S Corporations: 10 Traps for the Unwary

S corporation tax treatment appears to be the best of both worlds; S corporations avoid double taxation (as compared to C corporations), and S corporation treatment can reduce the amount of employment taxes paid by employee-shareholders (as compared to partners in a partnership). However, the benefits of S corporation status come with rigid rules that may be overlooked, putting S corporation status in jeopardy.

In cases where the S corporation rules have been broken, an entity instead may be treated as a C corporation for US federal income tax purposes, which can have devastating consequences to the entity and the shareholders in terms of substantive income tax, penalties, and interest. Further, the longer the rules have been broken, the more tax exposure to the entity and its shareholders.

Below, we describe generally the S corporation rules and then outline ten traps for the unwary. Additionally, we describe ways to prevent a violation of a rule or how to rectify an inadvertent termination of S corporation status. We will refer to S corporation “shares” herein; however, both a state law corporation and a state law limited liability company may be treated as an S corporation for US federal income tax purposes.

Read the full article here.