With the new Corporate Income Tax going into effect January 1, 2012, some Michigan corporations have been contemplating converting to an S Corporation. Although S corporations will not be subject to the new 6% Corporate Income Tax, there are many issues a company would want to consider before electing the S corporation status. These issues will have an impact on both the corporation and individual shareholders. It’s important to have a thorough understanding of the tax impact of everyone involved. Below are some examples of issues you will want to consider:

  • Does your corporation meet the eligibility requirements for making the S corporation election?

o Cannot have shareholders that are partnerships, corporations, or non-resident aliens.

o Cannot have more than 100 shareholders

o The corporation must only have one class of stock

o Cannot be an ineligible corporation (ex. Certain financial institutions, insurance companies, etc)

  • Will your company still be able to grow and expand after converting to an S corporation? For example, is there a possibility that in the future the number of shareholders in your company could exceed 100?
  • Does your company plan to sell any assets or the business within 10 years from the conversion?

Note: Built-in Gains (BIG) tax is a corporate level tax imposed on S Corporations on the net built-in gains that the C Corporation has on the date the S election become effective. For example, if a corporation has an asset with a market value of 100,000 and a basis of 40,000, there is a built-in gain of 60,000 on the date of conversion. If the asset is sold within 10 years (recent legislation reduced the years to 5 or 7 years depending on the circumstances), the built-in gain of 60,000 is subject to the highest corporate tax rate (currently 35%).

  • Is your corporation a cash-basis taxpayer with accounts receivable? If so, the corporation may be subject to BIG tax on the accounts receivable collected after the S election is made.
  • Does your corporation use LIFO to value inventory? Tax must be paid on the benefits received by using LIFO after a conversion.
  • Does your corporation have net operating losses? If so, they cannot be carried over to an S Corporation. They will be lost.
  • Shareholders will want to consider the impact a conversion will have on their personal income tax liability, since S corporation income, gains & losses, will pass through to them personally.
  • Other issues to consider: Passive Income, undistributed accumulated earnings & profits, & fiscal year-end taxpayers.

Any corporation considering a conversion will want to contact a tax professional for assistance in making the right decision. Contact Heintzelman Accounting Services for additional questions or to schedule a free consultation.