Not An S Corporation?

Generally, the conversion of a C corporation to an S corporation is tax-free for both the corporation and its shareholders. Also, an S corporation avoids double taxation, eliminates unreasonable compensation and unreasonable surplus problems.

Columns From: 9/1/1998 Modern Machine Shop,

Generally, the conversion of a C corporation to an S corporation is tax-free for both the corporation and its shareholders. Also, an S corporation avoids double taxation, eliminates unreasonable compensation and unreasonable surplus problems. It's an easy way to divide income with low-bracket family members, allows an almost tax-free transfer of your business using a grantor retained annunity trust and the list could go on and on. Yes, there are some minor disadvantages.

Under the Clinton administration budget plan, an election by a C corporation to become an S corporation would be treated as a taxable liquidation of the C corporation. Result: Two immediate taxes-(1) on the corporation (based on the fair market value of the corporation over its book value, just as if the corporation had sold its assets) and (2) on you and all your fellow shareholders Oust as if you sold your stock for its fair market to a stranger). Simply put, the IRS wants to close the door on the tax goodies you enjoy as an S corporation.

The tax-expensive crackdown would apply to S elections that take effect after January 1, 1999. "Large C corporations" could elect S corporation status tax-free for taxable years beginning in 1998 or on January 1, 1999. For this purpose, a large C corporation is one with a "value" of more than $5 million at the time of conversion. This is fair market value of all corporation stock on the date of conversion.

Unless there are solid tax-saving reasons for the long-term, elect S corporation status. Now!

Joint Tenancy Helps The IRS

Before you keep or put property into joint tenancy, there are two important points you should know.

First, your right and ability to pass $625,000 in 1998 of property free of the estate tax can be lost through joint tenancy. An example is the easiest way to explain. Suppose the combined worth of Joe and Mary in 2006 will be $2 million, and they hold all their property in joint tenancy. Joe dies first. Instantly, Mary becomes the sole owner of all the property. Suppose Mary lives off the income and dies many years later with the same amount ($2 million) of property. She leaves the $2 million to her children. Her estate tax will be $435,000.

Suppose instead that Joe and Mary each own $I million in property in their own names when Joe dies. Joe sets up his estate so Mary gets the income from his $1 million for as long as she lives, and upon her death, this property goes to the children. When Mary dies she also leaves! her $1 million of property to the children, for a total of $2 million. The estate tax for both Joe and Mary?.. . ZERO!

Second, joint tenancy can also cost you income tax dollars. The tax basis of any property owned by a decedent (a person who dies) receives a new tax basis-its fair market value on the date of the decedent's death. For example, Joe owns Public Co. stock that he purchased for $2,000 more than 25 years ago. When he dies the stock has a value of $100,000; the $100,000 becomes the new tax basis for the stock. He leaves the stock to Mary who sells it for $103,000. She only pays income tax on $3,000 ($103,000 minus $100,000).

Now suppose the same stock was held in joint tenancy and Mary sells it for the same $103,000. Her tax basis is only $51,000. Why? According to the tax law, she owned half of the property with a tax basis of $1,000, while Joe's half becomes hers with a new tax basis of only $50,000. Mary must pay income tax on $52,000 ($103,000 minus $51,000). A true tax tragedy!

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