Timing is Everything
Is your client considering making an S corporation election? Selling or exchanging 50 percent or more of the total interests in an LLC or limited partnership? If they make an election or change in ownership mid-year, they will have to file two short-year returns and pay for two entities. They may want to consider the timing of making the election or change.
A C corporation that makes a federal S corporation election that takes effect during the year must file two short-period returns. Each short-period return is deemed a separate tax year, and both will be subject to the annual minimum tax. Remember that the federal S corporation election is binding for California.
For example, if a calendar year C corporation makes an S corporation election which takes effect on July 1, the C corporation must file a short-year return for the period from January 1 to June 30. It must also pay its tax liability, but no less than the minimum tax. The S corporation files a return from July 1 to December 31 and pays its tax liability, but no less than the minimum tax.
A multiple-member LLC may find itself in a similar situation if there is a sale or exchange of 50 percent or more of the total interest in the LLC capital or profits, commonly referred to as a Technical Termination. A multiple-member LLC that has a technical termination is required to file two short-period returns, unless the termination occurs on the last day of the year. We treat each short-period return as a separate tax year.
Both the annual tax and LLC fee are assessed for each short-period return of the LLC. For example, if a multiple-member LLC is taxed as a partnership with two members, each owning 50 percent, and one member sells his interest to the other on June 30, the LLC terminates as a partnership effective June 30. The remaining member continues doing business as a disregarded single member LLC. The multiple-member LLC must file for the period from January 1 to June 30, and pay the annual tax and fee. The single member LLC must file for the period from July 1 to December 31, and pay the LLC annual tax and fee. Remember for tax years beginning on or after January 1, 2009, LLCs must estimate and pay the LLC fee by the 15th day of the sixth month after the beginning of the tax year. An estimated fee penalty may be assessed if it is underpaid.
Had the S election or the technical termination occurred on the last day of the year, December 31, there would not be a short-year return due and two payments of the minimum tax or annual tax for each entity. Timing is everything.