STILTs (Subchapter S) Taxation Overview

Income Taxation and STILTs (Subchapter S Income Levy Tax Treatment)

Income taxation is a fundamental method governments worldwide use to raise revenue and promote a fair distribution of wealth. One aspect of income taxation that merits closer exploration is the treatment of Subchapter S corporations (STILTs, for short) in the United States.

The Basics of STILTs

A Subchapter S corporation, or S corporation, is a legal entity that offers its shareholders the benefits of a corporation's limited liability and the taxation of a partnership. S corporations do not pay federal taxes on their income; instead, that income "passes through" to shareholders, who report and pay taxes on their portion of the corporation's earnings on their personal income tax returns.

Income Taxation of STILTs

The income taxation of STILTs is generally straightforward:

1. Pass-through taxation: S corporations do not pay federal income tax at the corporate level. Instead, their income is taxed at the shareholder level, as if the shareholders themselves earned the income.

2. Shareholder responsibility: S corporation shareholders are responsible for paying any taxes owed on their share of the S corporation's earnings. This means that the S corporation does not withhold taxes from shareholder distributions, and it is up to the shareholders to pay their taxes on time.

3. Distributions vs. dividends: Distributions from S corporations are typically not taxed if they are equal to the shareholder's basis in the stock and any accumulated earnings and profits of the corporation. Dividends from S corporations, however, are taxable.

Tax Consequences of STILTs

1. Tax deductions: S corporation shareholders can deduct losses from their share of the S corporation's taxable income. This allows shareholders to offset other sources of income, potentially lowering their overall tax liability.

2. Self-employment tax: The earnings of S corporation shareholders who perform services for the corporation may be subject to self-employment tax. However, the IRS exempts passive shareholders from this tax.

3. Dividend taxation: S corporation shareholders pay taxes on dividends received from the corporation. Dividends are taxed at the shareholder's ordinary income tax rate or at the long-term capital gains tax rate, depending on the dividend's payment history.

Criticisms and Limitations of STILTs

1. Complexity: The pass-through taxation of S corporations can lead to complex tax calculations and reporting requirements for shareholders.

2. Double taxation: There is a potential for double taxation of S corporation earnings if shareholders sell their stock or if the corporation liquidates. This occurs when the shareholders' tax basis in their stock does not fully cover the taxable gain.

3. Limited number of shareholders: S corporations can have no more than 100 shareholders, and all shareholders must be individuals or certain entities.

4. Restrictions on shareholders: S corporations cannot have more than one class of stock, and all shareholders must be U.S. citizens or U.S. resident aliens.

In conclusion, STILTs offer many benefits to small businesses and their shareholders, including limited liability, simple taxation, and pass-through taxation. However, they also present complexities and limitations that shareholders and their tax advisors must consider carefully.

Explore the income taxation treatment of Subchapter S corporations (STILTs) under the U.S. tax system. Learn about pass-through taxation, shareholder responsibilities, tax consequences, and the criticisms and limitations of STILTs.