Cream of the Crop 1/Cream of the Crop 1.iso/BUSINESS/SBA62.ARJ/FSBA.EXE/F308.SBE

Text File | 1992-04-30 | 16KB | 440 lines

@Q01

                  ┌─────────────────────────────────┐
                  │ IS MY COMPANY ELIGIBLE TO ELECT │
                  │      S CORPORATION STATUS?      │
                  └─────────────────────────────────┘

An "S corporation" is just a regular corporation that has made an
election on Form 2553 for federal tax purposes to be taxed in a
different way than other corporations (C corporations).  Under state
law, an S corporation provides the same degree of limited liability as
any other corporation.  In general, an S corporation is simply a cor-
poration that elects not to be taxed AT ALL.  Instead, its income or
losses pass through to the individual shareholders, who include such
income and (in most cases) such losses on their tax returns.  As such,
an S corporation can, in many situations, save a great deal in income
taxes, as compared to a C corporation.  However, there are a number of
technical requirements that must be met to elect "S" status.

  QUESTION:  Is your corporation incorporated in the United States? (Or
             will it be, if your business is not now incorporated?)
@YN
01\Q03
02\Q02

@Q02

CONCLUSION:  It appears that your corporation will not qualify to be
an S corporation.  The requirements are quite strict.

@BR\02

@Q03

INELIGIBLE TYPES OF SHAREHOLDERS:  In general, the stock in an S
corporation can only be held by individual persons or their estates.

An S corporation cannot have any shareholders that are corporations
or partnerships.  If even one share of its stock is owned by a part-
nership or another corporation, or any other kind of entity other than
a natural person (with certain exceptions for trusts, or the estate
of a deceased person or an estate in bankruptcy), a corporation will
not be eligible to become an S corporation.  Or, an existing S corpor-
ation will lose its "S" status if such an entity becomes a shareholder.

  QUESTION:  Will any of the stock of your corporation be owned by
             a partnership, another corporation, or by any other kind
             of entity (such as a pension fund), other than trusts,
             estates, or individuals?

@YN
01\Q02
02\Q04

@Q04

TRUSTS AS SHAREHOLDERS:  Trusts generally are not permitted as share-
holders of an S corporation, although there are a few limited excep-
tions to this general rule.

  QUESTION:  Is any of the stock of your company held by a trust?

@YN
01\Q05
02\Q06

@Q05

TRUSTS PERMITTED AS SHAREHOLDERS:  While having a trust as a holder of
its stock will usually disqualify a corporation from becoming or being
an S corporation, there are several exceptions, as follows:

  . Qualified Subchapter S Trusts.  This is a special kind of trust
    that makes an election to become such a trust and which must meet
    a number of technical requirements, to hold S corporation shares.

  . Grantor trusts or other trusts whose property is treated as owned
    by an individual for tax purposes, such as the grantor.

  . Voting trusts, set up to hold stock of a corporation, primarily to
    control the exercise of its voting rights.

  . Testamentary trusts, which receive the stock of an S corporation
    under someone's will.  (But only for 60 days after stock received.)

  QUESTION:  Does the trust that owns stock in your corporation come
             within one of the allowable exceptions listed above?
@YN
01\Q06
02\Q02

@Q06

  QUESTION:  Is any shareholder of your corporation a NONRESIDENT
             alien individual?

@YN
01\Q02
02\Q07

@Q07

AFFILIATED GROUPS OF CORPORATIONS:  An S corporation cannot be a member
of an "affiliated group" of corporations.  Thus, for example, if it
owns 80% of the stock of another corporation, it will not be able to
qualify under the S corporation rules.  (Don't count stock it owns in
a dormant corporation that has not yet begun business and has no gross
income--That's O.K.)

  QUESTION:  Is your corporation a member of a group of "affiliated
             corporations"?

@YN
01\Q02
02\Q08

@Q08

PRIOR REVOCATION OF S CORPORATION STATUS:  If your corporation was
previously an S corporation and had its S corporation election ter-
minated (voluntarily or otherwise), it may not make another election
to become an S corporation again until it has been a C corporation
for five consecutive taxable years (unless the IRS grants special
permission).

  QUESTION:  Has your corporation previously been an S corporation,
             during any of its last 5 taxable years?

@YN
01\Q02
02\Q09

@Q09

NUMBER OF SHAREHOLDERS:  An S corporation cannot have more than 35
shareholders at any given time.  If any of its shares are held by
joint tenants, or by tenants in common, each such joint owner is
counted as a separate shareholder.  However, each husband and wife
pair who owns stock in the corporation, regardless of whether they
hold it jointly or separately (or both), are counted as only one
shareholder.  (Thus there could actually be up to 70 stockholders
in an S corporation, if its stock were owned by 35 married couples.)

