timely election. | Invalid status sends the problem back to C corporation treatment. |
| 2. Track stock basis | Increase basis for income and contributions, then reduce it for distributions and losses in the correct order. | Loss deductions and tax-free distributions cannot exceed available basis. |
| 3. Separate debt basis | Identify direct shareholder loans and restore debt basis when later income is allocated. | Corporate borrowing does not automatically create shareholder debt basis. |
| 4. Apply AAA and E&P ordering | Determine whether distributions reduce AAA, stock basis, accumulated E&P, or create gain. | Prior C corporation history can turn an S corporation distribution into dividend income. |
| 5. Allocate annual items | Use the correct allocation method when ownership changes, shares transfer, or the S election terminates. | The same annual income can belong to different shareholders depending on timing. |