S Corporation Tax Treatment

Revenue and Taxation Code Chapter 4.5 of Part 11 of Division 2 deals with the tax treatment of S corporations and their shareholders in California.

Section 23800 provides that Subchapter S of Chapter 1 of Subtitle A of the Internal Revenue Code, relating to the tax treatment of “S corporations” and their shareholders, applies.

Section 23800.5 states that Section 1361(b)(3) of the Internal Revenue Code, relating to treatment of certain wholly owned subsidiaries, is modified as specified. Section 1361(b)(3)(A)(i) of the Internal Revenue Code applies. There is a tax imposed annually in an amount equal to the applicable amount specified on a qualified Subchapter S subsidiary that is incorporated under the laws of this state, qualified to transact intrastate business in this state or doing business in this state.

Every qualified Subchapter S subsidiary is subject to the tax imposed from the earlier of the date of incorporation, qualification, or commencement of business in this state, until the effective date of dissolution or withdrawal or, if later, the date the corporation ceases to do business in this state.

Section 23801 provides that a corporation that has in effect for federal income tax purposes a valid election under Section 1362(a) of the Internal Revenue Code is an “S” corporation for purposes of state law. A corporation that is an “S corporation” for federal income tax purposes, is an “S corporation” and its shareholders are shareholders of an “S corporation” without regard to whether the corporation is qualified to do business or is incorporated in this state.

Section 23802 states that Section 1363(a) of the Internal Revenue Code, relating to the taxability of an “S” corporation, does not apply.

Section 23802.5 states that Section 1366(a)(1) of the Internal Revenue Code, relating to determination of shareholder’s tax liability, is modified to apply to the final taxable year of a trust or estate that terminates before the end of the corporation’s taxable year. Section 1366(d)(1)(A) of the Internal Revenue Code, relating to losses and deductions that cannot exceed shareholder’s basis in stock and debt, is modified. Section 1366(d)(3) of the Internal Revenue Code, relating to carryover of disallowed losses and deductions to post-termination transition period, is modified.

Section 23803 states that, with respect to credits that are otherwise allowed to reduce the taxes imposed under this part, the amount of any credit to be claimed is limited to one-third of the amount otherwise allowable. Section 1366(f) of the Internal Revenue Code, relating to special rules, is modified as specified.

Section 23804 states that Section 1367(b)(4) of the Internal Revenue Code, relating to adjustments in case of inherited stock, applies.

Section 23806 states that Section 1371(a) of the Internal Revenue Code, relating to application of Subchapter C rules, is modified. No election under Section 338 of the Internal Revenue Code, relating to certain stock purchases treated as asset acquisitions, is allowed for state purposes unless the “S corporation” or its shareholders made a valid election for federal purposes under Section 338 of the Internal Revenue Code. Section 1371(d) of the Internal Revenue Code does not apply.

Section 23807 states that Section 1372 of the Internal Revenue Code is modified so that references to partnership treatment are to Internal Revenue Code partnership provisions, as modified.

Section 23808 states that Sections 1373 and 1379 of the Internal Revenue Code are not applicable.

Section 23809 imposes a tax on built-in gains attributable to California sources, determined in accordance with the provisions of Section 1374 of the Internal Revenue Code, relating to tax imposed on certain built-in gains, as modified by this section. The rate of tax specified in Section 1374(b)(1) of the Internal Revenue Code is equal to the rate of tax imposed under Section 23151 in lieu of the rate of tax specified in Section 11(b) of the Internal Revenue Code.

Section 23811 provides that there is imposed a tax on passive investment income attributable to California sources, determined in accordance with the provisions of Section 1375 of the Internal Revenue Code, relating to tax imposed on passive investment income, as modified by this section.

Section 23813 states that Section 1377(b)(2) of the Internal Revenue Code, relating to determination defined, is modified to include three specified items.