A client’s decision to change business structures isn’t just a checkbox, but a move with real tax consequences. Your guidance can shape the outcome, whether they’re going from an LLC to a corporation or converting to an S-corp.
You’ll need to evaluate entity-level impacts, flag ownership issues like nonresident shareholders, and determine if the change offers tax benefits or creates risk.
Below, you’ll find a few of the top questions from a recent webinar on the topic and their corresponding answers. If you choose to attend the on-demand version of this webinar, you can access the full recording and the entire list of Q&As.
Q: Why are C corporations referred to as “the king of fringe benefits”?
A: Of the entities in this webinar, only the C corporation can deduct all fringe benefits as a corporate expense. For sole proprietorships, for example, the owner’s benefits are not deducted on Schedule C, Profit or Loss from Business, but may be deducted individually on Form 1040, U.S. Individual Income Tax Return, Schedule 1. Partners, whose benefits are generally considered compensation in the form of guaranteed payments, are treated similarly for some benefits (but not all). S corporation shareholders also may have benefits added to compensation, or deducted by the corporation as a business expense, depending on the benefit. So, “the king” is the C corporation for ease of fringe benefit deductions.
Q: What exactly is a qualified small business?
A: In the context of §448(c) it refers to corporations with gross receipts under $31M allowing those entities favorable tax treatment, or small business exceptions such as ability to use cash basis method of accounting, non-incidental materials and supplies (NIMS) inventory methods and exemption from UNICAP rules.
Q: When does the recognition period for built-in-gains tax expire?
A: Under current federal tax law, the recognition period is five years, beginning on the first day of the corporation’s first tax year as an S corporation.
Q: How do you determine reasonable compensation for S corporation officer/shareholders?
A: This is not defined statutorily; however, it has been primarily developed through court cases. Based on those court cases, factors to consider include:
- Nature of the work performed
- Comparable industry standards
- Experience and qualifications
- Size and financial condition of the business
- Compensation of similar employees – (probably most important)
Additionally, the IRS provides guidance on the following website: S corporation compensation and medical insurance issues | Internal Revenue Service.
To learn more about changing corporate structure, you can watch our on-demand webinar. NATP members can attend for free, depending on membership level! If you’re not an NATP member and want to learn more, join our completely free 30-day trial.
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Information included in this article is accurate as of the publish date. This post is not reflective of tax law changes or IRS guidance that may have occurred after the date of publishing.