Question

BCS was a C Corporation in 2016 and an S Corporation in 2017. Net income for 2016 was $80,000; net income for 2017 was $500,000. For 2016, the three shareholders of BCS were each allocated ordinary business income of zero, as well as separately stated items of zero. Why?​

Answer 1

When shareholder of C Corporations elect to be treated as S Corpration then such Corporation is treated as flow through entities (ie. it become S Corporation) for the purpose of taxation and accordingly all the income earned by the Corporations are taxed in the hand of Owner of the Corporation (ie Shareholder). Such entites are covered by Subchapter S of the Internal Revenue Service Code. Whereas when entity is formed as C Corporation, it is taxed in its own hand for all income earned by it in during the particular year at tax rate as applicable to C Corporation. Shareholders are not taxed again for income of C Coroporation except income received in the form of dividend. Thus when BCS is C Corporation, there is no requirement to allocate ordinary business income or separately stated items to the Shareholders.

Thus in 2016 entire income was taxed in the hand of the BCS when it was C Corporation (and not flow through entity) and hence BCS has not allocated any ordinary business income or separately stated items to Shareholder. In 2017, when it elected to treat it as S Corporation (assuming that all Shareholder has given their ascents to this election), BCS become S Corporation and there onward treatment of allocation of ordinary income and separately stated items in the hand of shareholder is followed.  

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