1. (a) I.R.C. Subchapter S adopted — Arkansas Code § 26-51-409. Subchapter S of the Internal Revenue Code of 1986, as in effect on January 1, 1997, regarding small business corporations, has been adopted for the purpose of computing Arkansas income tax liability.

2. (b) Corporations that must file as a Subchapter S corporation — Arkansas Code § 26-51-409.

   1. (1) Corporations incorporated in Arkansas, registered to conduct business within Arkansas, or having income from Arkansas sources must file an income tax return with the State of Arkansas.

   2. (2) Such corporations must file a Subchapter S corporation income tax return (AR1100S) with the State of Arkansas if the:

      1. (A) Corporation elected, by filing Form AR1103, to be taxed as a Subchapter S corporation within seventy-five (75) days of incorporation;
      2. (B) Election was accepted by the State of Arkansas; and
      3. (C) Election remains in effect.
   3. (3) Having “income from Arkansas sources” means income derived from property located within Arkansas or from business activity carried on within Arkansas.
3. (c) Applicable rules — Generally — Arkansas Code § 26-51-409. The rules of Subchapter C (corporate distributions, liquidations, contributions, and reorganizations) apply to Subchapter S corporations, unless the Internal Revenue Code or Arkansas law otherwise provides or a Subchapter C rule is inconsistent with a Subchapter S rule.

4. (d) Subchapter S corporation — Auditing — Arkansas Code § 26-51-409.

   1. (1) Subchapter S corporations are generally audited on a shareholder-by-shareholder basis.
   2. (2) The general rule is that a Subchapter S corporation's taxable income is computed under the rules that apply to individuals.

5. (e) Consistency between Subchapter S corporation returns and shareholders’ returns — Arkansas Code § 26-51-409.

   1. (1) A Subchapter S corporation shareholder should generally treat a Subchapter S item on his or her own individual income tax return consistently with the treatment of that item on the Subchapter S corporation's return.

   2. (2)

      1. (A) If the shareholder treats an item or items inconsistently between his or her return and the corporation's return, the shareholder must notify the Individual Income Tax Section of the Department of Finance and Administration (as well as the Internal Revenue Service) of the inconsistency.
      2. (B) This notification should be provided on IRS Form 8082.

6. (f) Reporting Subchapter S corporation income, loss, deductions, and credits — Arkansas Code § 26-51-409(c)(1).

   1. (1) All resident and nonresident shareholders of corporations that have elected to be taxed by Arkansas as Subchapter S corporations and who receive a share of the corporation's income, loss, deductions, or credits must file an Arkansas individual income tax return reporting the share so received.

   2. (2)

      1. (A) However, a nonresident shareholder of such a corporation shall only be required to file an Arkansas individual income tax return if some or all of his or her share of the corporation's income, loss, credits, or deductions are attributable to Arkansas sources.
      2. (B) When an Arkansas return is required to be filed, the nonresident must report all of his or her gross income on his or her Arkansas nonresident return pursuant to Arkansas Code §§ 26-51-435 and 26-51-504.
   3. (3) Moreover, a shareholder's share of Subchapter S corporation income attributable to Arkansas is subject to Arkansas income tax whether or not it is actually distributed to the shareholder.

7. (g) Reporting Subchapter S corporation income, loss, deductions, and credits — Shareholder termination — Arkansas Code § 26-51-409(c)(1).

   1. (1) A Subchapter S corporation's items of income, loss, deduction, and credit for its tax year are usually allocated to its shareholders on a per-share, per-day basis.

   2. (2) An equal part of a tax year's items is:

      1. (A) Assigned to each day of the tax year; and
      2. (B) Divided pro rata among the shares outstanding on the day to which it's assigned.

   3. (3)

      1. (A) However, if the corporation and all affected shareholders agree, an election could be made to terminate the Subchapter S corporation's tax year when a shareholder terminated his or her interest in the corporation.
      2. (B)

8. (i) The effect of the election is that the tax year of the corporation is treated as if it consists of two (2) tax years, with the first tax year ending on the date on which the shareholder's interest was terminated.

   1. (ii) I.R.C. § 1377(a)(2)(A).

      1. (C) The items of income, loss, deduction, and credit, determined for each separate tax year by closing the books, are allocated on a per-share, per-day basis to shareholders who were shareholders during the separate tax year.

      2. (D)

         1. (i) Affected shareholders include:
9. (a) (a) The shareholders who terminate their interests; and

10. (b) (b) All shareholders to whom the terminating shareholders transfer their shares during the tax year.

    1. (ii) If shares are transferred to the corporation, all persons who were shareholders during the tax year are treated as affected shareholders.

       1. (iii) I.R.C. § 1377(a)(2)(B).

11. (h) Subchapter S corporation shareholder basis — Arkansas Code § 26-51-409(c)(1).

    1. (1) A Subchapter S corporation shareholder's basis is significant because:

       1. (A) Distributions in excess of his or her basis may result in gain to the shareholder; and
       2. (B) The shareholder can deduct his or her pro rata share of the corporation's losses only to the extent of his or her adjusted basis in the Subchapter S corporation's stock and debt.

    2. (2)

       1. (A) The adjusted basis of the shareholder's stock for purposes of computing the limitation on the amount of the Subchapter S corporation's losses he or she can deduct (the loss limitation) is computed after the basis is reduced by the year's nontaxable distributions made to the shareholder.
       2. (B) I.R.C. § 1366(d).

    3. (3)

       1. (A) The adjusted basis of the shareholder's stock for determining the tax effects of the Subchapter S corporation distributions to him or her is determined by increasing the basis for his or her share of the Subchapter S corporation's income items for the year, but without decreasing the basis for his or her share of the Subchapter S corporation's losses for the year.
       2. (B) I.R.C. § 1368.

Codification Notes: I.R.C. § 1377(a)(2)(A) is codified at 26 U.S.C. § 1377(a)(2)(A). I.R.C. § 1377(a)(2)(B) is codified at 26 U.S.C. § 1377(a)(2)(B). I.R.C. § 1366(d) is codified at 26 U.S.C. § 1366(d). I.R.C. § 1368 is codified at 26 U.S.C. § 1368.