Question

2.) Define pass-through taxation. What business entities have pass-through taxation?

3.) What is the benefit of a corporation electing to be taxed as a S-corporation? What are the limitations of a company making this election.

4.) What factors affect the tax treatment of corporate distributions?

5.) A corporation currently has income solely generated within the United States. However, next year the corporation plans to extend into foreign markets. What tax issues may arise?

Answer 1

2) A pass-through entity is a special business structure that is used to reduce the effects of double taxation. Pass-through entities don't pay income taxes at the corporate level. Instead, corporate income is allocated among the owners, and income taxes are only levied at the individual owners' level.

Pass-through taxation refers to how individual owners of a business pay taxes on incomederived from that business on their personal income tax returns. Pass through taxation applies to sole proprietorships, partnerships, and S-Corporations.

3) Benefit of a corporation electing to be taxed as a S-corporation are:

• Limited liability for management and shareholders.
• An unlimited number of management, no state residency requirements.
• Distinct, court-recognized existence, which helps protect you from personal liability that can cause you to lose your personal wealth in assets like your home, car, or nest egg.
• Flow-through taxation: Profits are distributed to the shareholders, who are taxed on profits at their personal level.
• Good privacy protection, especially in Nevada and Wyoming.
• Great income-splitting potential for owner/employees. Can take a smaller salary and pay income taxes and regular payroll deductions, then take the remainder of profit as a distribution subject to income tax only.
• S Corporations are great for businesses that:
• will provide a service (i.e. consultants);
  • will not have significant start-up costs;
  • will not need to make major equipment purchases before beginning operations; and
  • will make a sizable amount of money without a great deal of effort and expense.

Limitations of a company making this election are:

• At shareholder level, shares are subject to seizure and sale in court proceedings.
• Maximum of 100 shareholders, all of whom must be U.S. residents or resident aliens. Shares must be held directly, except in special circumstances.
• Owner/employees holding 2% or more of the company’s shares cannot receive tax-free benefits.
• Because flow-through taxes will be paid at the personal rate, high-income shareholders will pay more taxes on their distributions.
• Not suitable for estate planning vehicle, as control is ultimately in the hands of the stockholders. In a planned gifting scenario, once majority control passes to children from parents, children can take full control of the company.
• If tax status is compromised by either non-resident stockholder or stock being placed in corporate entity name, the IRS will revoke status, charge back-taxes for 3 years and impose a further 5-year waiting period to regain tax status.
• Not suitable to hold appreciating investment. Capital gain on sale of assets will incur higher taxes than with other pass-through entities such as LLCs ad Limited Partnerships.
• Limited to one class of stock only.

4) Distributions not taxed as dividends because of insufficient E & P are nontaxable to the extent of the shareholder's stock basis and will reduce the basis accordingly. Any excess of the distribution over shareholder's basis usually is a capital gain. Distributions by a corporation to its shareholders are presumed to be dividends unless the party can prove otherwise. Section 316 makes such distribution dividend income to the shareholder to the extent of E & P of the distributing corporation accumulated since 1913 or to the extent of E & P of the current year.