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Hop aboard the S corp express for 2006

by on
in Small Business Tax,Small Business Tax Deduction Strategies

If you’ve considered switching your business to an S corporation but have been ineligible in the past, it’s time to take another look.

Why? A 2004 tax law opened up S corporation status to a whole truckload of previously disqualified small and midsize businesses, and it paves the way for your S corp’s future expansion without forfeiting any tax breaks.

New IRS guidance clarifies how you can take advantage of these changes, particularly by electing to treat a group of family members as a single shareholder. The new IRS guidance applies to S corp elections made for the 2005 tax year and beyond.

First some basics: S corporation status offers several legal and tax advantages to small business owners. Significantly, it protects you from personal liability while you avoid the double-taxation threat that plagues regular C corporations. The income and losses from S corporations pass right through to the owners, who report that information on their individual returns.

The 2004 tax act loosened some of the organizational restrictions on S corporations. For instance, it increased the maximum allowable number of shareholders from 75 to 100. Even better: You can elect to treat all of the members of the family as a single shareholder for this purpose.

Bottom line: You can load up on family shareholders without exceeding the 100-shareholder restriction.

New IRS guidance says family members can include common ancestors; lineal descendants of common ancestors; spouses or former spouses of lineal descendants of common ancestors; and certain beneficiaries of electing small business trusts who are members of the family. (IRS Notice 2005-91)

The IRS says that two or more elections can be made for the same S corp. The members of one family for which the election has been made can include the members of another family for which the election has also been made.

The S corp must be notified of such elections. This notification should include:

1. The name of the family member making the election.

2. The common ancestor of the family to which the election applies.

3. The first tax year the election is effective. The election remains in effect until it is terminated. Forthcoming regulations are expected to address this issue.

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