Problems with S Corps
By Thomas Rose |
Fri, 14 Mar 2008
S Corporation Election, Subchapter S Election Or Sub-s Election
As stated in my article entitled Help in Choosing the Form of the Legal Entity: "Each form of entity presents its own advantages and its own disadvantages." I=ve observed in my practice that the entrepreneur's
certified public accountant frequently suggests that the new entity
should be a Texas corporation, with an Internal Revenue Code election
to permit the pass-through partnership treatment of income and loss (an
"S corporation election", or a "subchapter S election", or a "sub-S election").
No Difference In Structure
First,
there is no difference between the structure of a corporation organized
in Texas as a C corporation or as an S corporation. However, to invoke
a federal S corporation election, there must be a timely filed Internal
Revenue Code Form 2553 consent signed by all corporation shareholders.
Late filing of this form has proven disastrous for some taxpayers.
Partnership Taxation Differences
S
corporations are not taxed as partnerships in the following areas: (a)
non-cash distributions of property are taxable events; and (b)
conversions or liquidations of the entity may be taxable events.
Other Problems And Challenges
S
corporations also pose some problems or challenges: (a) S corporations
are not permitted to make disproportionate allocations of income and
loss among its shareholders; (b) the number of classes of outstanding
stock may be limited in S corporations; (c) certain penalty taxes for
built-in gains and excessive passive income may affect S corporations;
(d) the federal tax election may be inadvertently forfeited; (e) a
judgment creditor of an S corporation shareholder may seize such
shareholder's stock, jeopardizing the federal tax election status of
the S Corporation; and (f) on the death of an S corporation
shareholder, the S corporation may not adjust the basis of its assets
to reflect the increase in the deceased shareholder's basis to its fair market value as of the date of death.
Carefully Weigh The Consequences
Do these situations mean that an entrepreneur should never select a corporation with the federal S corporation election? No. But
the certified public accountant and the entrepreneur must carefully
weigh the negative consequences of such an election before choosing to
go forward.
