18 Oct 2018 / 11:55 GMT
01 Articles Overview
02 Business Planning, Benefits & Strategies
03 S Corporations and C Corporations
04 Estate Tax, Discussion
05 Non profit corporation
06 Schedule C, Unincorporated Businesses
07 Section 1244 Stock
08 Stock transaction tax rules For Day Traders
09 Tax Treaty Countries
10 Trademarks
11 USA, State Death taxes
Articles of Interest
Comparison of S Corporations and C Corporations
 

 
The listing of advantages and disadvantages of S corporation status identifies some of the tax planning and tax compliance implications of deciding to elect S status.
 
  • Advantages of S corporations compared to C corporations:


    1. Avoid double taxation associated with C corporations:
      1. Annual earnings are taxed to the C Corporation and again to the shareholder upon dividend distributions, sales of stock, or liquidation.
      2. Appreciated assets trigger corporate tax upon sale or distribution at the C corporation level and again to the shareholder upon liquidation or sale of stock.
      3. IRS audit adjustments to C corporation expenses often result in dividend treatment to shareholders.
    2. Losses, deductions, and credits pass through to the individual returns of S corporation shareholders.
    3. Deduct interest expense incurred by the shareholder to acquire the stock of the S corporation; such interest is treated as deductible business interest (if the shareholder materially participates in the trade or business and all of the corporation's assets are used in the conduct of the business), as opposed to investment interest incurred in the acquisition of C corporation stock.
    4. Split income with other family members.
    5. Avoid the risk of the accumulated earnings tax.
    6. Minimize the risk of an unreasonable compensation attack for excessively high salaries.
    7. Avoid the personal holding company tax (but beware of the S corporation excess net passive income tax.
    8. Minimize payroll tax costs by holding corporate salaries below FICA maximum and increasing S distributions.
    9. Avoid the 35% flat tax imposed on personal service corporations.
    10. Avoid converting cash-method C corporations with $5 million or more in gross receipts to the accrual method of accounting.
    11. Avoid the corporate alternative minimum tax (AMT) that generally applies to C corporations with annual gross receipts of $7.5 million or more.


  • Disadvantages of S corporations compared to C corporations:


    1. Imposition of corporate level Section 1374 built in gains tax following conversion from C to S status:
      1. Smaller "qualified corporations" will escape built-in gains tax on capital gains if they elected S status before 1989.
      2. Built-in gains affected by the net income limit carry over to future years if the S election was filed on or after Mach 31, 1988.
      3. Corporations with high risk include:
        • Cash-method taxpayers with accounts receivable,
        • Cash-method farmers with appreciated inventories, and
        • Taxpayers with substantially appreciated Section 1231 assets.
    2. S election by a C corporation using the LIFO inventory method triggers recapture of the excess of FIFO over LIFO inventory values.
    3. Deduction of pass-through losses by the shareholders may be limited by:
      • Insufficient tax basis in stock and direct loans to the corporation (no basis for third party loans to the entity as with a partnership), and
      • Application of the Section 465 at-risk rules.
    4. Pass-through losses and credits at the shareholder level may be limited by the Section 469 passive activity loss rules in the event of:
      1. Lack of material participation by the shareholder, or
      2. Rental activity limitations.
        (Note: C corporations that are personal service corporations are also subject to the passive activity loss rules. Closely held C corporations may use passive losses to shelter business income but not portfolio income)
    5. Loans to shareholder/employees from qualified retirement plans may result in plan disqualification and penalties upon electing S status.
    6. Eligibility criteria for S status may be a barrier or result in unintended termination. The eligibility criteria include:
      1. 75-shareholder limit,
      2. b. Single class of stock,
      3. Generally corporations, partnerships, nonresident aliens, or certain types of trusts may not be shareholders (however, for tax years beginning after 1997, section 501(c)(3) charitable organizations and tax-exempt qualified retirement plan trusts may be shareholders), and
      4. Insurance companies do not qualify.
    7. Non- taxable fringe benefits are curtailed for shareholders owning directly or indirectly more than 2% of stock.
    8. A calendar year must be used by S corporations, with exceptions for:
      1. "Business-purpose" application (to IRS) to adopt or retain a fiscal year, and
      2. Election of fiscal year per IRC Sec. 444.
    9. Income passed through by an S corporation may be taxed at a higher individual rate (up to 39.6%) as compared to a maximum 35% corporate tax rate.
    10. The lower corporate tax tiers are lost.
    11. Carryovers of NOL's and business credits from C corporation years generally are deferred under IRC Sec. 1371(b) and may expire unused.
    12. The corporate dividends received deduction is lost.
    13. Taxation of income to shareholders may not be consistent with cash flow to shareholders.
    14. The accumulated adjustments account (AAA) and basis rules are complex with respect to S corporation distributions if the corporation has accumulated earnings and profits (AE&P).
    15. Corporate level tax is imposed on S corporations with more than 25% of gross receipts from passive investment income plus C corporation AE&P; potential termination of S status after three years.
    16. The S election results in potential AMT at the shareholder level. AMT adjustment and preference items pass through to shareholders, even if the S corporation has annual gross receipts of (generally) $7.5 million or less.
    17. Possible adverse state income tax consequences, including non-recognition of S status by state, additional individual state returns, and shift of S income to state of shareholder residency.