Subchapter S of the Internal Revenue Code governs S corporations and their shareholders.1 Over the 12–month period ending March 2025 covered by this article, several court cases and items of IRS guidance had a bearing on S corporations, with implications for their tax preparers and advisers. The AICPA S Corporation Taxation Technical Resource Panel, a volunteer group of practitioners devoted to study and advocacy concerning S corporations and their shareholders, writes this annual survey in The Tax Adviser of these developments. The topics are arranged by Code section (starting with those in Subchapter S and then other sections).
Sec. 1361: S corporation defined
Sec. 1361 sets forth the basic qualifications for S corporation status. Among the most important are the limitation on types of shareholders and restrictions to a single class of stock.
Single class of stock
Nonconforming operating agreements create multiple classes of stock: In 2023, the “Current Developments in S Corporations” article in The Tax Adviser contained a detailed discussion of Rev. Proc. 2022-19.2 One of the important rules this revenue procedure introduced was permission for an S corporation to retroactively correct nonidentical governing provisions, under which an S corporation may be treated as having multiple classes of stock.3
This self–correction rule may apply, for instance, if an entity (most likely an unincorporated entity that has elected S corporation classification under Regs. Sec. 301.7701–3(c)) has an agreement that provides that liquidating distributions are to be proportional to members’ capital accounts, or other language incompatible with the single–class–of–stock rules. Under the revenue procedure, the entity may correct this problem by retroactively adopting new agreements that conform to Subchapter S, if the entity has not made any disproportionate distributions and has filed consistently as an S corporation and the IRS has not yet discovered the issue.
However, the offending language must be the only violation of Subchapter S for the self–correction rule to apply. Thus, it appears that any additional violation, such as the failure to file a timely Form 2553, Election by a Small Business Corporation, renders this self–correction provision inoperable, even if the late election would otherwise be eligible for service center relief under Rev. Proc. 2013–30. Moreover, Rev. Proc. 2013–30 would also be unavailable for late election relief, since the late election must be the only violation for this revenue procedure to apply. Thus, it appears that a ruling request would be the only possible solution for an entity that has both these two offenses, even though either one, by itself, would be within the more expeditious domains of Rev. Proc. 2013–30 and Rev. Proc. 2022–19.
Tax Court refuses to terminate S election: In August 2024, in Maggard, the Tax Court held that the founder of an S corporation was liable for taxes on income that was never distributed to him because the corporation’s S election was not terminated when it made disproportionate distributions to its other shareholders.4
James Maggard founded an engineering consulting partnership that was later incorporated as an S corporation. The bylaws provided for 10,000 shares of one class of common stock, which entitled each owner under the relevant state law to a pro rata share of any dividends as well as any distribution of the corporation’s assets on liquidation. Maggard maintained a 40% interest in the corporation and sold a 60% interest to two individuals (40% to one and 20% to the other).
According to the court, the two individuals proceeded to misappropriate funds and make disproportionate distributions to themselves. In addition, they did not file Forms 1120–S, U.S. Income Tax Return for an S Corporation, with the IRS or send Maggard Schedules K–1, Shareholder’s Share of Income, Deductions, Credits, etc., showing his share of distributions.
Maggard accused the individuals of embezzling more than $1 million from 2012 to 2015. The individuals then cut Maggard off from the corporation’s books and out of meetings, voted to increase their salaries and benefits, and authorized payouts to themselves based on retroactively increasing their paid time off.
The individuals then sued Maggard in California Superior Court, alleging breach of contract and fraud, and Maggard filed a countersuit in 2013. The California Superior Court found that the corporation had overdistributed to one of the individuals and underdistributed to Maggard and ordered the company to make corrective distributions to Maggard, which the individuals refused to do. Maggard then agreed to an offer from one of the individuals to buy his entire stake in the corporation for about $1.26 million.
The S corporation filed its Forms 1120–S in 2018 for tax years 2011—2016. Maggard’s attorney asked one of the individuals to inform Maggard of his share of the corporation’s income and expenses, and the individual provided a napkin with the number $300,000 written on it, representing Maggard’s pro rata portion of the corporation’s losses for tax year 2014. The individual did the same for 2015, with a loss of $50,000. The corporation subsequently issued Schedules K–1 to Maggard for the 2011—2016 tax years showing his proportionate share of the earnings as profits, not losses.
The IRS audited Maggard and determined that he and his wife did not correctly report income from the corporation for the years 2014–2016.
