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Businesses

This is archived information that pertains only to the 2002 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.

Estimated quarterly income taxes for a corporation were not paid. What is the penalty amount? Is there any way to reduce the penalty?

If the corporation does not pay a required installment of estimated tax by its due date, it may be subject to a penalty. The penalty is figured separately for each installment due date. The corporation may owe a penalty for an earlier due date, even if it paid enough tax later to make up the underpayment. This is true even if the corporation is due a refund when its return is filed.

Use Form 2220 (PDF), Underpayment of Estimated Tax by Corporations, to determine if a corporation is subject to the penalty for underpayment of estimated tax and, if so, the amount of the penalty.

If the corporation is charged a penalty, the amount of the penalty depends on the following three factors:

  • The amount of the underpayment.
  • The period during which the underpayment was due and unpaid.
  • An interest rate that is published quarterly by the IRS in the Internal Revenue Bulletin.

The penalty may be waived by IRS on a case-by-case basis if the failure to make estimated payments was caused by a casualty, disaster, or other unusual circumstance.

For more information, refer to Publication 542 (PDF), Corporations and the Instructions for Form 2220

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12.1 Small Business/Self-Employed/Other Business: Entities: Sole Proprietor, Partnership, Limited Liability Company/Partnership (LLC/LLP), Corporation, Subchapter S Corporation
As a Domestic LLC (limited liability company), what forms do I use to file a return?

The form you use will depend on what kind of entity your business is for Federal tax purposes. Following are some general guidelines and the forms which go with each entity:

  • If your business has only one owner, it will automatically be considered to be a sole proprietorship (referred to as an entity to be disregarded as separate from its owner) unless an election is made to be treated as a corporation. A sole proprietorship files Form 1040 (PDF), U.S. Individual Income Tax Return and will include Form 1040, Schedule C (PDF), Profit or Loss from Business. If an election is made to be treated as a corporation, Form 1120 (PDF), U.S. Corporation Income Tax Return, is filed.
  • If your business has two or more owners, it will automatically be considered to be a partnership unless an election is made to be treated as a corporation. A partnership files Form 1065 (PDF), U.S. Partnership Return of Income. If an election is made to be treated as a corporation, Form 1120 (PDF), U.S. Corporation Income Tax Return, is filed.
The election referred to is made by filing Form 8832 (PDF), Entity Classification Election.

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For IRS purposes, how do I classify a limited liability company? Is it a partnership or a corporation?

A limited liability company (LLC) is an entity formed under state law by filing articles of organization as an LLC. Unlike a partnership, none of the members of an LLC are personally liable for its debts. An LLC may be classified for Federal income tax purposes as a sole proprietorship (referred to as an entity to be disregarded as separate from its owner), partnership or a corporation. If the LLC has only one owner, it will automatically be considered to be a sole proprietorship (referred to as an entity to be disregarded as separate from its owner), unless an election is made to be treated as a corporation. If the LLC has two or more owners, it will automatically be considered to be a partnership unless an election is made to be treated as a corporation. If the LLC does not elect its classification, a default classification of partnership (multi-member LLC) or sole proprietorship (single member LLC) will apply. The election referred to is made using the Form 8832 (PDF), Entity Classification Election.

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For federal tax purpose, is a limited liability company (LLC) with a single member (owner) treated as a partnership, corporation, or sole proprietorship?

An LLC having a single owner will be treated as a sole proprietorship unless an election is made to be treated as a corporation. The election is made using Form 8832 (PDF), Entity Classification Election.

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How is the IRS notified of the entity classification under the tax regulations?

Under regulations, many business entities can elect the tax entity (partnership, corporation, or disregarded entity) that best suits their needs. This approach is popularly called "check the box." Taxpayers should notify the IRS of any check-the-box election by filing Form 8832 (PDF), Entity Classification Election. If a taxpayer does not file Form 8832, a default classification will apply.

Read Reg. 301.7701-3 and Form 8832 for more information.

References:

  • Form 8832 (PDF), Entity Classification Election
  • Reg. 301.7701-3

Must a partnership or corporation file a tax form even though it had no income for the year?

A domestic partnership must file an income tax form unless it neither receives gross income nor pays or incurs any amount treated as a deduction or credit for federal tax purposes.

A domestic corporation must file an income tax form whether it has taxable income or not.

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How do I set up a company as a subchapter S corporation?

Once you have established your corporation according to your state's requirements, you elect S corporation status for federal tax purposes by filing Form 2553 (PDF), Election by a Small Business Corporation. Several requirements must be met before you can elect S corporation status. Instructions for Form 2553, Election by a Small Business Corporation, provides the information on these requirements.

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I have a C corporation. What is the procedure to change it to an S corporation?

