S-Corp Tax Perks and Traps

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S-Corp Tax

Perks

  • Comparable C-Corp benefits- The S corporation is a hybrid, it enjoys many of the tax perks of the C corporation but is treated a pass-through entity for taxation purposes. This allows the S corporation to enjoy the tax-free reorganization provisions of the code like the C corporation. S corporations also allow for multi-entity structuring, through qualified subchapter S subsidiaries (QSSS). Each QSSS is a disregarded entity for tax purposes and also the parent S corporation to be the owner of all the assets, liabilities, deductions, and tax credits. 
  • Pass-Through Income- The income of the S corporation is passed through to its owners. This substantially similar to the partnership/LLC entities. This eliminates the issues of double taxation faced in the C corporation. Also because of the passed through status an S corporation may qualify for a the new 20% deduction and may also qualify as passive income for shareholders who aren't "materially participating."
  • Pass-Through Losses- Pass through losses can be passed through to its owners subject to the same four requirements as partnership taxed entities. However, there are stricter rules for S corps regarding basis calculations. 
  • Stock Basis Perk- There is no locked in basis in regards to S corporation stock like there is for C corporations. This allows the S corporation shareholder's stock to be adjusted up and down for the allocable losses and cash distributions, which is very similar to the partnership-taxed entity. 

Traps

  • Eligibility Limitations- There are eligibility requirements for S corporation status. Some of which can be negatives, for example there is only one class of stock allowed, there are limitations on who can qualify as a shareholder, also there is a cap of 100 shareholders.
  • Tax Year Trap- Unlike the C corporation that can pick its tax year calendar to achieve optimal tax planning, the S corporation is treated like the partnership taxed entity so there is not the flexibility to plan a business tax year.
  • No Special Allocations- Unlike the great benefits afforded to partnership taxed entities, an S corporation can not structure special allocations among its owners. Income and losses are passed through the S corporation to the owners according to the owner's stock ownership percentages.
  • Conversion Traps- There can be some difficulties converting out of an S corporation into a partnership taxed entity status, especially when it comes to built-in asset gains, accumulated earnings, LIFO inventory, and excessive S corporation passive income.

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