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LJN NewslettersNewsSectionsThe Bankruptcy Strategist

The Effect of Bankruptcy on a Subchapter S Election

BY Marvin A. Kirsner
September 01, 2003

A new tax case from the U.S. Tax Court addresses the question of whether the filing of a Chapter 11 case by a Subchapter S corporation terminates the company's Subchapter S election. This case is important to the shareholders of a Subchapter S corporation that might have post-petition taxable income.

Background

Most closely held corporations have filed Subchapter S elections for sound tax planning purposes. A Subchapter S corporation (S Corp.) is generally not subject to an income tax at the corporate level. Rather, the shareholders pay tax on the S Corp.'s income. On the other hand, a corporation that has not filed the Subchapters S election is governed by Subchapter C of the Internal Revenue Code (C Corp.). A C Corp. is subject to federal corporate income tax at the corporate level, at rates up to 35%. The marginal tax rate for a C Corp. climbs rapidly to 34% for taxable income of over $75,000, so the top tax rate kicks in at much lower income bracket than for an individual. In addition to the federal tax, states also impose their own corporate income tax. The combined federal and state tax can result in a combined tax rate of over 40% in some states. Furthermore, a C Corp. does not get the benefit of the 15% tax rate on long-term capital gains available to individuals.

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