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Corp. Sol., 2008 Chap.11

Corp. Sol., 2008 Chap.11 - Chapter C:11 S Corporations...

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Chapter C:11 S Corporations Discussion Questions C:11-1 Eight advantages of S corporation treatment are illustrated on text page C:11-3. Nine disadvantages of S corporation treatment are illustrated on text pages C:11-3 and C:11-4. C:11-2 Many items must be considered when converting a C corporation to an S corporation. Julio must compare his and the corporation’s potential tax liabilities under both the C and S corporation scenarios. Although his marginal tax rate is lower than the marginal corporate rate, he is getting some benefit from the lower corporate rates on the first $75,000 of corporate taxable income. Also, his dividend income is taxed at only 15%. If Julio elects S corporation status, the entire amount of corporate income would be taxable to him regardless of whether the corporation distributes it. Accordingly, most of the income would be taxed at the 28% to 35% marginal rates (in 2007). However, none of the $25,000 in dividends currently being paid would be subject to the double taxation under the current C corporation status if the corporation made an S election. In addition, the income passed through to Julio will step-up the basis of Julio's S corporation stock. Such a basis step-up does not occur with a C corporation. He also must consider the possible effect of the built-in gains tax that could arise during the first ten years after a C corporation converts to an S corporation. Thus, Julio should make a thorough analysis of the short- and long-term benefits of S corporation status including a comparison of the treatment of pensions and fringe benefits for each class of corporation, and the potential estate planning considerations. Some of the advantages and disadvantages of making an S election are outlined on pages C:11-3 and C:11-4. C:11-3 Taxpayers must consider many items in making the decision regarding the initial tax form of a business. The corporate (either C or S corporation) form offers the advantage of limited liability, which is important for a new business. S corporations often are an attractive form for a new business because the losses in the initial years pass through to the shareholder and offset any income that Celia would earn from other sources. The S corporation status can be terminated fairly easily, if in the future C corporation status becomes more desirable. The noncorporate entity form known as a limited liability company (LLC) also should be investigated. This business form provides the limited liability benefits usually associated with a corporation, and it provides the tax benefits associated with a partnership. Under the check-the-box regulations, an LLC also can elect to be taxed as either a C corporation or an S corporation even if not organized as a corporation under federal or state law. It may prove advantageous for an LLC to elect to be taxed as a C corporation. An LLC probably would not want to elect to be treated as an S corporation because, in most instances, it already is treated as a partnership under the check-the-box regulations without such an election.
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