Last weeks blogs discussed tax considerations of C-Corps. This week’s blog discusses some similar tax considerations of S-Corps, which is a form of flow through entity for tax purposes.
The net income of an S corporation is not taxable at the corporate level. Instead, it flows through to the individual shareholders. The shareholder is taxed on his share of the corporation’s income, regardless of whether or not the income is distributed to the shareholder. The corporation’s items of income and deductions are allocated to the individual shareholders in proportion to their stock ownership. The shareholder’s adjusted tax basis in his stock is increased by the share of income recognized, and decreased by the share of deductions taken. The shareholder’s loss deduction is limited to the basis he has in the stock, plus the basis of any debt owed to him by the corporation. In addition to the individual shareholders paying California income tax based on the income and deductions flowing through from the S-Corp, the corporation itself pays California income tax equal to 1.5 percent of the S-Corp’s taxable income.
A shareholder’s disposition of shares of corporate stock generally constitutes a taxable event. Gain or loss is recognized equal to the difference between the value of the money and property received for the stock and the shareholder’s adjusted tax basis in the stock. The gain or loss will generally be treated as resulting from the disposition of a capital asset, and will be taxed at the lower capital gains rate rather than the higher ordinary income tax rate. The sale of a shareholder’s stock of the corporation is not a taxable event to the corporation.
Upon the liquidation of the entire corporation each shareholder will recognize capital gain or capital loss equal to the difference between the fair market value of cash and property received and the shareholder’s adjusted tax basis in the shares. At the same time, to the extent that the distribution to the shareholder is made in property, the corporation must recognize gain on an amount equal to the fair market value of the property being distributed less the corporation’s adjusted tax basis in the property. Consequently, the liquidating distribution may result in double taxation.
The merger of a corporation into another entity may result in a tax-free reorganization if it is properly structured under the Code. Consequently, it may be advantageous to structure a business as a corporation if the owners believe the company may be acquired by another entity sometime in the future.
Finkel Law Group, with offices in San Francisco and Walnut Creek California, has provided comprehensive corporate and tax counsel to many different forms of business enterprises starting up in many different types of industries for more than 10 years. We have the knowledge and experience to help your company navigate state corporate law and federal and state tax laws. When you need intelligent, insightful, conscientious and cost-effective legal counsel to assist you with forming and managing your new business enterprise, please contact us at (415) 252-9600, (925) 274-9600, or firstname.lastname@example.org to speak with one of our attorneys about your matter.