To convert from a C corporation to an S corporation, you must meet the same requirements as a newly formed corporation electing S corporation status. You must meet the requirements of a "small business corporation" which are, in general:

  • Be a domestic corporation organized under the law of any state or U.S. territory;
  • Have only individuals, estates or certain trust as shareholders (no partnerships or corporations as shareholders;
  • Have only citizens or residents of the United States as shareholders;
  • Have only one class of stock (differences in voting rights are OK)

The S corporation can have no more than 75 shareholders and must make the election to be an S corporation on Form 2553 (PDF), Election by a Small Business Corporation, before the 16th day of the third month following the close of the C corporation's tax year if the election is to be effective for the current tax year. The C corporation must qualify as an eligible corporation during those 2 1/2 months and all shareholders during those 2 1/2 months must consent, even if they do not own stock at the time of the election. If the election is filed after the 15th day of the third month of the tax year, the election will be in effect for the next tax year and all shareholders at the time of the election must consent.

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What is the procedure for revoking subchapter S election for a corporation?

Voluntary termination of an S election is made by filing a statement with the Service Center where the original election was properly filed. A revocation may be made only with the consent of shareholders who, at the time the revocation is made, hold more than one-half of the number of issued and outstanding shares of stock (including nonvoting stock) of the corporation. There is specific information that must be included in the statement and this information is outlined in Regulations section 1.1362-6(a)(3) and in Instructions for Form 1120S, U.S. Income Tax Return for an S Corporation.

The revocation may state an effective date as long as it is on or after the date the revocation is filed. If no date is specified and the revocation is filed before the 15th day of the third month of the tax year, the revocation will be effective for the current tax year. If the revocation is filed after the 15th day of the third month of the tax year, the revocation will be effective for the next tax year.

You may want to consult the IRS Customer Service phone line at 800-829-8374 or you may wish to consult with a tax professional to be certain you have all the necessary information to file a proper revocation.

The S corporation election terminates automatically under certain conditions. Refer to Instructions for Form 1120S, U.S. Income Tax Return for an S Corporation.

References:

  • Instructions for Form 1120S, U.S. Income Tax Return for an S Corporation
  • Treas. Reg. section 1.1362-6(a)(3)
  • Treas. Reg. section 1.1362-2(a)

Can you give me plain English definitions for the following: (1) a closely held corporation, (2) a personal holding corporation, and (3) a personal service corporation?

Generally, a closely held corporation is a corporation that, in the last half of the tax year, has more than 50% of the value of its outstanding stock owned (directly or indirectly) by 5 or fewer individuals. The definitions for the terms "directly or indirectly" and "individual" are in Publication 542 (PDF), Corporations. Generally, closely held corporations are subject to additional limitations in the tax treatment of items such as passive activity losses, at-risk rules, and compensation paid to a corporate officers.

A personal holding company is defined in Internal Revenue Code section 542. Basically, a corporation is a personal holding company if both of the following requirements are met:

  • Personal Holding Company Income Test. At least 60% of the corporation's adjusted ordinary gross income for the tax year is from dividends, interest, rent, and royalties.
  • Stock Ownership Requirement. At any time during the last half of the tax year, more than 50% in value of the corporation's outstanding stock is owned, directly or indirectly, by 5 or fewer individuals.
Refer to the Instructions for Form 1120, Schedule PH for more information and a list of exceptions.

A personal service corporation is a corporation where the main work of the company is to perform services in the fields of health, law, engineering, architecture, accounting, actuarial science, the performing arts, or consulting. Examples may be law firms and medical clinics. Also, substantially all of the stock is owned by employees, retired employees, or their estates.

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12.9 Small Business/Self-Employed/Other Business: Starting or Ending a Business
I invested personal funds to start a new corporation last year. How can I get credit for this on my personal income tax return?

If you invest your personal funds to start a corporation, this is your basis in the stock of the corporation. Your stock basis will show on the balance sheet of the corporation's Form 1120 (PDF), U.S. Corporation Income Tax Return. Your investment will not show up on your personal income tax return until you sell the stock or until the corporation goes out of business.

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Which form do I use to file my business income tax return?

To determine which form you should file for your business entity, select one of the following links:

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How do I terminate or close down a corporation (S orC)?

The process for closing a corporation consists of many steps that need to be followed in a specific order and within specified time frames. See Small Business/Self Employed - Closing a Business for information to properly terminate your business entity with the Internal Revenue Service.

References:

  • Small Business/Self Employed - Closing a Business

What do I need to do to become a Corporation?

Corporation are formed at the state level first. For additional information on requirements at the federal level, please seePublication 542 (PDF), on Corporation.

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Where is a loss reported on my return and how much can I deduct?