Because an S corporation is a passthrough entity, the IRS argued, Maggard must pay tax on his share of the corporation’s income for the years at issue, regardless of whether the income was distributed to him. Maggard, however, argued that the corporation’s S election terminated before the years at issue by virtue of the repeated disproportionate distributions made by the corporation, which, Maggard maintained, violated Sec. 1361(b)(1)(D)’s requirement for an S corporation to have only a single class of stock. As a result, Maggard asserted, the corporation was no longer a passthrough entity from 2014 to 2016, and he should not be required to pay tax on his share of the corporation’s income.
In concluding that the disproportionate distributions made before the years at issue did not terminate the corporation’s S election, the court cited the relevant regulations and emphasized that, despite the history of disproportionate distributions, the corporation did not formally change its governing documents or authorize or create a second class of shares. Thus, the governing provisions continued to provide for identical rights to distributions and liquidation proceeds.
Citing case law and the regulations, the court said, “One cannot help but sympathize with a taxpayer caught in this situation. But it is a situation that we’ve seen before.”
Of all the statutory requirements that must be satisfied for an entity to be an S corporation, perhaps the most misunderstood is Sec. 1361(b)(1)(D)’s requirement for a corporation to have only a single class of stock. Many taxpayers and tax advisers alike interpret this rule to mean that an S corporation must make every distribution precisely pro rata and that even a single disproportionate distribution will result in an immediate, cataclysmic termination of the corporation’s S election.
As the Tax Court reminded in Maggard, however, that is not how Regs. Sec. 1.1361–1(l) works. Instead, those regulations look not to what a corporation actually does in making its distributions but rather to what the corporation’s governing provisions say. This rule creates a fascinating and often confusing dichotomy: As evidenced in Maggard, a corporation may make years of disproportionate distributions, but those distributions should not create a second class of stock as long as the governing provisions provide for identical rights to distribution and liquidation proceeds. Conversely, if an S corporation makes every distribution pro rata to the penny but confers nonidentical rights to distribution and liquidation proceeds in its governing provisions, the election will terminate.5
A common concern for practitioners has been the fear that the IRS would treat a pattern of repeated disproportionate distributions as creating a deemed, implied governing provision. But it is difficult to imagine a longer — or more egregious — pattern of disproportionate distributions than the one found in Maggard, and yet the IRS and Tax Court refused to terminate the corporation’s S election.
Of course, all S corporations should make each distribution pro rata. After all, an S corporation must allocate all income pro rata on a per–share, per–day basis; as a result, if distributions are made disproportionately, at least one shareholder will be burdened with paying tax on his or her pro rata share of income without a corresponding pro rata distribution of cash.
Sec. 1362: Election; revocation; termination
As outlined in previous update articles,6 Sec. 1362(b)(5) instructs the IRS to accept late S elections if the delinquency is due to reasonable cause. As mentioned above, Rev. Proc. 2013–30 permits S corporations to file for relief for such delinquencies, including for late qualified Subchapter S subsidiary (QSub) elections and entity–classification elections for unincorporated entities electing S corporation status.
However, certain relief under Sec. 1362 requires a taxpayer to submit a request for a private letter ruling. The user fees prescribed by Rev. Proc. 2025–1 for a private letter ruling request submitted after Feb. 1, 2025, were increased from those of the previous annual period.7 However, taxpayers considering requesting a letter ruling for an inadvertent S election termination should review Rev. Proc. 2013–30 and Rev. Proc. 2022–19 for potential relief without requesting a ruling and paying the user fee. Since publication of the last S corporation update in the July 2024 issue of The Tax Adviser,8 the IRS has issued numerous letter rulings granting relief for failure to file timely trust elections.9 There were several other rulings where trusts had been qualified for two years following the grantor’s death but took no action to maintain eligibility thereafter. The trusts had not only failed to file elections as QSSTs or ESBTs within this qualification period but had also missed the three–year–and–75–day period in which they could have filed for relief with the service center, as permitted by Rev. Proc. 2013–30. Thus, the parties filed applications for relief more than five years and 75 days after the death of the grantor.10 In one ruling, six trusts owned stock in three S corporations, resulting in 10 inadvertent terminations. The IRS granted relief for eight ESBT and two QSST elections.11
Sec. 1362(g) election after termination
A corporation that has terminated an S election may not convert back to S status within five years unless the IRS grants permission for early election. The only means to obtain this relief is via a letter ruling, accompanied by a proper ruling application and a user fee. The IRS policy is to permit an election within five years only if more than 50% of the stock has changed hands since the termination.12
In one letter ruling, the IRS permitted an early reelection when the shareholders had transferred the requisite ownership to an employee stock ownership plan (ESOP) after the corporation terminated its S election. However, the IRS conditioned the ruling on the representation that the selling shareholders would not defer their gains under Sec. 1042.13
Sec. 164: Taxes
Because the Tax Cuts and Jobs Act (TCJA), P.L. 115–97, placed a $10,000 cap on the individual deduction for state and local taxes (SALT), many states now offer passthrough entity tax (PTET) regimes.14 These are intended to replace tax historically assessed directly to passthrough entity owners with a tax on the passthrough entity itself, in an effort to work around the SALT cap by avoiding having such state and local taxes treated as itemized deductions. In Notice 2020–75, issued in late 2020, the IRS announced that it would issue proposed regulations governing the federal income tax treatment of PTET payments. However, at the time of this writing, no such proposed regulations have appeared, and, moreover, there is no mention of the PTET in the current IRS priority guidance plan.15 Thus, the sole IRS authority on the matter as of this writing remains Notice 2020–75.
