1. Built-in gains tax: S corporations that were once C corporations are taxed on built-in gains (such as appreciated property) recognized within 5 years after the S election, which may be unfavorable.
2. Passive income: S corporations may be subject to a special tax if their passive investment income exceeds 25% of gross receipts and accumulated earnings and profits are carried over from C corporation years. This tax can lead to termination of S corporation status if owed for three consecutive years.
3. LIFO inventories: C corporations using LIFO inventories must pay tax on the benefits derived by using LIFO if they convert to S corporations, spread over four years. This cost must be weighed against potential tax gains from converting to S status. 1. Unused net operating losses from a C corporation cannot be used to offset income as an S corporation.
2. Shareholder-employees of S corporations may not have access to the same tax-free fringe benefits as C corporations.
3. Shareholders with outstanding loans from qualified plans may encounter complications when switching from C to S status.
4. There are strategies available to eliminate or minimize these tax problems and avoid potential pitfalls.
5. It is important to consider the specific circumstances of the company before making the switch from C to S status.
Tax Issues to Assess When Converting From a C Corporation to an S Corporation
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