s-corporations

S-Corporations are pass-through entities with corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. However, not every corporation can elect S-Corporation status. There are certain eligibility requirements, which have to be maintained not only at inception to keep S status. The biggest ones are domestic corporation that has no more than 100 shareholders, and allowable shareholders may not be partnerships, corporations or non-resident alien shareholders.

OUR SERVICES AND WHAT WE CAN HELP WITH

1. S Corporation Formation and Election

Choosing S Corporation Status: Advise clients on the advantages and disadvantages of electing S Corporation status, such as avoiding double taxation and self-employment taxes on distributions.
Filing Form 2553: Assist clients with the process of making the S Corporation election by preparing and filing Form 2553 with the IRS.

2. Compliance and Reporting

Tax Returns: Help clients understand their obligations to file Form 1120S (U.S. Income Tax Return for an S Corporation) and Schedule K-1 for shareholders.
Record Keeping: Advise on maintaining proper documentation, including minutes of meetings, corporate resolutions, and records of shareholder decisions.

3. Shareholder Agreements and Distributions

Drafting Shareholder Agreements: Assist in creating comprehensive shareholder agreements that outline rights, responsibilities, and profit distribution.
Distributions vs. Salaries: Guide clients on the distinction between salary and distributions, including the importance of reasonable compensation to avoid IRS scrutiny.

4. Tax Planning and Strategy

Entity Structure Optimization: Analyze whether an S Corporation is the best choice for clients compared to other entities (LLCs, partnerships, C Corporations) based on their business activities and income levels.
Loss Limitations: Advise clients on the limitations regarding the deductibility of losses for S Corporation shareholders, including basis limitations and at-risk rules.

5. Corporate Formalities and Compliance

Maintaining Corporate Status: Counsel on the importance of adhering to corporate formalities to maintain S Corporation status, including annual meetings and maintaining separate business records.
State Compliance: Ensure clients are compliant with state-specific requirements for S Corporations, including state tax filings and franchise taxes.

6. Changes in Ownership and Structure

Transfer of Shares: Guide on the tax implications of transferring shares, including issues related to built-in gains and loss recognition.
Adding New Shareholders: Assist in structuring the addition of new shareholders while ensuring compliance with S Corporation requirements.

7. S Corporation Audits and Issues

Audit Representation: Provide representation for S Corporations during IRS audits and respond to inquiries regarding tax filings and deductions.
Handling Noncompliance: Advise clients on rectifying issues that could jeopardize their S Corporation status, such as exceeding the shareholder limit or foreign shareholder restrictions.

8. Dissolution or Termination

Dissolving an S Corporation: Guide clients through the tax implications and processes involved in dissolving an S Corporation, including the handling of assets and liabilities.
Filing Final Returns: Assist in preparing and filing final tax returns and ensuring proper distribution of assets to shareholders.

9. International Considerations

Foreign Shareholders: Advise on the implications of having foreign shareholders in an S Corporation, including tax withholding obligations and potential loss of S Corporation status.
Cross-Border Operations: Provide guidance for S Corporations engaged in international business, addressing compliance with U.S. and foreign tax regulations.

TIMELY ELECTION FOR S STATUS IS REQUIRED

In order to become an S corporation, the corporation must submit Form 2553, Election by a Small Business Corporation signed by all the shareholders.

The window for timely filing is:

No more than 2 months and 15 days after the beginning of the tax year the election is to take effect, or
At any time during the tax year preceding the tax year it is to take effect.

NUANCES OF S-CORPORATIONS:

There are some S-Corporations specific rules that have to be followed, and here are some of them:

Distributions, generally, have to be proportionate to shareholder's ownership interests. For example, in 50/50 ownership scenario, each shareholder's distribution must be 50% of the total distribution. In other words, one can't take more than the other, otherwise, distributions may need to be equalized. This is something that is different for partnerships where partners enjoy better flexibility with distributions and beyond.

Also, with S-Corporations, generally, shareholders are required to compute stock and debt basis. There are nuanced debt restoration rules that shareholders must follow. It can get complex quickly where shareholders are planning to inject funds into the S-Corporation not sure best approach to go about capital contribution v. shareholder loan. Typically, capital contribution could be better, however, there are situations where shareholder loan is better to inject in and then take it out. It is case-by-case.

In addition, with Accumulated Adjustment Account (AAA) reporting, distributions cannot make AAA go below zero or cannot increase negative balance.

Finally, reasonable compensation can be at issue. For example, if it is a service corporation, let's say a law firm, where shareholders earn revenue by providing professional services to clients, and their S-Corporation reports no compensation to lawyers, rather, they take distributions out, it could be a problem. Technically, they are taking tax-free distributions, assuming no basis limitations without paying payroll taxes. The IRS has the authority to reclassify payments made to shareholders from non-wage distributions. If this is to happen, there is a great chance that interest and penalties may be accessed.

Comparison S-Corporation v. Partnership

LLC taxed as S-Corp vs. LLS taxed as Partnership

1. Managing member of LLC taxed as partnership pays self-employment (SE) tax on K-1 income while shareholders at S-Corp do not.

2. Assets in corporation can be taken out as a sale, asset taken from partnership are treated tax free under the general rule.

3. Recourse loans (guaranteed by member) are a part of the basis so more losses can be deducted. This concept is not recognized in S-Corp. As long as there is a note showing loan from corporation, it is then a part of the basis

Comparison C-Corporation v. S-Corporation

C-Corporation vs. S-Corporation

1. Limitations on non-resident status and number of shareholders.

2. S-Corp may be limited in employee benefits: can’t have Sec 125 cafeteria plan or group term life insurance.

3. C-Corp pays income tax +Florida income tax + 15% on dividends if take money out. It is double taxation, not the case with S-Corps. Companies that have goodwill or appreciated capital assets like real estate might not want to be C-Corp because when they sell—big gains could be subject to double taxation.

4. Shareholder’s health insurance is deductible on C-Corp Books. Some C-Corps have medical reimbursement plan (makes sense if shareholders are the only employees). On S-Corp medical reimbursements are generally taxable to employees (not on C-Corp).

NEXT STEPS

Our attorney can assist with evaluating and optimizing your options.

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