As of early 2025, 36 states permit S corporations and partnerships to elect to treat state income taxes as payments imposed on the entity, even though many of these states allow shareholders and partners to claim a credit against their personal income tax liabilities for their allocable portions of the PTET paid by the entity. In 2024, three states that do not currently offer this alternative considered PTET bills but did not enact the legislation.16
It is beyond the scope of this article to cover each state’s nuances. However, it is extremely important for S corporation owners to review each state’s rules, as they are not uniform in their application. Practitioners and taxpayers are advised to address several questions before making decisions involving PTETs.17
At the time of this writing, there are discussions about not extending the SALT cap along with other temporary individual TCJA provisions expiring at the end of 2025, increasing it, and/or even extending it to C corporations.18 However, even if the SALT cap disappears, the treatment of the PTET as an ordinary deduction for the S corporation or partnership gives many owners tax advantages over the treatment of the state income tax payment as an itemized deduction. However, the complications when an entity does business in multiple states, has owners in several states, or is a member of a tiered passthrough entity may mitigate against electing this treatment.
As 2025 moves forward, S corporations and their advisers will need to watch carefully for legislative developments at both the federal and state levels.
Sec. 6418: Transfer of certain credits 19
Under Sec. 6418 and related regulations, an S corporation can be either a transferor or transferee of eligible credits. These include 11 credits for investment in qualifying property or production of energy from clean sources.20
This allows for the creator of eligible credits to sell them to an unrelated party at a discounted rate, increasing the seller’s cash flow and providing the buyer the ability to pay their federal income tax at a discounted rate.21
Example 1: An S corporation places in service a solar and battery energy storage project in January 2025, calculating a $250,000 Sec. 48E credit. The S corporation may choose not to allocate the energy credit to the shareholders for the 2025 tax year, as the shareholders may not be able to fully utilize the credit, or the shareholders would like to receive the cash tax benefit from the credit prior to filing their 2025 federal income tax return. Rather, the S corporation can opt to sell the $250,000 credit, generally at a discounted amount, allowing the collection and distribution of cash to their shareholders before the tax year end, thereby preventing the S corporation shareholders from having to wait until April 15, 2026, or even Oct. 15, 2026, if their personal tax returns are extended, to receive the cash benefit.
The buyer of the S corporation’s clean–energy credit can utilize the purchased credit to offset estimated income tax payments. As provided by the IRS’s frequently asked questions related to the transferability of the credits, a buyer can consider eligible credits that are purchased or intend to be purchased when calculating its estimated tax payments.22 Therefore, in this example, the buyer can decrease its first–quarter estimated tax liability by the credit purchased, or expected to be purchased, for $250,000, while paying a discounted amount to the seller. The discount range varies according to the current market but could currently range between approximately 90 cents and 94 cents for each dollar of credit purchased.23
On April 25, 2024, Treasury and the IRS issued final regulations, effective July 1, 2024, prescribing the rules and definitions for transfers of eligible credits, including specific rules for S corporations.24 While credit usage for C corporations is generally relatively straightforward, the credit usage for S corporations can be more complex due to the flowthrough nature of the credits to shareholders, including the application of the passive–activity rules as well as general business credit limitations regarding tentative minimum tax and alternative minimum tax (AMT).
The final Sec. 6418 regulations
An S corporation can be considered a transferee taxpayer as well as purchase eligible credits.25 The type of eligible clean–energy credits that can be transferred is expansive but notably does not include the commercial vehicle credit under Sec. 30D. IRS Publication 5817–G, Clean Energy Tax Incentives: Elective Pay Eligible Tax Credits (6–2023), provides a list of transferrable tax credits.
