Business Tax Preparation
  • Benefits of S Corporation Basis and Distribution Elections: Getting the Most From Your Tax Planning Services

Benefits of S Corporation Basis and Distribution Elections: Getting the Most From Your Tax Planning Services

S corporations provide possible tax advantages over C corporations in the right circumstances. This can be the case if you expect a business will incur losses in its early years, as shareholders in a C corporation generally receive no tax benefit from these losses. Conversely, as an S corporation shareholder, you can deduct your percentage share of these losses on your personal tax return to the extent of your basis in the stock and any shareholder loans (debt) you personally lend to the entity.

Losses that cannot be deducted (as they exceed your stock and debt basis) are carried forward and can be deducted by you at a future point when there is sufficient basis to do so.

Therefore, tax planning services that evaluate your ability to utilize losses that pass through from an S corporation depends upon your basis in the corporation’s stock and debt. Basis is also crucial for other purposes, such as determining the amount of gain or loss you recognize if you sell the stock of the corporation. Your basis in the corporation is adjusted to reflect various events such as contributions made to the corporation, distributions received from the corporation, and the corporation’s income or loss each year.

Elections related to adjustments to basis

However, some shareholders may not be aware of several elections available to an S corporation or its shareholders that can affect the basis adjustments caused by distributions and other events. Ensure that your tax planning services provider addresses all the elections possible for an S Corporation. Here is some information about four particular elections that could prove useful:

1. An S corporation may elect to reverse the ordering of basis adjustments, potentially changing the amount of basis to be used when applying against losses. Making this election may permit the shareholder to deduct more pass-through losses in a given year.

2. S corporations with significant “passive income” and accumulated earnings and profits (E&P) from prior C corporation years, may benefit by reducing their E&P to avoid certain taxes or loss of S status. A “deemed dividend election.” can be useful if the corporation is seeking to reduce or eliminate E&P, but cannot (or does not want to) make an actual dividend distribution in cash.

3. When a shareholder’s interest in the corporation is transferred or terminates during the year the corporation and all affected shareholders can elect to treat the corporation’s tax year as two separate tax years: the first short year as having ended on the date the shareholder’s interest terminated, and the second short year as having begun on the date following the termination of the shareholder’s interest. This election affords flexibility in the allocation of the corporation’s income or loss to the shareholders (and perhaps the category of accumulated income out of which a distribution is made) for each newly-created short tax year.

4. The election to bifurcate the S corporation’s tax year (into two “short” tax years in a similar structure as noted above) may also be available if there has been a disposition by (or redemption of) a shareholder of 20% or more of the corporation’s stock within a 30-day period, or if stock equal to or greater than 25% of the previously outstanding corporate stock is issued to one or more new shareholders within a 30-day period. All shareholders of the corporation must consent to this particular election.

Contact us if you would like to go over how these elections, as well as other S corporation planning strategies, can help maximize the tax benefits of operating as an S corporation.