In America, corporations can opt for shareholder level taxation. In this situation, the corporation determines its' taxable income and files a corporate tax return.
The income that is taxed, including the different tax credits and deductions, is distributed amongst shareholders. All shareholders include their part of the funds, credits and deductions on their personal tax returns.
Corporate level taxation is not applied at all. Rather, every income item is taxed at the personal income tax rate. A corporation that does this is known as an S corporation -- 'S' being the subchapter S in the Internal Revenue Code's first chapter.
The Characteristics of an S Corporation
S corporations choose to send corporate income, deductions, credits and losses to shareholders to fulfill their federal tax requirements. These shareholders declare the losses and income on their tax returns. Then, they are taxed at their personal rate of tax. This enables S corporations to prevent double corporate income taxation. These corporations are liable for tax on specific entity level passive income and inbuilt gains.
Corporate Level Taxes in Focus
S corporations have to pay the following corporate level taxes:
-Inbuilt gains tax
-Recapture LIFO tax
-Excess passive income
The recapture LIFO tax and excess passive income tax only apply if corporations have reorganized with C corporations, or used to be C corporations. Excess passive income taxes the passive profits generated by S corporations. This can include profits from dividends, interest, rents, royalties and annuities. When passive profits exceed twenty-five percent of a corporation's gross receipts, excess passive income taxes apply.
Recapture LIFO tax is payable if either of the below conditions apply to the corporation:
-The C corporation passed LIFO inventory in nonrecognition transactions to the corporation where that inventory was transferred basis property.
-The LIFO inventory method of pricing was used by the corporation during its' previous tax period, when it was a C corporation.
LIFO is the 'last in, first out' way of assessing inventory for the purpose of taxation.
Inbuilt gains tax is applicable if S corporations get rid of assets within a five year period of obtaining those assets, and the corporations either obtained the assets when they were C corporations, or used transactions where the asset basis was governed by their status in C corporations.
Passing Through tax Items
An S corporation passes through items of deduction, tax credits and income to its' shareholders. Should the corporation sell assets that are suitable for capital gains treatment over the long term, this income is declared appropriately on the Schedule K1 to the shareholder from the corporation. Therefore, individuals would declare this income as a long term gain on their Schedule Ds.
Often, small businesses fall into the trap of trying to maintain their accounts, without professional assistance. While it might be less expensive to keep their own books, professionals can ensure that every record is correct and accurate. For this reason, you should book a consultation with ALJ Business Services by calling (974-476-6381). These consultation sessions are free, and cover all aspects of business finance.
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