An S corporation may qualify as a transferee taxpayer to the extent it is not related, within the meaning of Sec. 267(b) or 707(b)(1),26 to the eligible taxpayer selling the eligible credits.27 Additionally, while the S corporation that purchases the credit is not allowed to transfer the credit again, an allocation of a transferred specified credit portion to a direct or indirect shareholder is allowed. In other words, the passthrough of the credits from a transferee S corporation to its shareholders is not considered an impermissible second transfer — but the purchasing S corporation and the S corporation shareholders would be prohibited from transferring their allocable share of the credits to another taxpayer.
Implications for the transferee taxpayer (‘buyer’)
When an eligible credit is purchased, the buyer is allowed to utilize the credit purchased in the first tax year ending with or ending after the tax year the seller determined the credit.28 If the buyer and seller both have a calendar year end, then an eligible credit that is determined for a tax year will be the same tax year in which the buyer will utilize the credit. However, if the buyer has a fiscal year end, the buyer must take into account the eligible credit in the first tax year that ends after the tax year of the seller. This causes fiscal–year buyers to explore credits earlier than a traditional calendar–year–end taxpayer. For example, if the tax year end of the buyer is June 30, 2025, a credit must be purchased from a seller with a Dec. 31, 2024, year end in order to utilize the eligible credit for the tax year ending June 30, 2025.
Alternatively, if the eligible taxpayer from whom the credits were purchased has a fiscal year ending June 30, 2026, and the transferred specified credit portion was generated from a project placed in service on Nov. 1, 2025 (i.e., during the seller’s fiscal year ending June 30, 2026), the buyer is treated as purchasing the credit during its calendar year ending Dec. 31, 2026, which is the first tax year ending after June 30, 2026.
The cash payment made by the S corporation buyer as consideration for a transferred eligible credit is treated as an expenditure not deductible in computing taxable income and not properly chargeable to capital account.29 As such, the cash payment is not considered a deductible expense for purposes of taxable income or a capitalizable item but would be required to reduce each shareholder’s stock basis in the S corporation pro rata.30 Generally, it is anticipated that the cash payment will be less than the actual amount of the purchased credit; thus, each shareholder’s pro rata share of the transferred credit will exceed their proportionate basis reduction for the cash payment.
The final regulations contain various other provisions pertaining to credit recapture, ineffective transfers, excessive credit transfers, etc., which are not addressed here. The passive–activity, tentative minimum tax, and AMT limitations may apply to S corporation shareholders receiving an allocation of credits from an S corporation purchasing eligible credits pursuant to Sec. 6418 and the final regulations.
Application of passive credit rules
Regs. Sec. 1.6418–2(f)(3)(ii) provides that a specified credit portion transferred to a buyer is treated as determined in connection with the conduct of a trade or business and, if applicable, such transferred specified credit portion is subject to the passive credit rules of Sec. 469. So, for example, if the transferee taxpayer is a C corporation, Sec. 469 is inapplicable. However, for the shareholders of an S corporation, the specified credit portion allocable to each shareholder would generally be subject to the Sec. 469 passive credit rules.
During the comment period for the proposed Sec. 6418 regulations, Treasury and the IRS received many comments on this issue, several of which argued against applying the passive credit rules to transferee taxpayers. Ultimately, they concluded that the language in Sec. 6418 supports not disregarding the passive credit rules for transferred specified credit portions or applying the rules in a different manner than they apply to other general business credits arising in a trade or business. In other words, there is no carveout for Sec. 469 in Sec. 6418. Instead, Sec. 469 provides that a credit is subject to the passive credit rules if the credit arises in the conduct of a trade or business in which the taxpayer does not materially participate in the year to which the credit is attributable, and the credit is a general business credit under Sec. 38.
