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When two S corporations are one too many

Entrepreneurs often set up a new corporation for each new business. It makes sense; if one has a catstrophe, the others are shielded from the damage. But if you aren't careful, multiple corporations can cause a tax catastrophe. It caused a $16 million problem in Tax Court this month for a Michigan couple.

S-walnut Owners of "S corporations" may be eligible to deduct the corporations business losses against other income on their personal tax returns. There are a number of limits on such losses, starting with the owners' "basis" in their S corporation stock.  Basis starts with their investment in the company; it is increased for earnings of the business and additional investments, and reduced for losses and distributions from the business.  Owners may also get basis for losses from personal loans to the S corporation.

If you have two corporations, one might be profitable, but the other might be losing money -- and short on basis.  Owners may be caught with non-deductible losses at year-end if they can't figure out how to get the basis where it needs to be.  That's what happened to the Michigan couple.

The easiest way to deal with this problem might be an "S corporation holding company."  If you have two S corporations with identical ownership, you can contribute all of their stock to a new corporation (it has to be all of the stock).  The new corporation makes a timely S corporation election on Form 2553, and the now-subsidiary corporations file timely "Q-Sub" elections. 

The tax law treats the new corporate group as a single corporation for basis purposes, eliminating the need to try to shuffle basis between them at year end.  The lawyers are happy because the liabilities of the businesses are still in separate corporations under state law.

Of course, don't try this at home.  Check with your tax and legal advisors before messing with your corporate equity structure.

- Joe Kristan


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