The place where your loss is reported depends on how much is deductible, the type of loss, and the type of return you are filing. If your business deductions are more than your business income for the year, you may have a Net Operating Loss (NOL). You can use an NOL by deducting it from your income in another year or years. Partnerships and S Corporations generally cannot use an NOL. But partners or shareholders can use their separate shares of the partnership's of S Corporation's business deductions to their individual NOLs. For additional help, see Publication 541 (PDF), Partnership, Publication 542 (PDF), Corporation, Publication 925 (PDF), Passive Activities and At-Risk Rules, and Publication 536 (PDF), Net Operating Losses (NOLs) for individuals, Estates, and Trusts.

If you have a Capital Loss, it is generally from the sale or loss of investment property, a business, or a capital asset used in a business. Publication 544 (PDF), on Sales and Other Disposition of Assets, will provide additional information on this subject.

Special Situations

S Corporations

In general, if an S corporation purchases a C Corporation at the end of the year and the C Corporation has a loss, the S Corporation does not get to claim the C Corporation loss. A C Corporation is a taxable entity in itself and gains and losses do not flow through to the shareholders.

S Corporation shareholder who hold stock at any time during the year may claim their proportionate share of corporate losses on their individual tax returns subject to certain limits. For more information about the limitations, see the instruction for Instructions for Form 1120S, Schedule K-1.

Partnerships

In general, a partner loss is allocated base on his/her percentage of ownership of the year. This percentage is referred to as the partner's distributive share. The partners' distributive share of items is reported to the partner on Schedule K-1 (Form 1065). A partner's distributive share of partnership loss is allowed only to the extent of the adjusted basis of the partner's partnership interest. A loss that is more than the partner's adjusted basis is not deductible. For additional deductibility of partnership losses, see Publication 541 (PDF), Partnership, and Publication 925 (PDF), Passive Activities and At-Risk Rules

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How does a corporation deduct a capital loss?

Subchapter C Corporation

This type of corporation can deduct capital losses only up to the amount of capital gains. If capital losses exceed capital gains, the excess is first carried back three years prior to the loss year and used to offset capital gains. Then, any unused loss is carried forward five years from the loss year to offset capital gains in those years. If the corporation is dissolved, the loss is not carried to any other year or return, it is simply lost.

A corporation may not carry a capital loss from or to a year in which it operates as a Subchapter S Corporation.

Rules for Carryback and Carryforward

When carrying a capital loss from one year to another, the following rules apply:

  • When figuring the current year capital loss, you cannot combine it with a capital loss carried another year. In other words, you can carry capital losses only to years that would otherwise have a net capital gain.
  • If you carry capital losses from 2 or more years to the same year, deduct the loss from the earlies year first.
  • You cannot use a capital loss carried from another year to produce or increase a net operating loss in the year to which you carry it back.

Corporation must include capital gain in full in gross but only to the extent they exceed capital losses. A corporation is taxed on net capital gain at the regular tax rate, including the additional phase-out rates for high-income corporations. See Instructions for Form 1120/1120A, U.S. Corporation Income Tax Return, and Publication 542 (PDF), Corporations for additional information.

Subschapter S Corporations

An S Corporation generally passes gains and losses through to the shareholders based on their percentage of ownership (distributive share). For more information on how to calculate and report these losses, see Instructions for Form 1120S, Schedule K-1, Form 4797 (PDF), Sales of a Business, Form 1120S (PDF), U.S. Income Tax Return for an S Corporation, Entities: Sole Proprietorship, Limited Liability Company/Partnershp (LLC/LLP, Corporation, Subchapter S Corporation.

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What type of entity am I?

If you operate a business as the sole owner and you have not incorporated, you are considered a sole prioprietor. If more than one individual owns an unicorporated business, it is not a sole proprietorship. An exception to this rule is a husband and wife. A husband and wife can own a business as a sole proprietorship or a partnership.

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What is the due date for business returns?

Some forms and entities have due dates other than the well-known April 15th due date. The instructions for the each type of form used will have the appropriate due date(s) noted. In general, sole proprietor's schedule of income and expenses is attached to the 1040. Therefore, the due date is the same as the 1040.

A Corporation must generally use the calendar year, unless the entity can establish a business purpose for having a different tax year. The due date is usually April 15th.

A partnership generally must conform its tax year to the tax year of the partners unless the partnership can establish a business purpose for having a different tax year. The tax year is the same as one or more partners that own (in total) more than a 50-percent interest in partnership profits and capital. If there is no majority interest tax year, the partnership must adopt the same tax year as that of its principal capital holder. Where neither condition is met, a partnership must use the calendar year. A Limited Liability Company reporting as a partnership has the same tax year as a majority of its partners.

References:

  • Publication 541 (PDF), Partnerships
  • Publication 542 (PDF), Corporation
  • Publication 334 (PDF), Tax Guide for Small Business
  • Entities: Sole Proprietor, Partnership, Limited Liability Company/Partnership (LLC/LLP), Corporation, Subchapter S Corporation

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