In the Summary of Comments and Explanation of Revisions accompanying the issuance of the final regulations, Treasury and the IRS stated that the application of Sec. 469 to a transferee taxpayer is not inconsistent with the language in Sec. 6418 that provides a transferee taxpayer shall be treated as the taxpayer for purposes of the Code with respect to the transferred credit.31 Regs. Sec. 1.6418–2(f)(3)(ii) further provides that, in applying Sec. 469, the buyer is not considered to own an interest in the eligible taxpayer’s (the seller’s) trade or business at the time the work was done, as required by the material–participation rules under Regs. Sec. 1.469–5(f)(1). Therefore, if an S corporation shareholder is allocated their pro rata share of S corporation eligible credits purchased, even if the S corporate shareholder materially participates in the S corporation, they generally will still be subject to the Sec. 469 passive–activity rules in relation to the eligible credit allocated, as the shareholder did not actively participate in the entity that created the eligible credit. Additionally, the transferee taxpayer cannot change the characterization of its participation (or lack thereof) in the eligible taxpayer’s trade or business by using any of the grouping rules under Regs. Sec. 1.469–4(c). The fact that the eligible credits purchased by S corporations must be allocated pro rata and all S corporation shareholders must have passive–activity income to utilize the eligible credits purchased limits the ability for S corporations to take advantage of purchasing eligible credits at a discount. However, partnerships may be able to use special allocations to align purchased energy credits with partners who could immediately benefit from their use.
Treasury and the IRS acknowledged that in certain limited circumstances involving a transferee taxpayer who materially participates in an eligible credit–generating activity within the meaning of Sec. 469(h) in which the transferee taxpayer owns an interest at the time the work is done, the transferee taxpayer should be permitted to purchase eligible credits generated from the activity — assuming the transferee taxpayer is not related to the eligible taxpayer within the meaning of Sec. 267(b) or 707(b)(1) — and treat those purchased credits as not arising in connection with a passive activity. However, this is presumed to rarely occur, as the shareholders of the S corporation who purchased the credit likely will have no relationship with or ownership in the eligible taxpayer from whom the credits were created.
Even though subject to passive–activity limitations, an eligible credit generated through the conduct of a trade or business and transferred does not lose its status as a Sec. 38 credit or its status of having arisen in a trade or business solely because the credit is transferred.
Passive credit limitations
In addition to receiving an allocation of credits from a transferee S corporation pursuant to Sec. 6418 and the final regulations, S corporation shareholders could also receive an allocation of other types of credits that may be generated or acquired by the S corporation. Depending on the specific facts and circumstances, these other types of credits may also be subject to the passive credit rules of Sec. 469 — a determination that will have to be made by the S corporation and its shareholders. For shareholders who do not materially participate in the S corporation’s trade or business activities, all tax credits allocated to those shareholders — whether eligible credits transferred to the S corporation pursuant to Sec. 6418, or other types of credits generated or acquired by the S corporation — will be subject to the passive credit rules of Sec. 469. However, for shareholders who do materially participate in the S corporation’s trade or business activities, their allocable share of eligible credits transferred to the S corporation pursuant to Sec. 6418 will most likely still be subject to the passive credit rules of Sec. 469, while other types of credits generated or acquired by the S corporation may not be subject to such rules. Therefore, the purchase of clean–energy credits may not be beneficial to those S corporation shareholders who materially participate in the trade or business and receive only ordinary compensation income as well as allocated nonpassive ordinary income from the S corporation.
Sec. 469 contains a complicated set of rules preventing certain taxpayers from deducting losses (or credits) from passive trade or business activities — to the extent such losses (or credits) exceed income from (or taxes attributable to) such activities — from other income, such as wages and portfolio income. It should also be noted that portfolio income (e.g., interest income, dividends, etc. not derived in the ordinary course of a trade or business) is generally not considered passive.32 The passive–activity rules effectively categorize a taxpayer’s income or loss into three categories: (1) active trade or business income; (2) portfolio income; and (3) passive income or loss. An activity generally will be considered a passive activity if it involves a trade or business activity in which the taxpayer does not materially participate. Special rules apply in the context of rental real estate activities and real estate professionals, which is beyond the scope of this article. Additionally, a limited partnership interest is generally treated as a passive activity.
Sec. 469(a)(1)(B) disallows any passive–activity credit, which Sec. 469(d)(2) defines as the excess of the sum of all credits otherwise allowable for the tax year that are attributable to passive activities, over the regular tax liability allocable to such activities.
Example 2: An S corporation shareholder materially participates in the S corporation’s trade or business activities. The shareholder’s allocable share of the S corporation’s ordinary income is $10,000. The shareholder also has W–2 income of $50,000, dividend and interest income of $5,000, and no other sources of income or loss. Based on the shareholder’s effective tax rate of 25%, the regular tax liability is $16,250. Additionally, the S corporation purchased eligible credits under Sec. 6418, of which $3,000 was allocated to this shareholder (and is deemed to be a passive–activity credit). The disallowed passive–activity credit is $3,000, as the shareholder has no regular tax liability allocable to any passive activity, due to the shareholder’s material participation in the S corporation’s trade or business activities.
