Basic benefits of a switch: If a C corporation owner elects S corp status, the corporation’s income and deduction items are passed through to the owner, and therefore, reported on his or her 1040 and taxed at personal rates. Significantly, switching to S status should avoid any threat of double taxation on:
- future corporate operating profits, and
- future appreciation in corporate assets that occurs after the switch.
As you may know, double taxation occurs when a C corporation pays corporate-level tax on its income and gains. The owner then pays tax again at the shareholder level when the income and gains are distributed as taxable dividends.
In contrast, a business owner is only taxed once under the S corp form of doing business, while retaining other benefits such as corporate protection from personal liability.
Basic drawbacks to a switch: The decision to switch is not always a slam-dunk. If the owner has substantial income from other sources, or if the company is quite profitable, he or she may be forced to pay the 35% maximum rate on most or all the incremental income passed through.
Rule of thumb: With the current tax brackets in effect, the owner often fares better if the company generates annual profits of less than $100,000.
In addition, beware of the onerous “built-in gains” (BIG) tax. This comes into play if the corporation owns appreciated assets when it switches from C to S status. When this corporate-level tax applies, the rate is 35%.
Since the deadline for an S corporation switch is March 15, 2011, do not delay in calling your Tax Consultant to discuss this possibility. Your Tax Consultant can help you determine if switching is advantageous to your situation.