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S Corporation Shareholders: Accelerating Income Into 2012

S Corporations with Prior C Corporation E&P

Because of the advantageous treatment afforded S corporation distributions, there is tremendous motivation for a C corporation with substantial E&P to convert to an S corporation prior to making a distribution, so that the distribution will be treated as a tax-free return of shareholder stock basis rather than a taxable dividend.

Recognizing this potential loophole, the statute provides that a C corporation’s accumulated E&P survives the S election and remains with the S corporation. Should this E&P be subsequently distributed — even during an S corporation year — the distribution will be taxed as a dividend to the recipient shareholders as if it had been made while the business was a C corporation.

Until December 31, 2012, dividends received by non-corporate shareholders from domestic and qualified foreign corporations are taxed at a maximum 15-percent rate. (This expiration date was extended for two years by the 2010 Tax Relief Act.) Accordingly, S corporations with C corporation E&P may wish to consider making an actual or a deemed dividend distribution of this E&P, which would be taxed to its shareholders at the present maximum 15-percent dividend rate.