S corporation taxable income

There are three types of income that result in a tax on a Sub-chapter S corporation and which cannot be reduced by any deductions:

• Built-in gains. Gains related to appreciation of assets held by a C corporation that converts to S status.

• Passive investment income. Income of a corporation that has earnings and profits from a time when it was a C corporation. A tax on the S corporation results only when this passive investment income exceeds 25 percent of gross receipts.

• LIFO recapture. When a C corporation uses last-in, first-out or LIFO to report inventory converts to S status, there may be recapture income that is taken into account partly on the C corporation's final return, but also on the S corporation's return.

If a corporation immediately elects S status on formation, it will always be solely a pass-through entity and there will never be any tax at the corporate level.