A lawyer explains that S corporations face complicated tax risks and how their shareholder can avoid some of risks.
When planning to go public, owners of S corporations face more complicated tax risks than C-corporation owners do. One big problem concerns whatever shareholder distributions of accumulated earnings take place around the time of an S corporation's initial public offering. "It usually makes sense to distribute whatever sum accountants would define as your 'triple-A balance' [basically, accumulated earnings]," says Benjamin Wells, a partner at the Houston-based law firm of Baker & Botts.
Don't worry about the technical jargon: The important message here is, whatever your triple-A balance, you must distribute it carefully to all shareholders at a carefully planned time. That way you reduce the risk of having the IRS call the distribution a "step transaction" (meaning, just another set of proceeds from your IPO) and then having it slam shareholders with unnecessary capital-gains taxes.
"The safest way to avoid the risk of unnecessary taxes," says Wells, "is to carry out the distribution well before the IPO happens." S corporations do have a window of opportunity to make tax-free triple-A distributions for a period that generally lasts at least 12 months after the IPO -- the "posttermination transition period." Here's the best caveat: avoid paying any dividends in the first year because payments to pre-IPO shareholders could trigger capital-gains taxes at a later date.
This is complex stuff: consult your tax lawyer and your accountant as soon as you think of going public.