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Tax

Calculating Additional Tax on the Sale of S Corp Stock

The 3.8% Net Investment Income Tax (NIIT) surtax on investment income from the sale of S Corp stock by individuals, trusts, and estates has been in effect since 2013. However, calculating investment income subject to the surtax remains a challenge.

Generally, if the S corporation has only one trade or business activity in which the shareholder materially participates and does not have any other non-business property, then the entire amount of the gain is excluded from Net Investment Income (NII).

Complications arise when:

  • the S corporation has multiple trade or business activities;
  • the shareholder does not participate in all activities; and
  • the S corporation has portfolio assets.

Regulation Section 1.1411-7 provides a series of complicated steps to determine what portion of the gain will be included in NII by applying a hypothetical activity-by-activity sale analysis.

The following steps will help S corporation shareholders calculate the gain from the sale of S corporation stock subject to the 3.8% NIIT surtax.

Step 1: Determine the gain or loss using regular income tax rules.
Step 2: Compute gain or loss on the hypothetical sale of each asset in the S corporation based on the fair market value (FMV).
Step 3: Allocate the hypothetical gain or loss to the shareholder.
Step 4: Determine which gains and losses from Step 3 would be included in NII, which includes gain from sale of assets not used in a trade or business or used in a trade or business that is considered passive to the taxpayer.
Step 5: The amount included in NII is the lesser of Step 1 or Step 4.

Below is an example to illustrate the calculation.

Facts:
1. Jack is an active business owner and owns 40% of ABC, Inc., an S corporation.
2. On December 31, 2018, Jack sold all of his ABC shares for $200,000 with a basis of $100,000.
3. ABC, Inc. has the following assets:

Calculation:

Step 1: Sales proceeds $200,000 – basis $100,000 = $100,000 capital gain.
Step 2 and Step 3: See chart.
Step 4: Gain from tangible capital assets = $48,000, which would be included in NII.
*Please note that goodwill is considered a business asset; therefore, the gain from the sale of goodwill is not included in the NII.
Step 5: Lesser of Step 1 or Step 4 = $48,000, which is Jack’s NII from the sale of
his ABC, Inc. shares.

However, if ABC, Inc. is a passive activity for Jack, the total gain of $100,000 from the sale of his shares in the S corporation is included in NII (Step 1).

If you have questions or would like more information, please contact Charlene Tao at ctao@windes.com or 844.4WINDES (844.494.6337).

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