  QUESTION:  Are there more than 35 shareholders in your corporation,
             counted as described above?

@YN
01\Q02
02\Q10

@Q10

INELIGIBLE CORPORATIONS:  Certain types of corporations are ineligible
to become S corporations.  Ineligible corporations include:

  . Financial institutions (such as banks);

  . Insurance companies--this would mainly include life insurance
    companies--some casualty insurance companies would qualify;

  . DISCs or former DISCs (Domestic International Sales Corporations);
    and

  . Certain corporations that have elected to be Sec. 936 corporations,
    that is, elected to be allowed a tax credit on income from Puerto
    Rico and from U.S. possessions.

  QUESTION:  Is your corporation an "ineligible corporation," as
             described in any of the categories listed above?

@YN
01\Q02
02\Q11

@Q11

SECOND CLASS OF STOCK:  A corporation cannot be an S corporation if
it has more than one class of stock outstanding.  An example would
be a corporation that issues both common stock and preferred stock.
However, just because the common stock has differences in its voting
rights, such differences won't be considered to result in a second
class of stock, if all the shares of stock are equal as to rights in
the income and assets of the corporation.

Note that debt issued by the corporation, particularly if the corpor-
ation is "thinly capitalized," may be characterized by the IRS as a
second class of stock, if it has "equity" characteristics.  However,
"straight debt" will not be treated as stock for this purpose.

  QUESTION:  Does your corporation have more than one class of stock?

@YN
01\Q02
02\Q12

@Q12

CONCLUSION:  It appears that your business, once it is incorporated,
may be able to elect S corporation status, since it appears to meet
all of the applicable requirements.  (However, many of the rules we
have described in this question-and-answer session are much more com-
plex and technical than you might suspect--so consult a good tax
adviser before electing to become an S corporation.)

To actually elect S corporation status, all of the corporation's share-
holders must consent by signing the election form, IRS Form 2553.  The
S corporation election form must be filed not later than the 15th day
of the third month of the tax year for which it is to go into effect
(that is, March 15th, in most cases).  Some states may also require a
separate state filing in order to become an S corporation for state
income or franchise tax purposes.

  QUESTION:  Is your business already incorporated, as a C corporation?

@YN
01\Q14
02\Q13

@Q13

Good.  Then you will not have to worry about a great many complex prob-
lems that can arise upon changing a C corporation over to S corporation
status, provided that when you do incorporate, you elect S corporation
status on a timely basis for your corporation's first taxable year.

The possible tax problems you will be avoiding by going directly from
unincorporated status to S corporation status include, among others, a
large tax bite if you are currently using "LIFO" inventories in your
business, and potential tax traps if a C corporation has any "built-in
gains" on assets, or if it generates "passive income" that might be
subject to a tax at the corporate level (despite the S corporation
election).

Fortunately, those problems should not apply to you if you elect S
status immediately after you incorporate your business.  Nevertheless,
S corporations are very complex beasts, and you need to consult a good
tax adviser before you decide to incorporate and make any S corporation
election.

@STOP

@Q14

FURTHER ADVICE:  Then we STRONGLY advise you to seek the help of a
competent tax adviser who is familiar with S corporations, before you
make an S corporation election.  There are a number of possible tax
traps and problems that may arise when an existing C corporation is
converted to an S corporation.  These would include, among others:

  . Being forced to change from a fiscal tax year to a different
    tax year (the calendar year in many cases).

  . While S corporations are generally not taxable, a corporation
    that was previously a C corporation and elects to change over to
    an S corporation may find itself immediately subject to tax if it
    previously used the LIFO method of accounting for inventories, to
    the extent of the "LIFO reserve" or deferral that it had built up
    previously while using LIFO accounting.

  . Any "built-in" gains on assets that have a value greater than
    their tax basis at the time of the changeover to S corporation
    status may be subject to a corporate-level tax if disposed of
    by the S corporation within the next 10 years.

  . If the C corporation has any "accumulated earnings and profits" at
    the time it becomes an S corporation, the S corporation may be
    subject to a flat 34% tax on its "excess net passive income" if
    more than 25% of its gross receipts are from passive investment
    income.  (Not to be confused with "income from passive activities"
    under the "passive loss" rules.  Simple, isn't it?)

 .  Conversion from C corporation to S corporation status may result
    in taxability of amounts paid by the corporation for fringe
    benefits for all shareholders owning 2% of more of the stock (for
    medical, group-term life insurance, and disability insurance
    coverage).

