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1120S returns

Computing the Tax on Excess Net Passive Income

This template is used to compute the tax on excess net passive income imposed by IRC Sec. 1375. The tax does not apply unless the S corporation has (1) accumulated earnings and profits (AE&P) at the end of the tax year, and (2) passive investment income that is more than 25 percent of its gross receipts for the year. Therefore, to be subject to this tax, an S corporation either must have been a C corporation or, less likely, must have acquired a C corporation with AE&P.  
Passive investment income generally includes gross receipts from royalties, rents, dividends, interest, annuities, and gains from the sale or exchange of stocks or securities. The main exception to this definition pertains to gross receipts derived in the ordinary course of a trade or business.

Entering Information

All of the information needed to produce the computation is entered on the Input worksheet.  The yellow highlighted cells are calculated fields, and no data should be entered in these cells.  Any gray cells are not calculated fields, but data should not be entered in these cells.

Enter the following information:

  • Gross receipts for the tax year [See IRC Sec. 1375(b)(3).]
  • Passive investment income [See IRC Sec. 1362(d)(3)(C).]
  • Deductions directly connected with the production of passive investment income [See IRC Sec. 1375(b)(2).]
  • Taxable income [See IRC Sec. 1375(b)(1)(B).]
Tax rate:
The tax rate equals the highest rate of tax imposed by IRC Sec. 11(b). Currently, this rate is 35 percent.  In the event of a law change, this number can be overridden by editing the cell on The Summary worksheet, column “g,” row “24.”
Warning:
Even if there is no tax liability, for example, when net passive income is less than zero or because of the taxable income limitation, the corporation’s S election will terminate under IRC Sec. 1362(d)(3) if the corporation has AEP and its gross passive investment income exceeds 25 percent of gross receipts for three consecutive tax years.