S corporation tax planning now

Your client owns a small business that operates as a subchapter S corporation. She elected S corporation status when the individual tax rates were lower than those for a C corporation.
DEC 09, 2008
By  Bloomberg
Situation: Your client owns a small business that operates as a subchapter S corporation. She elected S corporation status when the individual tax rates were lower than those for a C corporation. When an S election is made, the prior retained earnings are trapped in the company unless a second tax is paid on the distribution of the retained earnings as a dividend. Your client wants to know how the policies of the new administration under President-elect Barack Obama could affect her taxes. Solution: While it appears that taxpayers are safe in 2008 and probably 2009, the 2010 tax year will most likely bring a tax increase. The ordinary income tax rates will likely increase to almost 40%, which was the rate in effect before tax cuts were put in place by President Bush. Further, dividends may no longer get the preferential tax rate of 15%. Your client should consider paying out accumulated earnings in the form of a dividend. The top tax rate on dividends is currently 15% and is almost certain to increase by 2010. Why should an individual pay a tax voluntarily? First, consider the rate will be higher in the near future. Second, some small business owners who intend to sell or wind down their businesses and want to continue to invest the sales proceeds in the existing company may find themselves in a tax trap. A little known tax law subjects S corporations to a special tax that is imposed only on S corporations that have prior accumulated profits. It is levied on S corporations that generate more than 25% of their earnings from passive sources — that is, interest, dividends and capital gains. This tax can be avoided by making sure the S corporation has no earning and profits, which can be accomplished by paying the 15% tax now on any so-called trapped earnings. By paying the tax at this low tax rate, the S corporation could save taxes in the future.

Latest News

Spotlighting the Fastest-Growing Fee-Only RIAs in the USA
Spotlighting the Fastest-Growing Fee-Only RIAs in the USA

Discover which fee-only RIAs had standout performances in 2024

Advisor AI startup Zeplyn adds ex-LPL leader Kabir Sethi to board
Advisor AI startup Zeplyn adds ex-LPL leader Kabir Sethi to board

The two-decade veteran, whose career also includes a stint at Merill Lynch, will help shape strategy for the Google engineer-founded fintech.

US wholesale inflation surprises on food, energy prices
US wholesale inflation surprises on food, energy prices

The latest PPI print, clocking in north of 3 percent, adds to concerns that inflation is far from tamed.

Robinhood earnings surge as TradePMR acquisition plan rolls along
Robinhood earnings surge as TradePMR acquisition plan rolls along

The DIY investment giant's positive earnings surprise, surpassing $1 billion in revenue for the first time, puts it on strong footing for future expansion.

Advisors expect revenue boost this year as Secure 2.0 provisions kick in
Advisors expect revenue boost this year as Secure 2.0 provisions kick in

Most retirement plan specialists anticipate gain of up to 10%.

SPONSORED Record growth: Interval funds emerge as key players in alternative investments

Blue Vault Alts Summit highlights the role of liquidity-focused funds in reshaping advisor strategies

SPONSORED Taylor Matthews on what's behind Farther's rapid growth

From 'no clients' to reshaping wealth management, Farther blends tech and trust to deliver family-office experience at scale.