Runninghead: S CORPORATION VS.

CORPORATION 1





S Corporation vs. Corporation
Twanna Grannum
Prof. Roderick D. Thomas, Esq
ACC317
August 29, 2013
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S CORPORATION VS. CORPORATION
This paper focuses on the comparison and the contrast as well as the advantages and
disadvantages in electing to become a corporation and an S corporation, including the resulting
choice that are likely to impact tax obligations.
A corporation is defined as an organization that is formed to act as an artificial person to
carry on as a business with the approval of the approval of the state government agency. Also
according to the IRS a corporation is formed under state law and is accomplished by first filing
articles of incorporation in the state it is conducting business.
An advantage to being a corporation is that if it decides to open up branch offices in
different states, you can have a parent corporation with subsidiaries underneath. So if it has, for
instance a holding company with subsidiaries underneath, while one subsidiary is profitable and
another is not profitable, income can be moved from one to the other to limit its tax liability.
Another advantage to being a corporation is that if a business decides to open up a branch in
another country, the company could take advantage of the foreign tax credits available, to limit
the tax liability. Even though a company may try to take advantage of using the foreign tax
credit that may be available the IRS has stringent rules in regards to the foreign tax credit as was
the case for Bank of New York Mellon Corporation, as Successor in Interest to the Bank of New
York, Inc. v. Commission of Internal Revenue.
The petitioner constructed a tax shelter known as STARS (Structured Trust Advantaged
Repackage Securities) which turned out to be an embellished shelter. Its purpose was to have
businesses sign up with STARS and in turn this created tax credits in return. The court ruled in
favor of the IRS and stated that credits were no more than a way for them to buck the system
and try to manipulate it so that foreign tax credits could be used to lower the banks tax liability.
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A final advantage to being a corporation is that it can pick the accounting method to report in
order to take advantage of the many deductions available to the corporation. Such as if the
company picks accrual method, salaries can be accrued for the specific time instead of when it is
paid. An example of which is if the company is a bi-weekly payroll and the first half of the
payroll is at the end of the year, that portion is expensed to the year-end whereas the second half
would be expensed to the being of the following year. Another example is if a contribution has
been elected to be made by the shareholders of the corporation at year end it can in turn be
expensed in that year. The IRS however has a stipulation on this in that the contribution has to
be paid by the fifteen day of the third month following its year end. Also, the corporation can
only deduct ten percent of its gross income towards the contributions it has made for the year; of
which the remainder has to be carried forward to the following year if this limit is exceeded.
There are also many disadvantages to being a corporation. Being taxed at a higher rate than that
of an individual is one of them. Corporations are taxed at a rate of thirty-five percent whereas
individuals, based on their taxable income can be taxed at a much lower rate.
A second disadvantage to being a corporation is that in essence they can be considered
double taxed. Whereas the corporation is taxed on its income and the shareholders in turn are
taxed again on their distributions. Also the distribution to shareholders is not considered
deductible as corporate spending.
The definition of an S corporation according to the IRS Publication 1.1361-1 means a
small business corporation for which an election under section 1362(a) is in effect for that tax
year.
An advantage to being an S corporation is that all the income is taxed at the shareholder
level. The tax return (Form 1120S) that is filed is just an information return only and the income
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and any deductions (such as charitable contributions, tax-exempt income, long and short-term
capital gains and losses and 1231 gains and losses) are then transferred to the shareholders K-1
for them to report on their individual return.
A disadvantage to being an S corporation as opposed to being a corporation is that it has
to be a domestic corporation. Meaning the company cannot have income producing businesses
outside of the United States. This in turn does not allow S Corporations to take advantage of the
foreign tax credits available to corporations.
Another disadvantage to being an S corporation is that none of the shareholders can be a
resident alien. Whereas this stipulation does not affect a corporation., this hindrance can affect
being able to cultivate and recruit new shareholders in order to obtain more capital for the
corporation.
Another disadvantage to being an S corporation is that if an S corporation has passive
investment income from when they were previously a corporation and its income from that
source is over 25% for three consecutive years, the S corporation will lose its status as an S
corporation beginning the fourth year.
As the Chief Financial Officer (CFO) at Scuba View, Inc. the decision was made to operate
as a corporation to minimize tax liability. The main this decision was made was so that we can
have subsidiaries underneath Scuba View, Inc. as the parent company. Even though we already
have Plexiglas, Inc. as a subsidiary, we may elect to consolidate for tax purposes to minimize our
tax liabilities in the future.
Also, if we have passive investment income from this subsidiary over many years, we will
not be able to have the S corporation status if the passive investment income is more than 25%
for more than three years. Another reason was if we also decide to branch out into the foreign
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market, we can take advantage of the foreign tax credits that are available to corporations. S
corporations have to be domestic corporations as well as being a small business corporation.
Finally, being a corporation and not an S corporation allows us to be able to take advantage
of the deductions not readily available to S corporations on our tax returns. Those are the
contributions we make, the dividend income and losses as well as long-term capital gains as
losses; which would not be deducted on the companys tax return. These deductions would be
not allowed and would be to the advantage of the shareholders to take on their individual tax
returns.
As the Chief Financial Officer (CFO) at The Lost and Found Corp., it has been decides that
we will operate as an S corporation. Below you will find the deciding factors that help come to
this decision.
The main reason why S corporation status was elected was so that the corporation does not
have to pay the 34% tax rate that would be assessed on the corporations income for the current
year. All income flows to the K-1s of the shareholders for them to pay the tax on the income for
the year at the lower rates assessed to individuals. For argument if our income for the year was
$100,000 the corporation would have to pay the IRS $22,250 and this is not including the state
income tax that would be due.
Finally, if we were to have passive investment income from our prior status as a corporation,
we could not have passive income of more than 25% for three years. If this were the case we
would in turn have to have distributions to the shareholders which in turn could hinder our cash
flow.
There are many steps that a corporation or an S corporation would have to take to change its
existing election. For starters for a corporation to elect to change to an S corporation status a
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Form 2553 would have to be completed. In order for this election to apply to the current year
(example for 2013), the election must be made in the prior year (2012) or by the fifteenth day of
the third month of the calendar year (March 15, 2013). S corporations have the advantage of not
having to pay federal income taxes because the S corporation is considered a pass-through entity.
This means that the S corporation files an information only return (1120S) and all the income is
passed through to its shareholders on a K-1 for them to pay taxes at the individual level.
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References

Hoffman, Jr., W., Raabe, W, Young, J., Maloney, D (2013). South-Western Federal
Taxation 2013Volume 2, 17-1 17-51, 18-1 18-35, 19-1 19-42, 20-1 20-29,
22-1 22-48.
IRS 1.1361-1 S corporation defined. Retrieved from
www.irs.gov/publications/p542/ar02.html
McKinnon, J. (February 11, 2013). IRS Wins Major Tax Shelter Case. Retrieved from
http://blogs.wsj.com/washwire/2013/02/11/irs-wins-major-tax-shelter-case.html
Tax Advantages of Corporations. Retrieved from http://legalzoom.com/incoporation-
guide/corporate-tax-advantage.html
U.S. Tax Court. Bank of New York Mellon Corporation v. Commissioner of Internal
Revenue. Retrieved from
www.ustaxcourt.gov/InOpHistoric/BankofNYMellonCorp.TC.WPD.pdf