Using the same other facts from the example, if the shareholder were not a material participant, the disallowed passive–activity credit would be $500 (the $3,000 passive–activity credit, less the $2,500 regular tax liability allocable to the passive income from the S corporation). Of course, if the shareholder generated passive income from other sources, the regular tax liability associated with this other passive income could also be used to offset the passive–activity credit. See the table “Material Participation by S Corporation Shareholder,” below.
Credits that are disallowed under Sec. 469(a)(1) can generally be carried forward indefinitely but cannot be carried back. Once the credit becomes allowable under the passive–activity limitations (i.e., there is sufficient passive income tax to allow its use), it is then aggregated with any credits relating to nonpassive activities of the taxpayer for purposes of determining other taxpayer limitations.
Other limitations
Even if the passive–activity limitations are avoided, further limitations can apply to individual taxpayers trying to utilize the passive eligible credits that they were allocated. Under Sec. 38(c)(1), the amount of the general business credit allowed cannot exceed the excess of the taxpayer’s net income tax over the greater of tentative minimum tax for the tax year or 25% of the taxpayer’s net regular liability as it exceeds $25,000. “Net income tax” means the sum of the net regular tax liability and the AMT, reduced by the credits allowed in Secs. 21 through 30D. In addition, “net regular tax liability” means the regular tax liability reduced by the sum of the credits allowed in Secs. 21 through 30D.
However, under Sec. 38(c)(4), when applying the limitation, the tentative minimum tax can be treated as zero for specified credits. Specified credits include Sec. 45 renewable electricity production credits and the Sec. 48 energy credit. They do not include Sec. 45X, an advanced manufacturing production tax credit, which is a popular eligible credit to purchase, as it does not have recapture provisions or prevailing wage and apprenticeship and domestic–content requirements.
Example 3: Assume an individual taxpayer was allocated a Sec. 45X credit of $1 million, which was purchased by the S corporation and is not subject to a passive–activity limitation at the individual level. However, like many S corporation owners, the individual taxpayer generates a qualified business income deduction under Sec. 199A of $1.2 million, causing the tentative minimum tax to be $1.5 million. The tax liability due for the tax year is $1.9 million, and the individual is not subject to AMT.
The Sec. 38(c) limitation limits the general business credit of $1 million to $400,000 ($1.9 million less $1.5 million). The credit was limited to the net income tax ($1.9 million) less the greater of $1.5 million or $468,750 (25% × [$1,900,000 — $25,000]). However, if the purchased eligible credits related to Sec. 45 or Sec. 48, then the tentative minimum tax would be deemed zero, as they are considered specified credits, and the full $1 million credit would be available to utilize in the current year.
If the individual was subject to AMT, then the general business credit of $1 million would not be allowed at all.
While the general business credit carryback is one year and carryforward is 20 years,33 designated clean–energy credits can be carried back three years and carried forward for 22 tax years.34 The revised carryback and carryforward provisions include credit carryforwards related to Secs. 48 and 48E related to an energy investment credit, Sec. 45X related to advanced manufacturing, and Secs. 45 and 45Y related to production tax credits.
S corporations that may purchase tax credits should consider the implications of these purchased tax credits for their shareholders, particularly if the tax credits are subject to the passive credit rules. If the shareholders have no sources of passive–activity income, the credits may not be available to offset shareholder tax liabilities and will be carried forward indefinitely. If individuals are not subject to the passive–activity limitation but are limited by the general business credit limitation rules, the carryback could range up to three years and the carryforward from 20 to 22 years. There may also be situations where the shareholders themselves may not be taxable — for example, where an ESOP owns a portion of the S corporation stock. As such, it is important to gain an understanding early in the process of how any purchased tax credits will benefit shareholders across the overall ownership group.
Sec. 6707: Failure to furnish information regarding reportable transactions
Sec. 6707 imposes penalties on taxpayers who engage in certain reportable transactions and fail to file Form 8886, Reportable Transaction Disclosure Statement. One type of reportable transaction involves microcaptive insurance arrangements.35 When the party involved in such a transaction is an S corporation, both the corporation and each shareholder must file Form 8886.
A recent Tax Court decision in Jones36 provides a detailed analysis of microcaptive insurance arrangements with respect to an S corporation. In that context, it also illustrates how an S corporation shareholder can realize a constructive dividend in the form of a purported loan from a microcaptive. The case concerns Sani–Tech West Inc. (STW), a California–based S corporation, the executive officers of which established Clear Sky Insurance Co. Inc. (CSI), a C corporation, as a captive insurance company in Montana. The ownership of STW and CSI overlapped, with CSI’s majority owner also being a shareholder and executive officer of STW. The arrangement followed a plan provided by a promoter of captive insurance arrangements.
