Page 361 - TaxAdviser_2022

S CORPORATIONS

Ward as an individual failed to include may acquire it through the liquidation
Of all the IRS these wages for income tax purposes. of a C corporation subsidiary, includ-
Ward’s failure to properly report
ing a qualified Subchapter S subsidiary
guidance over the the passthrough of income from the (QSub) election, or through a merger.
last year and a half, S corporation on the individual return Courts split on split-dollar
stemmed from confusion on her part.
none has raised more As sole shareholder, Ward should In De Los Santos,22 the taxpayer was
questions than Notice report all S corporation nonseparately a medical doctor who conducted his

2020-75. computed income or loss on Schedule practice as the sole shareholder of an S
E, Supplemental Income and Loss, of
corporation. The corporation employed
Form 1040. At trial, she argued that the doctor, his wife, and four other
distributions and compensation for distributions from an S corporation individuals. The corporation adopted
services of a shareholder. Ward was were tax-free to the extent of basis and an employee welfare plan that provided
the sole shareholder and officer of an therefore reduced the share of income benefits to its six employees. For their
S corporation operating as a litigation reported on Schedule E. Here, the court services to the S corporation, the plan
law firm in Minnesota. She had one properly distinguished between income provided the employees with life insur-
salaried associate attorney, for whom and distributions of capital. Ward was ance, among other benefits, pursuant to a
applicable taxes were withheld and also denied a variety of expenses for compensatory split-dollar life insurance
properly reported. Ward’s reported sal- lack of substantiation and held to have arrangement under Regs. Sec. 1.61-22.
ary, however, was inconsistent on Form cancellation-of-debt income because she The issue before the Tax Court
1120-S; Form 941, Employer’s Quarterly failed to show she was insolvent at the was whether the economic benefits
Federal Tax Return; and Form 1040, U.S. time of discharge. that Ruben De Los Santos received
Individual Income Tax Return. Specifi- from the arrangement were taxable as
cally, Ward failed to pay employment Sec. 1368: Distributions ordinary compensation income (com-
tax on amounts designated as officer The tax treatment of distributions from pensatory arrangement) or treated in
compensation, failed to report wages for an S corporation depend on whether the a more taxpayer-friendly manner as a
income tax purposes, and failed to prop- corporation has AE&P. For corporations Sec. 1368(b) distribution (corporation/
erly report passthrough income from the with no earnings and profits (E&P), shareholder arrangement). In a recently
S corporation. distributions are first a tax-free return decided case with similar facts, the Sixth
Generally, officers are employees of a of capital to the extent of basis. Once Circuit adopted the taxpayer-friendly
corporation unless they do not provide a shareholder’s stock basis is reduced approach. The Tax Court in De Los San-
services to the company or solely provide to zero, any additional distributions are tos strongly stated its disagreement with
minor services not entitled to remunera- capital gain. When a corporation has the Sixth Circuit.23
tion.21 Compensation paid to an officer E&P, distributions first come from the As pertinent to this case, a split-
as an employee are wages. The court, corporate AAA and are tax-free to the dollar life insurance arrangement is
finding that Ward failed to provide a extent thereof, provided the shareholder generally any arrangement between an
reasonable basis to treat her status as has enough stock basis available. Once owner of a (nongroup-term) life insur-
anything other than an employee, held AAA is fully distributed, any additional ance contract (here, the S corporation24)
that employment taxes were due from distributions are a dividend to the extent and a nonowner of the contract (here,
the S corporation on Ward’s officer of E&P. S corporations with E&P typi- De Los Santos) under which either
compensation. Further, the court found cally have a C corporation history or party to the arrangement (here, the S

21. Sec. 3121(d)(1) and Regs. Sec. 31.3121(d)-1(b). 24. Generally, the person named as the policy owner of the contract is the
22. De Los Santos, 156 T.C. No. 9 (2021), reviewed by the court. owner of the contract for purposes of the split-dollar regulations (Regs.
23. That De Los Santos was “reviewed by the court,” with all judges agreeing Sec. 1.61-22(c)(1)(i)). However, although the welfare benefit trust actually
with Judge Albert Lauber’s opinion, also demonstrates the court’s strongly owned the policy, the S corporation is deemed the owner for split-dollar
held belief in this regard. purposes (Regs. Sec. 1.61-22(c)(1)(iii)(C)).

30 July 2022 The Tax Adviser