809 / Under what circumstances may an S corporation be taxed at the corporate level?

In addition, a tax is imposed at the corporate level on excess “net passive income” of an
S corporation (passive investment income reduced by certain expenses connected with the production of such income) but only if the corporation, at the end of the tax year, has accumulated earnings and profits (either carried over from a year in which it was a nonelecting corporation or due to an acquisition of a C corporation), and if passive investment income exceeds 25 percent of gross receipts. The rate is the highest corporate rate (currently 21 percent, decreased from 35 percent prior to 2018).² “Passive investment income” for this purpose is rents, royalties, dividends, interest, and annuities.³ However, passive investment income does not include rents for the use of corporate property if the corporation also provides substantial services or incurs substantial cost in the rental business,⁴ or interest on obligations acquired from the sale of a capital asset or the performance of services in the ordinary course of a trade or business of selling the property or performing the services. Also, passive investment income does not include gross receipts derived in the ordinary course of a trade or business of lending or financing; dealing in property; purchasing or discounting accounts receivable, notes, or installment obligations; or servicing mortgages.⁵ Regulations provide that if an S corporation owns 80 percent or more of a C corporation, passive investment income does not include dividends from the C corporation to the extent the dividends are attributable to the earnings and profits of the C corporation derived from the active conduct of a trade or business.⁶ If amounts are subject to tax both as built-in gain and as excess net passive income, an adjustment will be made in the amount taxed as passive income.⁷

Also, tax is imposed at the corporate level if investment credit attributable to years for which the corporation was not an S corporation is required to be recaptured.⁸

Furthermore, an S corporation may be required to make an accelerated tax payment on behalf of its shareholders, if the S corporation elects not to use a required taxable year.⁹ The corporation is also subject to estimated tax requirements with respect to the tax on built in gain, the tax on excess net passive income and any tax attributable to recapture of investment credit.¹⁰

1. IRC § 1363(d).