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Changes in Store for S Corporations in 2017

February 06, 2017

How might taxation of S corporations change under Trump’s presidency? Any other changes in store for these pass through entities?

With the Trump presidency now in office, there continues to be much talk about what tax reform might look like under his administration. Just check out our blog, “How will the Election Results Affect Taxes in 2017”. As far as S corporations go, more than just the election results have affected these firms in recent months—learn more.

A refresher on S Corporations

Corporations that elect to be treated as S corporations are treated, for federal and most state tax purposes, as a pass-through entity, meaning it “passes through” its income and loss items to its shareholders.

  • There is no “double taxation” like a regular C corporation. Each shareholder is subject to his/her own individual tax rate on the income or losses passed through from the S corporation.
  • Owners are able to deduct their pro-rata share of losses on their personal returns.
  • Each shareholder’s personal assets are shielded from S corporation creditors, as they would be in any corporation.

What’s new with S corporations?

Changes made by 2015’s tax law- Electing S corporations that were formerly C corporations are subject to a corporate level built-in gains tax of 35% on gains from sales of appreciated assets that were owned at the time the corporation elected S status. This corporate level tax is levied on top of the gains also being taxed at the shareholder level.

Historically, the tax has been applied to sales of built in gain assets within ten years of the corporation electing S status. Beginning in 2009, Congress had shortened the lookback period on a temporary basis, first to seven years, then to five. Under the Protecting Americans from Tax Hikes (PATH) Act of 2015, the five year lookback period has now been made permanent.

Permanent extension on S corporations’ charitable donations- Shareholders can reduce their stock basis by the cost of assets donated, rather than by the value.

2 new Congressional bills- Under one bill, traditional and Roth IRAs would be allowed as eligible S shareholders. The hope is that this measure will allow S corporations to raise more capital. Keep in mind, however, that IRAs could be subject to tax on investments if their share of income is above $1,000.

Under another bill, corporations with accumulated earnings and profits from C corporation tax years and that switch to S status can treat more of their income as “passive” before a special penalty tax would apply. Under current law, An S Corporation is not permitted to generate more than 25 percent of its gross receipts from passive income in any year if it has accumulated earnings and profits from prior years in which it operated as a C corporation. If over 25% of a corporation’s gross receipts are passive, the S corporation owes a 35% tax on the excess. Also, S status can be removed if this 25% of gross receipts limit is surpassed in three consecutive years. Under the bill, S corps would not owe the tax unless passive income exceeds 60% of gross receipts, and they would no longer risk losing their S status by having excess passive income in consecutive years.

Less tax under Trump- S corporation shareholders are expected to owe less under Trump’s tax plan. He has proposed a 15 percent income tax rate on regular corporations and extends this rate to owners of pass-through entities, like LLCs, S corporations, and sole proprietors. Competing congressional proposals would require a higher tax rate of 25 percent, still an improvement over how S corporation shareholders are taxed today.

Stay tuned for how the new president’s administration will shake things up in the S corporation world.

Contact any member of our Tax Services Team for further information.

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