Tax Benefits for “S” Corporations

Many insurance agencies have chartered themselves (or changed to) sub-chapter S Corporations over the years. The S Corp was the mechanism for obtaining the limited liabilities of a corporation while enjoying the continued benefits of flow-through profits to be taxed only at the individual’s level.

While LLC’s (Limited Liability Corporations) are now the rage, existing corporations find that there are expensive restrictions that prohibit them from changing to this new form of company.

The 1996 Tax Reform Act added thousands of pages of tax law to the books. A few of these regulations have actually helped the course of small businesses. We have already strongly touted the exclusion from taxation of the transfer of certain family owned businesses (Pipeline November, 1997). But more positive twists are being encountered by S Corps as the law has had time to mature. Some of the benefits are:

* An S Corporation can now have wholly owned subsidiaries – for instance, if an agency is acquired and for financial or payout reasons, it must be kept separate, it is now permissible for your S Corp to own another entity. More importantly, in the past if you owned separate corporations and one lost money while the other profited, you couldn’t offset the profits of the latter with the losses of the former. Now, you can have two or more wholly owned subsidiaries and consolidate returns to offset the profits of one with the losses of the other.

* An S Corporation can now have 75 shareholders (the limitation used to be 35). If spouses are involved, you can double that number to 150. This is important in some of the Virtual Insurance Agencies, mergers and acquisitions that are taking place in which many shareholders are involved in the parent company.

* The rules now make it possible to retroactively elect S Corporation status. Previously, if you wanted to move from a regular corporation to an S Corp you had until March 15 to make the change. Now, you can create an S Corp and transfer your C Corp stock into it at any time in the year with the same effect of having the S Corp all year. This is important to businesses who have been losing money and find themselves in a profitable situation mid-year. This method allows you to take advantage of the S Corp pass through of profits.

* An S Corp can now have an ESOP as a shareholder. This has long been a problem with S Corp agencies who wished to begin an ESOP and were forbidden by the restrictive shareholder rules.

Other, more esoteric rules exist that also make S Corps more flexible for small businesses. See your tax professional for more advice on how these rules can help you.