STW paid more than $800,000 in premiums for tax year 2015 to CSI, which elected to be taxed under the small–insurer exception, allowing it to exclude premium income from taxation.37 The premiums were deducted in the year paid. However, the IRS disallowed STW’s deductions for these premiums and CSI’s exclusion of them from income, asserting that the arrangement failed to meet the requirements of legitimate insurance.
A notable aspect of the opinion was what it referred to as a “primer” on business insurance. The primary definition of insurance for tax purposes requires that “(1) the arrangement involves an insurable risk of loss; (2) the arrangement shifts the risk of loss from the insured to the insurer; (3) the insurer distributes the risk of loss among its policyholders; and (4) the arrangement is insurance in the commonly accepted sense.”38The court found that CSI’s operations did not satisfy the essential elements of insurance, particularly risk distribution and risk transfer.
Although CSI participated in a reinsurance pool named OMNI to ostensibly achieve risk distribution, the court determined that the STW/CSI/OMNI structure involved circular cash flows and lacked genuine risk–sharing mechanisms.
The court highlighted that the computation of the premium amounts was not determined using standard actuarial practices. In criticizing the amount of premiums charged by the captive, the court noted that STW did not have any losses in the prior five years; much of the coverage provided by CSI overlapped with STW’s existing commercial insurance policies, rendering it redundant; and STW did not cancel its existing commercial insurance.
The promoter recommended that the captive insurance arrangement stay in place for five to 10 years, but STW did not renew the captive insurance after one year. STW’s president and CEO, Richard Shor, testified at trial as to the business reasons for the cancellation. But the court found Shor’s testimony on this point not to be credible and concluded that the reason for cancellation was a desire to enhance STW’s earnings preparatory to its sale. In 2016, CSI issued a $400,000 unsecured advance to Shor, which he subsequently repaid, to purchase real estate for STW’s operations.
The Tax Court ultimately upheld the IRS’s disallowance of tax benefits claimed by STW and CSI for 2015 and 2016. In addition, the court held that the $400,000 advance to Shor was a constructive dividend to him.
FinCEN beneficial ownership information reporting
The Corporate Transparency Act (CTA)39 took effect on Jan. 1, 2024. The act mandated beneficial ownership information (BOI) reporting by many U.S. businesses. Many S corporations that fell within this rule were required to report information about beneficial owners and certain persons who controlled the corporations to Treasury’s Financial Crimes Enforcement Network (FinCEN).
Throughout 2024 and early 2025 several court cases contested the BOI reporting rules and even the constitutionality of the underlying statute. In March 2025 FinCEN announced that it had removed the reporting requirement for all domestic entities and U.S. persons.40 Therefore, for now, S corporations41 and their shareholders42 are exempt from filing these reports.
Footnotes
1Secs. 1361–1363, 1366–1368, 1371–1375, and 1377–1379.
2Brajcich et al., “Current Developments in S Corporations,” 54-7 The Tax Adviser 26 (July 2023).
3Rev. Proc. 2022-19, §3.06.
4Maggard, T.C. Memo. 2024-77. See also McKinley and Geiszler, “Disproportionate Distributions Did Not Terminate Corporation’s S Status,” 238 Journal of Accountancy46 (December 2024).
5See, e.g., IRS Letter Ruling 202247004. See also Nitti, “How S Elections Go Wrong and How to Fix Them,” 56-5 The Tax Adviser 52 (May 2025).
6Jamison et al., “Current Developments in S Corporations,” 55-7 The Tax Adviser 26 (July 2024).
7See Rev. Proc. 2025-1, Appendix A, Schedule of User Fees.
8Jamison et al., “Current Developments in S Corporations,” 55-7 The Tax Adviser 26 (July 2024).
9Letter Rulings 202408001, 202410002, 202414001, 202418003, 202421005, 202427002, 202428001, 202428003, 202441001, 202447002, 202447011, 202447012, 202503004, 202507006, and 202509007.
10 Letter Rulings 202411001, 202412004, 202413006, 202416004, 202418008, 202426010, 202429006, 202438003, 202438007, 202438008, 202438009, 202438010, 202438011, 202438012, 202444001, 202447011, 202448001, 202450002, 202510001, 202510002, 202510003, 202510004, and 202511005.
11Letter Ruling 202431011.
12Regs. Sec. 1.1362-5.
