CHAPTER 4 - HOW TO MAKE YOUR CORPORATION TAX-FREE

Would you and your corporation like to receive the following benefits?

• Avoid the double taxation problem of C corporations by paying no corporate federal income tax or state corporate franchise tax
• As a shareholder, be able to benefit from the corporation's deductions and credits on your own individual income tax return
• Aid your family financial planning by reducing your income tax through shifting income to family members in lower tax brackets
• Invest earnings inside or outside the corporation without the accumulated earnings penalty tax
• Reduce the likelihood of an IRS "excessive compensation" challenge

You and your corporation can enjoy these benefits if it qualifies as an S corporation. You can incorporate and still reap the tax advantages of a partnership by electing to be an S corporation for state and federal tax purposes.

A qualifying domestic corporation may "elect" to be generally exempt from federal income taxes and will continue to be exempt as long as the election is in effect. Corporations that have made a valid election are known as S corporations or "electing small business corporations." Corporations that have not made an S election are known as regular C corporations.

The corporation's taxable income or loss (with certain adjustments or limitations) for the current tax year is taken into account pro rata by the shareholders on their individual returns. Jobs, investment and research, and development credits and losses are passed through to the shareholders on a pro-rata basis.

The amount of deductible loss is limited to the shareholder's basis for stock plus any loans made by him or her to the corporation. But the losses may be carried forward to future tax years.