List and discuss five advantages and five disadvantages of electing to be taxed as an S corporation over a C corporation or a partnership.
What will be an ideal response?
Some of the advantages and disadvantages which might be included in the answer are:
Advantages:
• The corporation's income is exempt from the corporate income tax.
• The corporation's losses are passed through to the shareholders.
• Undistributed income that has been taxed to the shareholder is not taxed again when subsequently distributed.
• Capital gains dividends and tax-exempt income are separately stated and pass through to the shareholders.
• Deductions, losses, and tax credits are separately stated and passed through to the shareholders.
• S corporations are not subject to the alternative minimum tax.
• S corporations are not subject to the personal holding company tax.
• S corporations are not subject to the accumulated earnings tax.
• S corporations may split income between family members.
Disadvantages:
• A C corporation is treated as a separate tax entity and can use the 15% tax bracket.
• S corporation earnings are taxed to the shareholder even if not distributed.
• S corporations are subject to an excess net passive income tax, LIFO recapture tax, and built-in gains tax.
• Dividends received by the S corporation are not eligible for the dividends-received deduction.
• Allocation of income and loss is based on stock owned on each day of the tax year. Special allocations are not permitted.
• The loss limitation is smaller for an S corporation than a partnership because of the treatment of general debts incurred by the S corporation.
• An S corporation and its shareholders are subject to the at-risk, passive activity, and hobby loss limitations with respect to their loss and deduction pass-throughs.
• An S corporation is restricted in the type and number of shareholders allowed and types of investments that can be made.
• S corporations are generally restricted to using a calendar year as their tax year.
The advantages and disadvantages are summarized on pages C:11-3 and C:11-4.
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