 .  Possible tax traps such as, for example, the double taxation of
    certain "unrealized receivables" (receivables of a cash basis
    taxpayer, for instance).  Collection of such receivables will not
    only result in taxable income which passes through to the share-
    holders, but could also give rise to a corporate-level tax as
    "built-in gains," where such receivables were earned by the cor-
    poration while it was still a C corporation.

Electing S corporation status may make great good sense in many cases,
but as the above items hint, the changeover from C corporation to S
corporation is fraught with complexity and possible booby traps for
the unwary (or poorly advised) taxpayer.

@STOP

@Q15

@STOP

@RD\01
A corporation that is incorporated outside the United States cannot
elect to be an S corporation.  The way to get around this particular
problem would be to re-incorporate your firm in the United States, if
that is feasible.

@RD\03
Ownership of a corporation's stock by certain types of shareholders,
such as corporations, partnerships, most kinds of trusts, or by non-
resident alien individuals will make that corporation ineligible for
S corporation status.

@RD\07
Being a member of an affiliated group of corporations will disqualify
a corporation from becoming or remaining an S corporation (although
there are some limited exceptions, such as an S corporation holding
the stock of an acquired subsidiary, if the subsidiary is liquidated
to get its assets, within 30 days of acquisition).

@RD\08
Having had a previous S corporation election makes your corporation
ineligible to elect S corporation status again, for a period of five
taxable years.  However, if you do not wish to wait this long, you
may apply to the Internal Revenue Service, requesting that they waive
this restriction.  You will need some good reasons to obtain such a
waiver, however.

@RD\09
Having over 35 shareholders will prevent your corporation from electing
S corporation status.  However, this is a problem that can often be
overcome, if the number of shareholders is only slightly over 35, by
buying out some of the smaller shareholders, and placing restrictions
on the stock of the remaining stockholders, thereby limiting their
ability to sell their stock in the future, if such a sale or other dis-
position would jeopardize the S corporation election.

@RD\10
"Ineligible corporations," such as DISCs, former DISCs, financial in-
stitutions, some kinds of insurance companies, and corporations elect-
ing the Section 936 credit, are not allowed to become S corporations.

@RD\11
A corporation is not allowed to become or remain an S corporation if
it has more than one class of stock.

@HELP

@H\01

Enter "Y" ("YES") if your corporation is
incorporated (or will be) under the laws
of any of the 50 states.  Enter "N" (for
"NO") if it is (or will be) incorporated
in a foreign country.

@H\03

Answer "Y" if any  stock will be held by
another corporation, by a partnership, a
tax-exempt entity of  any kind,  or by a
pension or profit sharing plan.

Answer "N" ("NO") if all of the stock of
the corporation will be held only by in-
dividual persons,  or else by estates or
trusts (other than pension plan trusts).

@H\05
A "Qualified Subchapter S Trust" is one
that has all of these characteristics:

 .  Only one current income beneficiary
    at any given time;
 .  All principal distributed must go
    to income beneficiary during term
    of the trust;
 .  Current income beneficiary of the
    trust will have his/her interest
    terminate on earlier of death or
    the termination of the trust, and
    if terminated during his/her life,
    all assets must go to him/her.
@H\06

Note that it is OK for an S corporation
to have alien (non-U.S. citizen) stock-
holders, but only if they are RESIDENTS
of the  United States,  and thus  fully
subject to the U.S. income tax system.

@H\07

Also, it is permissible for an S corpor-
ation to  acquire and  briefly hold  the
stock of another corporation in order to
get its assets, if the subsidiary is li-
quidated within 30 days  after being ac-
quired.   In  that case,  the subsidiary
will not be considered an "affiliate" of
the S corporation.

@H\10

"Insurance companies" are companies that
actually issue the insurance;  companies
that merely  SELL (or broker)  insurance
would  not  be  considered  "ineligible"
under  this  definition  of  "ineligible
corporations."

@H\11
"Straight debt"  is debt  issued by the
corporation that has all of the follow-
ing characteristics:

 . Evidenced by a written unconditional
   promise to pay a fixed amount on
   demand or at a specified date;
 . Interest rate and payment dates are
   not contingent on profits or on any
   similar factors;
 . Debt is not convertible into stock;
 . The creditor holding the note is an
   individual, estate, etc., that is
   eligible to hold stock in an S cor-
   poration.
@H\12

A "C corporation" is  a technical term,
but, fortunately,  is a relatively easy
one to understand.  A C corporation is,
quite  simply,  any corporation  (other
than a  not-for-profit  one) OTHER THAN
an "S corporation" (formerly known as a
Subchapter S corporation). Thus, unless
your corporation  is one that  has made
an election to be taxed as an S corpor-
ation,  it is an C corporation.  There-
fore,  answer this  question "N" ("NO")
only if your  company is an  S corpora-
tion, or is not a corporation at all.

@END