Entity Selection Revisited: Will Gitlitz Provide Continuing Vitality for S Corporations?

Simply put, S corporations are not as popular as other types of entities in Florida for lawyers. However, a recent Supreme Court decision confirmed that S corporations have an advantage when it comes to certain tax consequences. The decision addressed whether shareholders of S corporations can increase their stock basis due to certain income, and therefore deduct previously suspended losses. This is important for S corporation shareholders. An S corporation shareholder can’t deduct losses that exceed the amount they invested in the company. These losses are saved for later when they have enough investment to deduct them. If the S corporation is in financial trouble and can’t pay its debts, the shareholders won’t be taxed on the company’s canceled debts. But they might be able to increase their investment in the company and use the previously saved losses to reduce their taxes in the future. Simply put, the argument is about whether shareholders of a company can deduct certain losses from their taxes. Taxpayers say they should be able to, based on the rules in the tax code. The IRS disagrees, saying it would give shareholders an unfair advantage. The Supreme Court ended up agreeing with the taxpayers in a recent case. The IRS originally said that S corporation shareholders couldn’t increase their stock basis to deduct canceled debt income, but then changed their minds. Different appeals courts also disagreed on this issue. The Supreme Court eventually ruled that S corporation shareholders can indeed increase their stock basis and deduct suspended losses. The IRS has a regulation that says S corporation shareholders can’t exclude cancelled debt income from their taxes. This is different from how it works for partners in a partnership. In a partnership, the cancelled debt income is included in the partners’ taxable income, but they can also deduct the losses from the partnership. If the partners try to convert the partnership to an S corporation to get the same tax treatment as S corporation shareholders, they will end up with a big tax bill. In simple terms, the tax consequences of canceled debt income for insolvent S corporations with solvent owners are better than for insolvent partnerships or LLCs with solvent members. This means that the owners of insolvent S corporations can get a tax benefit that allows them to deduct more losses than they actually spent. The IRS and courts have tried to change this, but the Supreme Court said the law doesn’t support that. The IRS won’t change the law, so S corporations will keep having an advantage over other types of businesses. Shareholders of S corporations that had canceled debt income in the past may want to file amended tax returns to take advantage of this. Craig E. Behrenfeld is a lawyer in Tampa. He got his B.A. from the University of Pennsylvania in 1988, J.D. from New York University in 1991, and LL.M.

Source: https://www.floridabar.org/the-florida-bar-journal/entity-selection-revisited-will-gitlitz-provide-continuing-vitality-for-s-corporations/