 Hello and welcome to this session. This is Professor Farhad and this session would look at the S-Corp special taxes and this is part two of three. It means there is a prior part and there's a subsequent part. This topic is covered typically in a corporate income tax course, the CPA exam regulation section, as well as the enrolled agent exam. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have over 1,600 plus accounting, auditing, tax, finance, CPA lectures. If you like my lectures, please like them, share them, put them in playlists. If they're benefiting you, it might benefit other people as well. So please share the wealth. On my website, you'll have additional resources such as PowerPoint slides, notes, true, false, multiple choice. And if you're studying for your CPA exam, 2,000 plus CPA questions, if you're a serious candidate and you want to pass, you study for your CPA once. I strongly suggest you check out what I have on my website for the CPA exam as well as if you are an accounting student. So today we're gonna talk about S-Corporation Special Taxes. Just real quick, we have to remember that S-Corporation are flow-through entities or pass-through entities. What does that mean? It means they don't pay taxes. It means the items flow. Income deduction flows to the shareholders and the shareholder pay the taxes. So the corp don't pay any taxes. The S-Corporation itself don't pay any taxes. However, we have four exceptions. The first exception is the built-in gains tax, which we already covered in a prior session. Passive investment income tax we will cover in this session. And we have two more life-for-recapture tax and general business credit recapture. I will cover those two briefly in the following session. So let's go ahead and talk about passive investment income tax. So hopefully you know what passive investment is. Passive investments is when you have money invested in stocks, bonds, a rental property where you don't manage the act if you have royalty income, means you are sitting somewhere on an island and the money is coming to you. This is what passive income is, passive investment income. So what is the idea? Why are we learning about passive investment income tax for an S-Corporation? Well, the same idea as the built-in gain tax is to avoid what's called double taxation. So when do we have, when does this tax comes into place? Well, first we have to have a conversion from a C, from a C-Corp to an S-Corp. Remember, the C-Corp, you pay taxes twice. You pay tax on the corporate level. Then once the money is distributed, the shareholder pay taxes. And an S-Corp, the tax, the money is taxed twice. So when you convert from a C to an S and you have a lot of earnings and profit, and now those earnings and profit, they're supposed to be taxed on the C and you convert it to S, you kind of avoid the double taxation on those passive investment income. So this tax exists when you have a conversion from C to S and you have passive investment income. And now the passive investment income for any particular year exceeds 25% of gross receipts. It's not only you have passive investment income, the income is substantial. Again, what's passive investment income, rent, interest, dividend, royalties? Basically, you're sitting doing nothing and the money's coming to you. You are being passive, you are not being active. You are not doing anything. Your money is working for you, okay? So technically the tax is applied to something called the access net passive income or EMPI. So we're gonna have some terms here, but don't worry about them, we'll take care of this. So how do we calculate this access net passive income? When we're gonna look at passive investment income, PII, passive investment income, we're gonna compute the greater of 25% of gross receipts for a particular year. We're gonna divide this by PII times the passive investment income, net passive investment income, which is PII minus deductions directly connected with the production of the PII, and that's gonna give us the EMPI. Well, does this sound confusing? Don't worry, we will work an example. Actually, we'll work couple examples to make sure you are comfortable with this computation, with this computation. We need to be aware of a limitation and is that that EMPI cannot exceed the S corporation taxable income, which is the access net passive income. So let's look at an example real quick. Actually, we'll work two examples to illustrate this concept. That's a CMB corp as an S corp generate gross receipts for the year totaling to 64, of which 110 is PII. So the generator 264,000, of which 110,000 is passive investment income. Okay, let me first let's do real quick here, quick computation, and I'm sure you know this, but basically is 110 divided by 264 is more than 25. It's 41, yes, okay, the total applies. Expandature directly connected to the production of PII is 30,000. It means net PII is 110 minus 30 equal to 80,000. And this is NPII, okay. So we'd report 80,000 and it's PII for the tax here, exceed 25%, we already kind of figured this one out, okay. So how do we input the formula? How do we, how do you input the formula? So what's the amount and access of 25%? Well, let's do some computation here. 264, 264 times 0.25 is equal to 66,000. Now we're gonna take 66,000 minus 110. So the amount is 44,000. So this amount is 25% in excess of, it's passive investment income in excess of 25% of gross receipts because 25% of gross receipts is 66,000. So we have 44,000 in access. Now we're gonna divide this by PII. Then we're gonna multiply it by NPII, which is 80,000 NPII, NPII. So 44,000, which is the denominator. Again, what is the 44,000? It's the PII in excess of 25% of the gross receipts. Whoops, okay. Which is gonna give us ENPI of 32,000. We're gonna take the ENPI and multiply it by, multiply it by the tax rate, which is 21% the corporate tax rate. And maybe this recording will stay valid till 2025. So our PII tax is 6,720. So that's our PII. Now let's take a look at another example to just reinforce what we just did. Flint and S-Corporate Substantial, AEP report operating revenue of 410, taxable interest income of 390, operating expenses of 260 and deduction attributable to the interest is 150, okay? So first let's find out if calculate any passive investment income penalty, if applicable, if applicable. So let's see, we have operating revenue of 410, operating revenue of 410 plus 390 of interest. All in all, we have 800,000. Now is 390, 25% of 800,000. And we should know this, yes, it's approximately 50%. So we do have the passive investment, the access net passive investment income tax will apply here. So how do we do this? First, we have to find the amount that's in excess of PII that's in excess of 25% of gross receipts. Gross receipts is 800,000. What's 25% of gross receipts? That's easy, that's 200,000. So we have passive income of 390 minus 200,000. The amount in excess is 190. And this is your numerator, 190,000. Your PII is 390, which is, this is, oops. This is your PII, PII is 390. And we're gonna multiply this by net PII. So net PII is 390 minus 150. That's equal to 240, that's equal, sorry. That's equal to 240 multiplied by 240. Now we're gonna take 190 divided by 390. So let's find the ratio, 190 divided by 390. That's 0.48 times 240,000. This is 16923, 16923. Now we're gonna multiply this by 21% to find the tax. It should be available times 0.21. That's 24,554 dollars, 24, so 24 or 25. 24,554 rounding, okay, so that's the tax. Now in the next session we're gonna look at special core three of three, okay, which covers life or recapture tax and general business credit recapture. I will work with these briefly. Now once again, if you are seriously studying for your CPA exam, if you're taking a CPA course, the CPA course don't go in details or they assume a certain level of knowledge that I don't assume when I teach you the material. So I strongly suggest you visit my website, you subscribe, you're gonna only study for your CPA once in your lifetime. It's a lifetime investment, it's gonna pay over 40 years of dividend and income for you. Take it seriously, I'm here to help you, subscribe, study hard and see you on the side of success.