When a corporation distributes dividends to its shareholders, the income is taxed twice. However, an S corporation can avoid this double taxation by passing its income and deductions to shareholders on their personal tax returns. Opting for S corporation taxation can be advantageous over C corporation taxation, making it important to understand S Corporations.
Happy owner of a small business
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.
Note; Distributions of profits to shareholders, whether or not the shareholders are active in the business, are not subject to self-employment tax.
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 limited corporate 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.
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3. A new corporation may elect an S corporation in its initial year 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 the use of the cash method of accounting if such method is otherwise available because of the nature of the business.
5. If an S corporation stockholder does not actively participate in the management of the corporation any income received will be passive and can be used to offset passive losses.
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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 legal for loan made 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 (Wikipedia) minimum tax; and
(ii) The personal holding company tax under §541 and the accumulated earnings tax of §531 do not apply to S corporations.
Advantages of an S Corporation
Single Level of Tax on Earnings
Limited Liability for All
Losses Can be diductable by S/Hs
Can Use Cash Method of
No AMT, PHC, PSC or EAE Issues
No Section 704(c) Problems
The unreasonable compensation issue
Distributions are tax-free
Section 1244 is available S corporation IRS
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