BY GEORGE G. JONES AND MARK A. LUSCOMBE
with S corporations
In spite of the growth and popularity of limited liability companies taxed as part- nerships, S corporations remain a very
popular option for doing business. Internal
Revenue Service records show that S corporations remain the most popular way for a
business to file tax returns.
In 2009, there were an estimated 2. 5 million C corporation returns filed, a figure that
has remained fairly stable over the last five
years. Over that same period, the number
of partnership returns filed has grown from
2. 5 million to more than 3. 5 million returns.
While this is a greater percentage increase
than the increase in the number of S corporation returns, S corporations, in absolute
numbers, are pretty well holding their own.
The number of S corporation returns filed in
2009 was about 4. 5 million, an increase from
3. 5 million five years earlier.
While S corporations must deal with a
number of statutory restrictions, such as the
number and type of shareholders and the
types of stock, they also provide a number
of advantages. They follow the general corporate structure of corporations in having
stockholders, a board of directors, and officers — a form that is a familiar structure to
Other than fairly standard bylaws, they do
not require an operating agreement that can
be costly to draft and even more costly to interpret down the road.
S corporations also have traditionally offered more certainty for owner/operators
as to which distributions are employment-related and which are capital-related. Of
course, any distributions are subject to risk
of recharacterization by the IRS, but as long
as employee compensation was reasonable,
practitioners felt fairly comfortable with the
ability to segregate what was compensation
and what was a distribution on capital.
care taxes passed by Congress this year in the
health care legislation.
The new Medicare taxes to be imposed
fall only on incomes in excess of $200,000
for single filers and $250,000 for joint filers. S
corporation employee/owners that can limit
compensation to those amounts and take
debated in the Senate (H.R. 4213) includes
a provision that would impose the 15. 3 percent self-employment tax on the dividend
distributions paid to employee/owners of
S corporations, on family members of employee/owners who are themselves shareholders, and on retained earnings in the S
corporation. In efforts to overcome opposition to the provision, current versions of the
proposal put a variety of limits on it. It would
apply only to personal service corporations
and only as long as 80 percent or more of the
corporation’s income is attributable to three
or fewer owners.
If this provision is adopted and applied to a
particular S corporation, it would effectively
eliminate any advantage that the S corporation has over partnerships by shifting income
from compensation to dividends. It would
also impose a significant additional tax burden on these entities at a time when small
business is being looked to as a generator of
any excess in the form of distributions could
avoid the new 0.9 percent tax on wages. Partnerships and partners have more difficulty
in trying to distinguish one type of income
from the other.
S corporations, as well as partnerships, may
be utilized to play a role in trying to shield
taxpayers from the 3. 8 percent Medicare tax
on investment income for taxpayers over
those same $200,000 and $250,000 income
levels. By using common estate-planning
techniques to use S corporations to transfer
investment assets to the younger generation,
some or all of the Medicare tax on investment
income might also be avoided.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA,
is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.
HEALTH CARE REFORM LEGISLATION
This advantage of the segregation of compensation and capital has been touted by commentators as a possible significant advantage
for S corporations in determining how best to
structure affairs in the face of the new Medi-
PROPOSAL FOR FICA TAXATION
OF K- 1 INCOME
This rosy scene, however, comes with a dark
cloud on the horizon. For some time, Congress has been considering making all of the
K- 1 income of S corporation employee/owners subject to self-employment taxes.
The extenders legislation currently being
S corporations continue to be a popular form
of doing business, in spite of the statutory restrictions imposed on them, due to their relatively simple structure and set-up requirements, the comfort level taxpayers generally
have with the corporate structure, and the
tax advantages that come from the ability to
segregate compensation from distributions
related to ownership.
Just as this latter advantage takes on
even more importance with the passage of
increased Medicare taxes, Congress is proposing to shut down this advantage with a
broad self-employment tax on distributions
to certain S corporation owner/employees
and their family members, as well as retained
Such a change might not detract much
from the attractiveness of the S corporation
structure. It would eliminate one key advantage it has over the partnership structure, but
then the two forms would be on more equal
footing, and many taxpayers may still prefer
their pass-through entity to operate in the
more familiar corporate structure. AT