Question

George, Inc., has been a C corporation for 5 years earning a taxable income of less than $100,000. Thus, the business has been subject to the lower C corporation tax rates, but due to cheap imports from Brazil, George’s two owners, Bill and Tom, expect operating losses for the next five years. They hope to outsource some of the manufacturing to Mexico and turn the company around. How can they deduct these anticipated future losses? The corporation receives some tax-exempt income, generates a small amount of passive investment income, and holds some C corporation earnings and profits. Each owner draws a salary of $82,000. George has issued two classes of stock, voting and nonvoting common. George, Inc., is located in Texas. Bill lives in Texas and Tom lives in Arkansas. Both Bill and Tom are married to nonresident aliens.

Should Bill and Tom elect to have George, Inc., treated as an S corporation.

Answer 1

The C Corporation is the standard corporation under the IRS Rules. S Corporation is a special tax status with the IRS and has some tax advantages. Determining the best type of corporation for the business is a very tough task to do. There are some similarities and differences between the C and S Corporation. The Major differences are:-

• There are chances of double taxation under the C Corporation. C Corporation pay taxes at a corporate level and further the income distributed to business owners as dividend is considered their personal taxable income. So corporate tax is paid at the first level and again at individual level.
• S Corporation file an return at income tax level but no tax is paid at the corporate level. the income is clubbed with the income of the business owners and reported on the owners personal tax returns. Any tax due is paid at the individual level.
• S Corporation shareholders who are eligible get a 20% deduction of net qualified business income.
• The losses of S Corporation pass through the shareholders and they can set off it with their personal income.
• For S Corporation shareholders must be individuals and U.S citizens or residenst whereas in C Corporation it is not compulsory.
• C corporation can issue more than one class of stocks with preference to dividends.

In the above case, George Inc. is a small business. It has issues two classes of stocks, Voting and non voting. Also it has tax exempt income and passive Investment income. They are estimating some future losses nd hence want to outsource some manufacturing to Mexico. Also both members tom and bill gets salary of $ 82000 each. Although they are married to non citizens but they are U.S Citizens only.

A business should choose to become S Corporation only when:-

• They are not planning an IPO and are not looking to sell their shares to more than 100 people.
• No plan on issuing preffered stock
• Shareholders tax liability taking their personal income tax rate and deduction will be lower under s corporation as compared to C corporation
• If there are losses, they will be set off from personal income taxes to offset income, resulting in tax savings.

If George Inc is converted to S Corporation, it will be able to set off their losses and enjoy paying taxes at lower rates. But they have already issued two classes of tocks which is not allowed under S Corporation. Also they are planning to outsource production to mexico and the turn the comany around, but for S Corporation the members cannot be non U.S Citizens. So george inc cannot opt for becoming a S Corporation.