Are S-Corporations Going to be Extinct?

As talk of tax reform intensifies during the final stretch of the tax filing season, one stream of discussion has many people asking if the S-corporation will become extinct as a tax filing entity. 

One of the advantages that has led to the steady increase in S-corporations (over 61% of corporate filings were S-corporations in 2003 per the IRS website) has been the single level of taxation.  It is well known that C-corporations income is taxed once when earned by the C-corporation and again when distributed to the shareholder.  S-corporation income is only taxed once to its shareholders.  Even with the additional taxes heaped on individuals in the last few years, taxation at individual rates was still seen as advantageous over the double taxation of C-corporations.

That well accepted premise may soon change as talk of tax reform heats up in Washington.  Several proposals from the President and members of Congress have called for a significant reduction in the corporate tax rate, with a much smaller reduction in individual tax rates.  Some proposals have even called for an elimination of the tax on dividends to C-corporation shareholders.  If these proposals were to become law it would clearly take away the advantage of S-corporations while also shining a light on the short comings of S-corporations (like the limit on the number of shareholders, and inclusion of greater than 2% shareholders health insurance in their income).  If it is no longer more advantageous to conduct business as an S-corporation, there could be a mass of S-corporation election terminations.  Companies should be considering the possibility of taking advantage of changing tax policy and rules if it resulted in a more favorable tax treatment for their business income.

While there is no definitive tax reform pending, if you are operating an S-corporation or considering an entity type for a new business, it would be worth your while to pay attention to any new tax legislation that Washington promises is coming soon.  It would also be advantageous to talk to your tax and legal advisors to strategize for potential tax changes considering the climate in Washington for tax reform.

Choosing a particular business entity type, or changing your entity type can have significant tax and non-tax implications so please check with your tax/legal advisor before making any decisions regarding your entity selection.