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REG CPA Practice Questions: S Corporation Status Termination and Revocation
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May 3, 2024
In this video, we walk through 5 REG CPA exam practice questions teaching the rules around S Corporation status termination and revocation. Important Links Link to the free study training webinar mentioned in the video: https://www.superfastcpa.com/strategic-study See the full post for this video: https://www.superfastcpa.com/reg-cpa-practice-questions-explained-s-corporation-status-termination-and-revocation/ See the other REG walkthrough videos here: https://www.superfastcpa.com/free-reg-cpa-practice-question-walkthroughs/ 00:00 Intro 00:48 Question 1: S Corporation Qualifications 02:34 Question 2: S Corporation Termination 03:53 Question 3: Voluntary Revocation 05:22 Question 4: Passive Income Threshold 07:04 Question 5: Eligible Shareholders 09:15 Pillar Topics
View Video Transcript
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Welcome to another reg walkthrough video
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I'm Logan, and in today's video, we're going to be going over S-Corporation Status Termination and Revocation
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And we're going to be doing that, the Superfast CPA way, which is diving straight into questions to learn the material
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If you don't know much about our strategies, make sure you go to superfast cpa.com and check out our free one-hour webinar training
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We go over the key ingredients to passing the CPA exam. Again, it's free, it's only one hour long, and it will save you so much time in struggling with your study process
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Also, if you like the idea of going through questions as your main learning material, make
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sure you check out our Super Fast CPA app where we not only have audio notes and review notes
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but we also have five-question mini-quises that you can easily access on your phone all throughout
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your day to continue practicing. With all that said, let's dive straight into the questions
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Okay, here's question one. To maintain eligibility for S-corporation status, which of the following conditions
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must a corporation meet concerning its shareholders? All right, this is the first question of the video, and we don't really know
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much about how corporations become S corporations and what those requirements are
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So let's go ahead and go straight into the answer to learn how this works. Okay, and the answer is D
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The corporation must have no more than 100 shareholders, all of whom must be natural persons
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estates, or certain types of trusts, and no shareholder can be a non-resident alien
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So let's read the explanation a bit more. To be eligible for S corporation status, a corporation must be a domestic entity with no
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more than 100 shareholders, who can only be individuals, certain trust, or estates, and specifically cannot include non-resident aliens, partnerships, or other corporations
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The corporation is allowed only one class of stock, though differences in voting rights are permissible
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All shareholders must agree to the election of S-Corporation status, which is formalized by filing Form 2553 with the IRS
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Typically, an S-corporation must also follow a calendar year for tax purposes, unless a valid business reason exists for a different tax year
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Continuous adherence to these rules is necessary to maintain S corporation status and benefit from its tax implications
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Okay, so we learned here there are multiple requirements to be an S corporation
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You have to have less than 100 shareholders who can only be basically individuals or some kinds of trusts or things like that
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Can't be non-resident aliens, can't be other corporations, can't be partnerships, mainly just individuals or things treated as individuals like trusts or estates
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And they can only have one class of stock and they all have to agree to be an S corporation
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Okay, so we learned the requirements there. Let's go ahead and go to the next question
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Okay, here is question two. JKL Corporation has been an S corporation for several years
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On June 15th 20x4 JKL Corporation issued a second class of stock to attract investors which offer different dividend rights but identical liquidation rights to the existing class of stock
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The company's shareholder base consists of 40 individuals, all of whom are U.S. citizens or residents
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and one qualified S-corporation trust. Based on these facts, which of the following statements is true
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Okay, we just learned about the different requirements to be an S-corporation
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so take a second, pause the video, try to remember what we just learned
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and then see which of the following statements is true. And when you're ready, come back and we will look at the answer together
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Okay, so one thing for sure is that JKL Corporation's S-Corporation status is terminated
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due to the issuance of a second class of stock with different rights. We learned that they can only have one class of stock
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S-Corporation status requires the company to have only one class of stock, and the rights to distribution and liquidation must be identical for each share
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Since JKL Corporation issued a second class of stock with different dividend rights, it has violated the single class of stock requirement, resulting in the termination of its S corporation status
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Okay, pretty simple there. If they have more than one class of stock that terminates their S corporation status
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Let's go ahead and go to the next question. Okay, here is question three. XYZ corp has been operating as an S corporation for the past decade
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The shareholders are contemplating revoking the S corporation election to explore new business opportunities
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In order to assess the feasibility of this decision, they need to determine the level of shareholder support required for the revocation
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If XYZ Corp has 80 shareholders in total and each share of stock entitles the holder to one vote
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how many votes must be cast in favor of the revocation for it to be approved
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Okay. So now we're not talking about termination but revocation, where the S corporation shareholders choose to stop being an S corporation
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So how many votes do they have to have if they have a total of 80 share. Let's go ahead and go into the answer to learn what the rule is here
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Okay, so they would have to have at least 41 votes. Let's read about it
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To revoke the S-corporation status, XYZ Corp must obtain the consent of shareholders representing more than 50% of the
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issued and outstanding stock. With 80 shareholders in total, the threshold for approval would be 40 votes, 50% of 80
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And again, it has to be more than 50%, which means at least 41 votes must be cast in favor of the revocation for it to be approved. Okay
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So now we've learned about what terminates an S corporation typically, and that usually is because they stopped meeting one of the qualifications
