As our readers know, the IRS is currently targeting S corporations, and only S corporations, for audits as part of its on-going “Tax Gap” research project. And the Joint Committee on Taxation and Treasury Inspector General for Tax Administration have, over the past couple year, proposed to dramatically increase the application of payroll taxes on S corporation income.
Now the Congressional Budget Office issues its new biannual “Budget Options” report, and there, on page 297 is an option entitled, “Repeal Tax-Free Conversions of Large C Corporations to S Corporations.” What follows is a long narrative of the history of C corporation conversions, the advent of LLCs in 1988, and the resulting disparity of converting from C to S verses converting to an LLC.
History aside, the option proposed by the CBO is just another shot at the S corporation community. Their reasoning, apparently, is to level the playing field between the treatment of S corporations and LLCs. As the report states:
“A major advantage of this option is that repealing tax-free conversions by C corporations would treat economically similar conversions — from two-tiered corporate tax systems to single-tiered systems — in the same way. Equalizing that tax treatment would, in turn, allow society’s resources to be allocated more efficiently by making tax considerations less important in decisions about what legal form a business should take.”
If equalizing tax treatment is the CBO’s motivation, why not just allow tax-free conversions of LLCs? The same economic arguments apply. Moreover, what about the myriad of advantages LLCs have over S corporations, like no limitations on the number or types of shareholders, the ability to issue multiple classes of stock and convertible debt, or the passive investment and built-in gains rules that apply to converted S corporations? We looked for CBOs recommendations to level the playing field in these areas, but were unable to find any.
The bottom line is the S corporation community needs to be as active as ever to ensure that Congress has all the facts when considering the rules under which we operate. With S corporations in the cross-hairs, anything less than constant vigilance is simply not going to succeed.