A single-member LLC owned by a nonresident alien files Form 2553. The election is void from day one, and the return the corporation filed on Form 1120-S is wrong for every year it stood.
An S corporation is a domestic corporation that elects, under Subchapter S, to pass its income, deductions, losses, and credits through to its shareholders. The shareholders then report those items on their own returns.
Before you rely on an S election, confirm that the corporation actually meets the requirements to qualify. They are statutory, not elective, and a single failure ends S status.
The eligibility tests under IRC 1361 run in five parts. The table gives each rule to qualify and the mistake that most often breaks it:
Only certain owners may hold S corporation stock, so check who owns every share. Qualifying shareholders are limited to United States citizens or residents who are individuals, estates (including bankruptcy estates), certain trusts, and IRC 501(c)(3) or 401(a) exempt organizations.
Common mistakes
- Guarantees give basis. They do not. A shareholder who personally guarantees a $400,000 bank line gets zero loan basis until an actual payment is made from personal funds. The guarantee alone is not an economic outlay, so it creates no basis.
- Ordering distributions after losses. Distributions come out of stock basis before losses do. Reversing the order turns a tax-free $30,000 distribution, like Priya's in Example 1, into a phantom capital gain.
- Adding stock and loan basis together. Keep two separate columns. A shareholder with $0 stock basis and $15,000 loan basis who receives a $10,000 distribution has a $10,000 capital gain, because loan basis does not shelter a distribution.
Bottom line
- Eligibility: domestic corporation, 100 shareholders maximum, one class of stock, and only individuals, estates, certain trusts, and exempt organizations as qualifying shareholders; no nonresident aliens, partnerships, or corporations.
- Election: Form 2553 with all shareholder consents, due by the 15th day of the third month of the election year; Revenue Procedure 2013-30 grants late relief for three years and 75 days.
- Basis order: increases first, then distributions, then nondeductible expenses, then losses. Losses hit stock basis before loan basis; income restores loan basis before stock basis.
- Loan basis comes only from a direct shareholder loan or an actual guarantee payment, never from entity-level debt.
Exam shortcut
Read the stem for the AE&P flag first. No AE&P means a two-tier distribution answer and you can ignore AAA entirely; the presence of AE&P is the only reason the four-tier ladder exists, and it is also half of both passive-income traps. When a question gives you a loss, a distribution, and a starting basis in the same year, write the five-line basis ladder vertically before touching an answer choice.
The full lesson (about 4,836 words, 32 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
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