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And they can also now revoke their S corporation status if more than 50% of the shareholders decide to revoke the S corporation status
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Let's go ahead and go to the next question. Okay, here is question four. Maple Leaf LLC a former C corporation with undistributed earnings and profits elected S status in year one The company has always had 50 shareholders
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Starting in year two, Maple Leaf LLC began earning increased passive investment income
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For years two, three, and four, the passive investment income accounted for 26%, 27% and 28% of its total gross receipts respectively
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What is the tax impact on Maple Leaf LLC's S-corporation status as of year five
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Okay, we have no idea what the rule is in this case. You know, does this have something to do with them being a former C corporation and now being
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an S corporation? What does passive investment income have to do with all this
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Let's go ahead and go straight into the answer to learn one more rule about all this. Okay, so the answer is that their status will be revoked as the beginning of year five
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So let's learn why. S corporation status is jeopardized when a former C corporation with undistributed earnings and
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profits, receives more than 25% of its gross receipts from passive investment income for three
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consecutive tax years. Maple Leaf LLC's passive investment income exceeded the 25% threshold for three
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consecutive years, and that again was this 26%, 27%, 28% in years 2, 3, and 4, leading to the
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automatic revocation of its S-corporation status on the first day of year 5. So this is one of the unique
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situations where even if they're meeting all the other requirements, if they were a former C-corporation
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and they had undistributed earnings and profits from that. And then for three consecutive years
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more than 25% of their income was from passive activity income, then that will revoke their S-Corporation status as well
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Okay, let's do one more question for this video. Okay, here's question five
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Sandstone Inc. and S-Corporation has undergone several changes in its shareholder structure
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during the current tax year. Four separate transactions resulted in shares being transferred to new entities
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Which of the following new shareholders would cause Sandstone, Inc's S-Corporation status to be terminated
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Okay, so we actually did learn a little bit about this at the very beginning of the video
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Who can be an S-corporation shareholder? Who can't? So pause the video, see if you can remember
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and look at these different options and decide which one would cause their S-corporation status
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to be terminated. And when you're ready, come back and we will look at the answer. Okay, here is the answer
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And S-corporations shares can only be held by eligible entities, which do not include partnerships
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or LLC's treated as partnerships for tax purposes. Therefore, when Sandstone Inc. transferred shares to an LLC that is treated as a partnership
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it violated the eligibility requirements for S-corporations, leading to termination of its S-corporation status
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So let's get one more refresher on who eligible shareholders are. An S can have a range of eligible shareholders including individuals who are U citizens or permanent residents certain trusts such as grantor trusts testamentary trusts for a limited period voting trusts qualified subchapter trusts or QSSTs and electing
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small business trusts or ESBTs. Estates are also qualified shareholders. However, ineligible shareholders include partnerships, C corporations, non-resident aliens, and
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certain trusts not meeting specific internal revenue service qualifications. It's important to note that each shareholder counts as one towards the 100 shareholder limit
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except for certain family members who can be counted as a single shareholder under family attribution rules
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The inclusion of any disqualified shareholder can result in the termination of an entity's as corporation status
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Okay, we learned one more thing there that sometimes, specifically when it comes to family members
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you know, maybe a husband and a wife or a parent and a child, they can count as one shareholder
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when it comes to this 100 shareholder limit. So that's one more thing that we needed to learn there at the end of this video
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All right, those are the questions for this video. Let's do one more part of the Superfast CPA strategy
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which is something called Pillar Topics. Now, the idea behind Pillar Topics is, as you're going through the questions
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you will notice certain things that keep popping up through the questions. These are the things that are obviously important according to your review course
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and these are the things that you now know you need to know for the CPA exam
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So let's go ahead and look at the Pillar Topics for this video. Okay, and here are the Pillar Topics
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As Corporate Status, once selected, has to maintain certain qualifications or else the status is terminated. And let's go over those qualifications
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The S corporation must have 100 valid shareholders or less, have one class of stock, and all shareholders
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have to elect the status. And again, they have to do it the correct way through the IRS
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but that's kind of a given. S corporation status can voluntarily be revoked if more than 50% of
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the shareholders elect to do so. Partnerships C corporations, non-residents, and some trusts
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cannot be shareholders in an S corporation. Just remember that. If you ever see a C-corporation
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partnership or anything like that, that cannot be a shareholder in an S corporation
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If an S corporation was originally a C corporation, and then they switched to an S corporation
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and it has passive income of 25% or greater of total earnings for the past three consecutive years
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the S corporation status can be terminated. All right, those are the basic things that you need to know
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for the CPA exam about this topic. And that is the end of the video. Thank you for watching
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Be sure to go check out our free training webinar on superfast CPA.com. Again, we teach
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the key ingredients to passing the CPA exam, you don't want to miss it. Also, if you liked going through questions to learn the material
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make sure you check out our Superfast CPA app, where we have five question mini quizzes that you can easily access on your phone
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all throughout the day to continue learning. If you like this video, make sure to like it and leave a comment
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I hope this was helpful, and I will see you in the next video
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