By Steve Parrish

Once unappreciated, S Corporations now are fueling most of the growth in the small- and medium-sized business market. In fact, according to the Treasury Department, more than 37% of companies with gross receipts over $1 million are S Corps.

Financial representatives who successfully work with S Corps understand their unique needs and undertake a process whereby they can properly devise solutions for the owners.

The successful S Corp advisor applies 3 key principles to help owners assess their financial needs. They are to:

Examine corporate history. A businesss corporate and tax structure history can affect how the owner takes distributions and exits the business. Some S Corps began as C Corps and then changed to S Corps as the owner(s) began to consider leaving the business. These companies typically require special accounting attention to deal with earnings and profits issues.

S Corps that always have been S Corps typically have more straightforward planning options.

Work with professional advisors. Contrary to popular opinion, S Corps are not taxed in a manner identical to LLCs and Partnerships. If the S Corp owners stock interest is a sizeable part of their wealth, the tax and accounting issues unique to their companies must be factored into the owners financial plan. Partnering advisors could point out strategies or information about the company that you might not otherwise have considered.

Incorporate a business continuation agreement into the owners retirement and exit plan. S Corporations are not publicly held companies. Further, their status with the IRS easily can be forfeited if an ineligible party is given stock or if a group of stockholders demands a change to C Corp status. These factors make a written business continuation plan a necessity for the owner who intends to retire eventually or sell while preserving the S Corp status.

Given these principles, experienced financial representatives follow a special process to make sure the unique S Corp issues align with the owners financial needs and strategies. The process not only assures better recommendations but also demonstrates empathy and value to the business owner and his/her professional advisors.

Step 1: Learn the history of the business. Run a search on the Web to see what information is publicly available. The businesss professional advisors are also a valuable source of information. If your client is not sure about the businesss tax status history, ask if the company has filed and/or paid income taxes separately. Also, ask if the company has acquired other companies. The answers to these questions may reveal a previous C Corp status.

Step 2: Determine whether the owner has a written business continuation agreement. The tax status of the business can affect substantially the owners personal financial situation. You should encourage the client to seek counsel and obtain a properly drafted business continuation agreement.

If no agreement exists, ask if the client is aware that S Corp status can be jeopardized by a fellow stockholder passing on company stock to a non-resident alien. Ask if the client realizes that non-voting stockholders can affect a decision to cease the S Corp election. If a business continuation agreement does exist, ask if it covers all contingencies, including death, disability and retirement, among others.

Step 3: Beyond inquiring about the companys benefit plans, ask about any differences in the benefits of owners and non-owners. The general rule is that there is no deduction for fringe benefits for owners of more than 2% of company stock. Examples include the first $50,000 of group term life insurance and company-paid disability insurance. By learning about benefits differences, you will be able to reveal whether the owner has missed tax opportunities in fringe benefit planning.

Step 4: Determine the amount of life insurance funding owned and how policies are held. A common misconception is that the applicable rules for life insurance planning in C Corps apply equally to S Corps. In fact, planning opportunities can be radically different.

For example, life insurance used to fund a buy-sell agreement with a closely held C Corp is often owned in cross-purchase format. This approach helps avoid the AMT and family attribution issues of C Corps and provides an increased basis for surviving shareholders.

In contrast, S Corp owners have more flexibility to use corporate-owned life insurance as part of a stock redemption agreement. AMT is not an issue and the tax-free life insurance proceeds can increase the tax basis of the owners stock.

Step 5: Request permission to speak with the owners professional advisors early in the planning process. The S Corp election is a key aspect of the owners tax picture and is important to coordinate the tax plan with the owners financial strategies. Raising tax issues and solutions to the professional advisors will not only help your client but also position you well with the advisors.

o Step 6: Proceed with normal fact-finding. The steps above are special considerations when dealing with owners of S Corps. As always, a thorough fact-finding process is a key part of the financial representatives responsibilities.

The owners of these privately held companies have significant financial needs, but their S Corp ownership also generates special issues. Successful financial representatives learn and apply approaches to make sure these issues and opportunities are factored into their financial recommendations.

Steve Parrish, JD, CLU, ChFC, RHU, is second vice president for individual markets at Des Moines, Iowa-based Principal Financial Group. He can be reached at parrish.steve@principal.com.


Reproduced from National Underwriter Edition, May 14, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.