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Paystub Maker inform you more about Income taxes and S Corporation
Specific circumstances where an S corporation may be desirable are: large losses.
(i) The business expectations are to incur significant losses and credits that the shareholders may better use than the corporation;
Note: Individual shareholders may benefit from a reduction in their taxable income during the first years of the corporation’s existence when it may be operating at a loss.
(ii) The business has little reason to accumulate capital;
(iii) The business will have a large cash flow that it intends to distribute;
(iv) Limited liability requires the use of a corporation; and
(v) When corporate rates are higher than individual rates.
For tax purposes, an S corporation is somewhat of a hybrid entity that has characteristics of both a corporation and a partnership. Although it operates as a corporation, the business is not subject to double taxation since it is the shareholders, and not the corporation, who pay federal income tax on the business profits. Nonetheless, the S corporation must still file an annual corporate tax return.
A subchapter S election has quite a few disadvantages (or potential disadvantages) that receive remarkably little press. It is important for you to take into account these factors before electing S corporation status:
1. Since there is no corporate tax rate, non-qualified deferred compensation plans are impractical.
2. There is no situation to accumulate corporate earnings in a lower corporate tax bracket. It is difficult for an S corporation to reinvest its profits since current profits are taxable to shareholders with distribution or not
3. Lower-taxed corporate funds cannot pay for split-dollar and other non-deductible fringe benefits for the shareholders.
4. The 80% of dividends received deduction is lost (§243 and §1373(c)-(d)).
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 similar provision to the federal Subchapter S. Thus, in some states a Sub Chapter 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 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.
11. There are restrictions on borrowings by S corporation shareholders from their qualified retirement plans (§4975(d)).
12. If an S corporation shareholder is not a material participant, S corporation losses may only be deducted against passive profits.
13. More record-keeping may be required by an S corporation because of the need to maintain accurate records for basis in shareholder’s stock, to maintain the accumulated adjustments account, and to determine the taxability of distributions.
Becoming an S Corporation
A corporation formation must be by both state and federal law. An S corporation, like other corporations, must obtain a corporate franchise or charter from the state in which it intends to incorporate or do business. Corporate capitalization involves the transfer of money and property to the corporation in return for stock in the corporation. Section 351 provides that
if one or more persons transfer property or money 2 to a corporation only in exchange for stock of that corporation, and immediately after the exchange, the transferors are in control of the corporation, no recognition of gain or loss to the transferors of the corporation.
Note: Control is defined as owning (1) at least 80% of the total combined voting power of all classes of stock entitled to vote; and (2) at least 80% of the total number of shares of all other types of stock of the corporation. (Quizlet) Read more
Flow-through entity Wikipedia
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, it will be explained later.
4. It files Form 2553, Election by a Small Business Corporation, to indicate it chooses S corporation status. S corporation Utah Government pdf 9-5
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