Was a Connecticut S corporation shareholder's share of interest income subject to the former dividend and interest income tax when federally reported as nonseparately computed income?

Note -- obsolete historical guidance. DRS marks this ruling "not current" and states that it was obsoleted by Announcement (AN) 94(2). The summary below explains the ruling's 1991 treatment; confirm current Connecticut law before relying on it.

Plain-English summary

A Connecticut resident owned shares in an S corporation. The corporation earned interest but properly reported it for federal income-tax purposes as part of its nonseparately computed income, rather than as a separately stated interest item on the shareholder's Schedule K-1.

DRS ruled that the shareholder's pro rata share of that interest was not subject to Connecticut's dividend and interest income tax under Conn. Gen. Stat. § 12-506(a)(1). The ruling distinguished the two layers of the historical system: the corporation business tax applied to the S corporation's nonseparately computed items, while the chapter 224 taxes applied at shareholder level to separately computed capital-gain, dividend, and interest items. Treating the same nonseparately computed interest as shareholder interest income would conflict with that division and risk multiple taxation.

The ruling relied on DRS Bulletin No. 19 and Conn. Agencies Regs. § 12-518-7a(a), which treated S corporations as conduits for separately characterized income while preserving the character the item had at the corporation level.

What this means for you

The federal reporting category controlled the historical result

The decisive fact was that the interest was properly included in nonseparately computed S corporation income. A separately stated interest item would fall under the different shareholder-level treatment described by the ruling.

This is not current tax guidance

DRS has marked the ruling not current and obsoleted it by AN 94(2). Use it to understand the former tax system, not to prepare a current return.

Common questions

Was all S corporation interest exempt from the former tax? The ruling addressed only interest properly reported as a nonseparately computed item. It contrasted that with separately computed interest income.

Why was the shareholder not taxed on this item? DRS treated nonseparately computed items as subject to corporation business tax at the S corporation level, while the shareholder-level chapter 224 taxes applied to separately computed items.

Can this ruling be relied on now? No. DRS expressly marks it not current and obsoleted by AN 94(2).

Citations and references

• Conn. Gen. Stat. § 12-506(a)(1) -- historical dividend and interest income tax.
• Conn. Gen. Stat. § 12-505(a) -- definitions referenced in the ruling.
• Conn. Agencies Regs. § 12-518-7a(a) -- conduit treatment of partnership and S corporation income.
• DRS Bulletin No. 19 (October 26, 1983) -- S corporation income-character guidance quoted in the ruling.
• Announcement (AN) 94(2) -- identified by DRS as obsoleting this ruling.

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 91-10

Original ruling text

Ruling 91-10, Dividend and Interest Income Tax

This information is not current and is being provided for reference purposes only

Ruling 91-10

Dividend and Interest Income Tax

This Ruling has been obsoleted by   AN 94(2)

ISSUE:

If interest income of an S corporation is properly reportable, for federal income tax purposes, as a nonseparately computed item of income, is a shareholder's pro rata share of such interest income subject to the dividend and interest income tax that is imposed by Conn. Gen. Stat. §12-506(a)(1)?

FACTS:

A resident, as defined in Conn. Gen. Stat. §12-505(a), is a shareholder of an S corporation.

The shareholder's adjusted gross income, as defined in Conn. Gen. Stat. §12-505(a), equals or exceeds $54,000.

The S corporation has interest income that it reports on its Form 1120S as a nonseparately computed item of income. On the Schedule K-1 that is issued to the shareholder, his pro rata share of such interest income is included in his pro rata share of the S corporation's nonseparately computed items of income.

DISCUSSION:

"An S Corporation will ... be treated as a conduit for the distribution of income and an S Corporation shareholder who is a Connecticut resident ... is subject to the Capital Gains, Dividends and Interest Taxes on the pro rata share of items of income which are treated, for federal tax purposes, as capital gain income, dividend income or interest income, respectively.

The character of any item of income which is included in a shareholder's pro rata share will be that character which it had when realized by the corporation." Department of Revenue Services Bulletin No. 19 (October 26, 1983).

"A partnership or S corporation is not subject to the taxes imposed under chapter 224. A taxpayer who is a partner or shareholder of such an entity which is treated, for federal income tax purposes, as a conduit for the distribution of income is subject to the taxes imposed under chapter 224 on his or her pro rata share of income which is treated, for purposes of the taxes imposed under chapter 224, as gains from the sale or exchange of capital assets, dividends or interest income." Conn. Agencies Regs. §12-518-7a(a).

The avoidance of multiple taxation of S corporation income is the purpose that underlies Bulletin No. 19. The capital gains tax is to be imposed on an S corporation shareholder's pro rata share of separately computed gains from the sale or exchange of capital assets. The dividend and interest income tax is to be imposed on an S corporation shareholder's pro rata share of separately computed dividend and interest income. The corporation business tax is to be imposed on the S corporation's nonseparately computed items of income and deduction. Just as the corporation business tax is not imposed on separately computed items of income and deduction, the taxes imposed under chapter 224 are not imposed on nonseparately computed items of income and deduction. The provisions of the subsequently promulgated Conn. Agencies Regs. §12-518-7a(a) are not to the contrary.

RULING:

If interest income of an S corporation is properly reportable, for federal income tax purposes, as a nonseparately computed item of income, an S corporation shareholder's pro rata share of such interest income is not subject to the dividend and interest income tax that is imposed by Conn. Gen. Stat. §12-506(a)(1).

LEGAL DIVISION

March 29, 1991