13Letter Ruling 202442001. However, after 2027 the deferral will apply to sales of S corporation shares to ESOPs.
1414Sec. 164(b)(6); see also Mucenski-Keck and Ramos, “Federal Implications of Passthrough Entity Tax Elections,” 53-11 The Tax Adviser 38 (November 2022).
15IRS, 2024–2025 Priority Guidance Plan.
16Maine, Pennsylvania, and Vermont. Myers and Sherr, “Recent Developments in States’ PTETs,” 55-9 The Tax Adviser 58 (September 2024).
17See Sherr, “Questions to Consider Before Electing Into a PTE Tax,”53-9 The Tax Adviser 26 (September 2022).
18Stanton, “Republican SALT Caucus in House Mulls Specifics on Raising Cap,” 116 Tax Notes State 196 (April 21, 2025); Walczak and Watson, “Congressional Policymakers Should Tread Carefully When Weighing New Corporate SALT Deduction Limits,” Tax Foundation (March 3, 2025). Also see §١١٢٠١٨ of the House Budget Resolution of May 12, 2025. Proposals would expand and complicate current law.
19Legislation being considered in Congress at the time of this article’s publication would restrict or phase out some of these credits, including by repealing their transferability.
20Listed at Sec. 6418(f)(1)(A).
21See also Gordon et al., “Sale of Clean-Energy Credits: Traps for the Unwary,” 55-6 The Tax Adviser 7 (April 2024).
22IRS webpage, “Elective Pay and Transferability Frequently Asked Questions: Transferability,” Q&A 12.
23The average discount in 2023 was 92 to 94 cents per dollar of credit, according to Crux Climate Inc., “Transferable Tax Credit Market Intelligence Report” (Jan. 16, 2024).
24T.D. 9993, 89 Fed. Reg. 34770, corrected by 89 Fed. Reg. 67859.
25Regs. Sec. 1.6418-3(a).
26Sec. 267(b) defines relationships for purposes of the loss-disallowance rules involving sales or exchanges of property between related parties; Sec. 707(b)(1) provides that no deduction shall be allowed in respect of losses from sales or exchanges of property between certain related partnerships and their partners.
27Regs. Sec. 1.6418-3(c)(2)(i).
28Regs. Sec. 1.6418-2(f).
29Regs. Sec. 1.6418-3(c)(2)(ii).
30Regs. Sec. 1.6418-3(c)(2)(iii).
31Preamble, T.D. 9993.
32Sec. 469(e)(1)(A)(i)(I).
33Sec. 39(a)(1).
34Sec. 39(a)(4).
35See Newkirk and Webber, “Microcaptive Insurance Arrangements Subject to New Rules,” 56-6 The Tax Adviser 60 (June 2025).
36Jones, T.C. Memo. 2025-25.
37Sec. 831(b).
38Citing Harper Group, 96 T.C. 45, 58 (1991), aff’d, 979 F.2d 1341 (9th Cir. 1992).
39Corporate Transparency Act, Title 64 of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, P.L. 116-283.
4090Fed. Reg. 13688 (March 26, 2025). See also “BOI Filing Requirements for US Companies, Persons Removed,” The Tax Adviser (March 21, 2025).
41Which must be domestic (Sec. 1361(b)(1)).
42Which may not be nonresident aliens (Sec. 1361(b)(1)(C)).
Contributors
Robert W. Jamison Jr., CPA, Ph.D., is author of CCH’s S Corporation Taxation and professor emeritus of accounting at Indiana University in Indianapolis. Robert S. Keller, CPA, J.D., LL.M., is a partner in KPMG’s Washington National Tax practice. Lynn Mucenski-Keck, CPA, MST, is a principal in Withum’s National Tax Service Group and leader of Withum’s Clean Energy practice. Tony Nitti, CPA, MST, is a partner in EY’s National Tax Department in Denver. Kevin F. Powers, CPA, is a partner in the national tax office of Crowe LLP. Kevin J. Walsh, CPA, CGMA, is a partner in Walsh, Kelliher & Sharp, CPAs, APC, in Fairbanks, Alaska. Keller, Mucenski-Keck, Nitti, Powers, and Walsh are members, and Jamison is an associate member, of the AICPA S Corporation Taxation Technical Resource Panel. For more information about this article, contact thetaxadviser@aicpa.org.
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Based in New York, Stephen Freeman is a Senior Editor at Trending Insurance News. Previously he has worked for Forbes and The Huffington Post. Steven is a graduate of Risk Management at the University of New York.