Election of S Corporation Status for Closely Held Corporations

Topics: Corporation, Limited liability company, S corporation Pages: 5 (1580 words) Published: May 14, 2013
Election of S Corporation Status
For Closely Held Corporations



The corporation structure comes in two flavors, S and C. An S corporation is similar to an LLC, in that its owners are taxed proportionately to their share in the firm's income and have limited liability. A separate tax return doesn't have to be filed on its behalf, which means the corporation's income or losses are passed through to its shareholders. This tax approach helps S corporations to avoid higher corporate tax rates and double taxations. All these significant benefits make the election of S corporation status become very popular among closely held corporations these years. However, existent pitfalls of S corp. status, such as loss of fringe benefits and additional taxes in certain states, require companies to balance the profits especially the tax benefits they can acquire of filing different forms of business organizations. Moreover, the restricted qualifications for filing S corp. status also limit some companies to elect S corp. status. For example, S corporation status limits the number of partners, requires them to be U.S. taxpayers and does not allow for multiple classes of stock, such as preferred or common stocks. Personal Service Corporations (PSCs) and banks are two examples in reality recommended to elect S corporation status. Nevertheless, no matter which type of industries, the decision to elect S corporation status still requires careful planning.

An S corporation, for United States federal income tax purposes, is a corporation that makes a valid election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. S corporation status provides many of the benefits of partnership taxation and at the same time gives the owners limited liability protection from creditors. As a result of the tax act, the election of S corp. status has become more popular than ever, especially to those closely held corporations. Benefits of electing S corp. status

Advantages to elect S corp. status are various.
First of all, S corporations are separate legal entities from their shareholders and, under state laws, generally provide their shareholders with the same liability protection afforded to the shareholders of C corporations. This benefit helps to avoid the unlimited liability transferred from corporations to individual shareholders. Another important benefit is that Subchapter S option helps to avoid higher corporate tax rates because of the different income tax brackets between individuals and corporations. In general, S corporations do not pay any federal income taxes. Instead, the corporation's income or losses are divided among and passed through to its shareholders. Since the maximum tax rate for individuals (35%) is less than for corporations (39%) nowadays, S corporations usually occurs a lower level of income tax liability than C corporations. Besides, S corporations can avoid double taxation on distributions of E&P at the shareholder level. The corporations’ losses can be passed through to shareholders and deducted on personal return. Moreover, there are also a lot of miscellaneous benefits of filing S corp. status. For instance, certain corporate penalty taxes, such as accumulated earnings tax, personal holding company tax and the alternative minimum tax, do not apply to an S corporation. Pitfalls of electing S corp. status

Even though an S corp. status may yield tax advantages for companies, there are also some significant pitfalls of using it. Here are some examples. When S corp. shareholders own 2% or more of stock, they shall be treated as partners of such partnership. Many tax advantages associated with incorporation for them, such as fringe benefits, are lost. For example, company-provided group term life insurance, health benefits, and company-paid meals and lodging on the premises would be treated as taxable income. S corp. is required to recognize its net built-in gain as a...
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