Entity taxation
The Passthrough Rules
Passthroughs separate what must flow through on its own, and the eligibility and contribution rules gate who gets in and how.
How the exam words it
- -The stem tests S corporation eligibility: the number and type of shareholders, one class of stock, and the election.
- -It asks which items are separately stated versus part of ordinary business income.
- -A partner receives a guaranteed payment or contributes services rather than property.
- -Section 751 hot assets or a service contribution under section 721 changes the character or triggers income.
The playbook
- 1Check S corporation eligibility: 100 or fewer shareholders, only individuals, estates, and certain trusts, all US citizens or residents, and a single class of stock.
- 2Separately state items that could affect a return differently at each owner level: capital gains, section 1231 gains, charitable contributions, investment interest, and credits.
- 3Treat a guaranteed payment as ordinary income to the partner and a deduction to the partnership, regardless of partnership profits.
- 4Apply section 721 (generally no gain on a property contribution, but services exchanged for a capital interest is ordinary income) and section 751 (hot assets convert a share of gain to ordinary).
The trap
Netting separately stated items into ordinary income. Capital gains, charitable contributions, and section 1231 items must pass through separately so each owner applies the right limits.
How the exam varies it
The same pattern, re-skinned along these axes:
Eligibility and elections versus the operating rulesOrdinary business income versus separately stated itemsGuaranteed payments, service contributions, and section 751 hot assets
Drill this pattern
8 questions of The Passthrough Rules from across the AUD topics. Clear it by getting 5 right with a streak of 3.