Z Corporation (\"Z\") is a domestic corporation which has 120 shares of voting
ID: 2481873 • Letter: Z
Question
Z Corporation ("Z") is a domestic corporation which has 120 shares of voting common stock outstanding. In each of the following alternative situations, determine whether Z is eligible to elect S corporation status:
(a) Z has 99 unrelated individual shareholders, each of whom owns one share of Z stock. The remaining 21 shares are owned by A and his brother, B, as joint tenants with right of survivorship.
(b) Same as (a), above, except that A and B are married and own 11 of the 21 shares as community property. The remaining 10 shares are owned 5 by A as her separate property and 5 by B as his separate property.
(c) In (b), above, assume that the shareholders of Z elected S corporation status. What will be the effect on Z's election if one year later A dies and bequeaths her interest in Z stock to F, her long-time friend?
(d) Same as (a), above, except that the remaining 21 shares are held by a voting trust which has three beneficial owners.
(e) Same as (a), above, except that the remaining 21 shares are owned by a revocable living trust created by an individual, the income of which is taxed to the grantor under § 671.
(f) Same as (a), above, except that the remaining 21 shares are owned by a testamentary trust under which the surviving spouse has the right to income for her life, with the remainder passing to her children. The trust is a "qualified terminable interest trust" (see § 2056(b)(7)).
(g) Assume Z has 100 individual shareholders and forms a partnership with two other S corporations, each of which also has 100 individual shareholders, for the purposes of jointly operating a business. Z's one-third interest in this partnership is its only asset.
(h) Z has 100 shares of Class A voting common stock and 50 shares of Class B nonvoting common stock outstanding. Apart from the differences in voting rights, the two classes of common stock have equal rights with regard to dividends and liquidation distributions. Z also has an authorized but unissued class of nonvoting stock which would be limited and preferred as to dividends. The Class A common stock is owned by four individuals and the Class B common stock is owned by E and F (a married couple) as tenants-in-common.
(i) Same as (h), above, except that Z enters into a binding agreement with its shareholders to make larger annual distributions to shareholders who bear heavier state income tax burdens. The amount of the distributions is based on a formula that will give the shareholders equal after-tax distributions.
(j) Z has four individual shareholders each of whom own 100 shares of Z common stock for which each paid $10 per share. Each shareholder also owns $25,000 of 15-year Z bonds. The bonds bear interest at 3% above the prime lending rate established by the Chase Manhattan Bank, adjusted quarterly, and are subordinated to general creditors of Z.
Explanation / Answer
a) Yes (since family members). Corp. has only 100 shareholders. §1361(c)(1)(B). b) §1361(c)(1) treats a husband and wife as one shareholder and the corporation will have only 100 shareholders. What is “marriage”? Cf. DOMA. The format of the husband/wife ownership is not relevant (e.g., JTWROS is not essential). Both A&B must file S corp. shareholder consents c) The §1361(c)(1) rule concerning shareholder count applies to spouses and their estates. Estates are also permissible shareholders. Upon distribution to F the election will terminate (under §1362(d)(2)(A)), since Z will then have 101 shareholders (with B & F not treated as “family”). Termination upon the share distribution date. d) A voting trust is a permissible S corporation shareholder under §§1361(b)(1)(B) & 1361(c)(2)(A)(iv). But, §§1361(b)(2)(B)(iv): Each beneficiary of the trust is treated as a shareholder; therefore, Z will have 102 shareholders. Z will not qualify as an S corp. e) A trust treated as owned by an individual is a permissible shareholder under §§1361(b)(1)(B) & 1361(c)(2)(A)(i). Z will qualify since only 100 shareholders (the deemed owner/trust grantor is treated as a shareholder). f) Is this trust a "qualified subchapter S trust" (QSST) under §1361(d)? See §1361(d)(3). The trust will be treated as a trust described in §1361(c)(2)(A)(i) if the beneficiary makes an election under §1361(d)(2). The beneficiary is treated (for income tax) as the owner of trust assets (under §678). g) Rev. Rul. 94-43 (no casebook reference): The three S corporations (each having the maximum shareholders) do not lose separate S status when organizing a partnership for joint operation of a business even when avoiding the shareholder limits. h) Does Z violate the one-class-of stock limitation in §1361(b)(1)(D)? 1) Under §1361(c)(4) the difference in voting rights between the two classes is not deemed to create two classes of stock for S corp. rules. 2) Authorized but unissued preferred stock is not relevant (until issued). See Reg. §1.1361-1(l)(1). i) Z will be treated as having more than one class of stock because the rights of all shareholders are not identical. Cf., Reg. §1.1361-1(l)(2)(ii) recognizing that some states may require direct payments to the state taxing authority; ok, assuming identical distributions (without regard to timing).
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