Below is an excerpt from the Solutions for problem 35 in Chapter 22 in the undergraduate book (South-Western Federal Taxation Comprehensive Volume 2015 edition). Please note what the Solution is labeling as “ordinary income” is likely more accurately labelled “nonseparately stated income” or 1120S page 1 line 21 income. Although the b. computation below is for stock basis (needed to answer 4(c) in your S corporation assignment), the computation of flow through tax items to the shareholder for 4(b) is similar.

The basis rules are also stated in slides 38 and 39 of the Chapter 22 PowerPoint posted in the ACCT 630 blackboard course. The AAA rules are stated at slide 34. (Please note that basis includes the original basis of the stock (purchase price and/or contribution to capital) and tax exempt income. AAA does not include those items.) The distributions rules are stated at slides 31 and 32.

All of these rules are needed for problems 4(c) and 4(d) of your assignment. The Solution below does not show a distribution, although a distribution would likely be reflected in a computation continuing in the format as in the Solution.

You might also want to look at the Schedule K of the Form 1120-S for S corporations and the Schedule K-1 for the 1120-S available at www.irs.gov to see items which are separately stated (in contrast to the nonseparately stated income of line 1 of the K and line 21 of page 1 of the Form 1120-S).

The 1374 built-in gain tax is basically discussed at slides 47 and 48 of the PowerPoint and the 1375 tax basically at slides 54 and 55.

Please recall the basic rules that there is no 1374 tax and no 1375 tax if the corporation has always been an S corporation, that built-in gain is only on an asset the S coporation had when it was a C corporation if it previously was a C corporation, and that the 1375 tax can only apply if the S corporation has E&P (and, since E&P is a C corporation account, the S corporation would have had to previously been a C corporation to have E&P). There is also the question of whether or not eliminating the E&P by the end of a year (by a distribution following slide 32 of the PowerPoint) would eliminate the 1375 tax.