Source: http://accurate-aa.com/s-corporation.html
Timestamp: 2018-04-24 10:45:27
Document Index: 776881257

Matched Legal Cases: ['§1361', '§1379', '§541', '§531', '§754', '§704']

S Corporation - Accurate Accounting Associates LLC
Eligible domestic corporations can avoid double taxation by electing to be treated as an S corporation under the rules of Subchapter S. Subchapter S provides an optional method of corporate taxation (§1361 through §1379). It allows small business corporations to elect unusual tax treatment.
Similar to partnerships, all items of income, deduction, credit, gain and loss are passed through on a pro rata basis to the individual S corporation shareholders. In this way, the S corporation passes its items of income, loss, deduction, and credits through to its shareholders to be included on their separate returns.
In short, the S corporation is taxed like a partnership; it pays no taxes, and its income and deductions pass through to the shareholders. In other respects, however, S corporations are taxed like C corporations.
There are many advantages to an S corporation:
1. An S corporation can distribute its profits to shareholders with only a single tax, whereas a C corporation incurs a double tax because dividends are not deductible.
2. The losses of an S corporation are currently deductible by shareholders; shareholders cannot deduct the losses of a C corporation. Thus, S corporations provide an opportunity for the owners of a new business who are anticipating initial losses in the early years to take advantage of both the corporate limited liability and the flow through of losses. If a C corporation were used, losses could only be used as net operating losses by the C corporation.
3. A new corporation may elect S corporation in its initial year in order for its shareholders to utilize initial losses of the corporation, even though the shareholders may ultimately want to have the corporation taxed as a regular C corporation.
4. An S corporation is specifically exempted from the accrual method rules and can continue use of cash method of accounting, if such method is otherwise available because of the nature of business.
5. If an S corporation stockholder does not actively participate in management of the corporation, any income received will be passive and can be used to offset passive losses.
6. An S corporation provides a corporate shield for liability purposes for those taxpayers who want income and losses taxed to them, but who do not want the potential liability problems of a partnership.
7. A subchapter S corporation may adopt tax deductible and non-deductible fringe benefit plans. However, there are special rules and limits applicable to such plans.
8. An interest expense deduction is allowed for funds borrowed by a shareholder to purchase stock in an S corporation. Such interest constitutes business interest when the shareholder materially participates in the business.
9. Also, many difficult problems of C corporations are not problems for S corporations. For example:
(i) An S corporation is not subject to the alternative minimum tax; and
(ii) The personal holding company tax under §541 and the accumulated earnings tax of §531 do not apply to S corporations.
A subchapter S election has quite a few disadvantages (or potential disadvantages) that receive remarkably little press. It is important to consider these factors before electing S corporation status:
1. Since there is no corporate tax rate, nonqualified deferred compensation plans are an impracticality.
2. There is no opportunity to accumulate corporate earnings in a lower corporate tax bracket. It is difficult for an S corporation to reinvest its profits in the business since current profits are taxed to shareholders whether they are distributed or not.
3. Split-dollar and other non-deductible fringe benefits for the shareholders cannot be paid for by lower taxed corporate funds.
4. The 80% dividends received deduction is lost
5. The state tax laws may not provide for anything like a subchapter S election. Often states that have enacted a corporate income tax have not adopted a provision similar to the federal Subchapter S. Thus, in some states a Subchapter S election will not avoid the corporate double tax.
6. A new or dissident shareholder can cause the termination of the subchapter S election through a disqualified transfer of stock.
7. Neither an S corporation nor a C corporation has the flexibility that partners and partnerships do under §754 to equalize the outside basis of the owner’s interest with the inside basis of the entity’s assets on certain acquisitions of these interests or on property distributions from the entity to the owners.
8. Subchapter S corporations do not enjoy the special allocation of deductions and basis that are afforded partnerships under §704(b) and (c).
9. All income, except long term capital gains, received by the corporation are taxable to the shareholders whether or not they are currently distributed.
10. Use of an S corporation results in a loss of lower tax bracket at the corporate level on the first $75,000 of taxable income.
A corporation can become an S corporation if:
1. It meets the requirements of S corporation status.
2. All its shareholders consent to S corporation status.
3. It uses a permitted tax year, or elects to use a tax year other than a permitted tax year, as explained later.
4. It files Form 2553, Election by a Small Business Corporation, to indicate it chooses S corporation status.