eral income tax changes enacted in 1986 are highly relevant to the use of the Subchapter S and C Corporation concepts. Subchapter S corporations are permitted to make an election whereby shareholders will be taxed (for federal income tax purposes) as individuals, as opposed to taxing the business organization as a corporation, and then taxing individual shareholders on income derived from the corporation. Similar (but differing in important aspects) federal income tax benefits are available to Subchapter C Corporation shareholders.
The provisions of the federal income tax law provide incentives to both switch to and to switch away from the corporate form of business organization (Tax Management, Inc., 1987, p. 111). Business operations organized as S type corporations for federal income tax purposes have the option of electing to be taxed as partnerships (wherein corporate shareholders are taxed as individuals, and the S corporation itself is not subject to federal income tax). Such election permits tax payers to receive the advantages of limited liability (through the corporate form of organization), while taking advantage of individual tax rates (in those instances where individual tax rates are lower than those for corporations). In other instances, a closely held C type corporation may provide a lower overall tax federal income tax liability, than would partnership income taxed at individual rates.
The elimination of special tax treatment for capital gains also provided an incentive for some tax payers to switch from a C corporation type of organization to a partnership, or to a Subchapter S Corporation. Depending upon the level of income, capital gains may be taxed as high as 35 percent under a C corporation form of organization, where the maximum applicable tax under a partnership (at individual rates) would be 28 percent. Thus, the Subchapter S Corporation would, in such a situation, be a superior organizational...