Question

Old Sea Corp. was organized as a C corporation in 1983. Four years ago, Old Sea made a valid S corporation election when it had $35,000 of undistributed E&P. It has generated excess passive investment income of 26%, 22%, and 28% for the last three years. Assuming Old Sea is a calendar year-end corporation, as of what date will the S corporation status be terminated?

Answer 1

Old Sea Corp. will lose its S corporation status on January 1 of the year following the third consecutive tax year in which it had excess passive investment income exceeding the 25% threshold, given the figures of 26%, 22%, and 28% in the last three years.

Step-by-step explanation:

The question is asking about the circumstances under which the S corporation status of Old Sea Corp., which has previously been a C corporation, will be terminated based on its generation of excess passive investment income.

According to the IRS rules, an S corporation that has accumulated earnings and profits from its C corporation years and derives too much passive income can lose its S status.

The specific condition that triggers this is if the corporation has excess passive income (interest, dividends, rents, royalties, etc.) that exceeds 25% of gross receipts for three consecutive taxable years. Since Old Sea Corp. has generated excess passive investment income of 26%, 22%, and 28% for the last three years, it has exceeded the 25% limit in two of those years.

So, as of January 1 of the following year, after the third consecutive year in which the passive investment income exceeded 25% (which was the 28% year), Old Sea Corp.'s S corporation status will be terminated.