Question

One operational challenge that S-corporations face is the challenge of converting from a C-corporation into an S-Corporation. We've studied the concept of corporate earnings and profits in some detail this term. If you think about it, earnings and profits and their associated tax consequences do not disappear because a corporation changes from a C-corporate form to an S-Corporate form. Rather those C-corporate earnings are tracked for decades and if they are ever distributed they are subjected to double taxation. Given that structure and the relative ease of completing a type F reorganization, should a C-corporation evet elect to become a S-corporation or is there a better way?

Answer 1

• If a corporation elects to be taxed as an S corporation, then it can avoid the corporate tax. However, its stockholders will have to pay personal taxes on the firm's net income.

• The easiest and least costly method to exit C status is to convert to S corporation status, but that has its limitations and may not be possible or desirable in all situations.

-->> Electing S corporation status: The shareholders of a C corporation may elect S status and, in general, the corporation will avoid a corporate-level federal tax on its operating income or on gain resulting from the sale of its business. Items of income, deduction, gain, loss, and credit are generally taken into account only by the shareholders and not by the corporation in computing taxable income and tax. A favorable aspect of an S election is that in many cases it takes a corporation out of C status and its attendant double taxation without a tax consequence.

-->> Eligible C corporations: Not every C corporation is eligible to be an S corporation. There are shareholder requirements, a capitalization requirement, requirements for corporations with accumulated earnings and profits where the corporation has certain levels of passive income, and requirements relating to the corporation itself.

-->> Corporate requirements: Only domestic corporations that are not (1) financial institutions using the Sec. 585 reserve method of accounting for bad debts, (2) insurance companies taxable under subchapter L, (3) possessions corporations, or (4) DISCs or former DISCs can qualify for S status.

C corporations are subject to double taxation, but methods of reducing corporate taxable income, such as increasing compensation to shareholder-employees, all have their own limitations.Even if double taxation of C corporation earnings can be acceptably and justifiably managed through payment of compensation to shareholder-employees, there remains the problem of managing double taxation of C corporation earnings when disposing of the C corporation itself or of its underlying business.