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Closely held corporations are referenced and defined in the internal revenue code. Specifically, §465(a)(1)(B) says a closely held corporation is one where more than 50% of a corporation’s stock is owned (directly or indirectly) by 5 or fewer individuals at any time during the last half of the tax year and is not a personal service corporation.
Why does this matter?
This matters because Closely Held Corporations are subject to additional tax limitations, such as:
- Passive Activity Loss Limitations (PAL) (§469): Closely held corporations, other than S Corps, are subject to the PAL limitations. This means passive losses may offset active income, but not portfolio income. Corporations subject to such loss limitations must file Form 8810 (individuals file form 8582).
- “At-risk” limitations (§465): Applies to certain closely held corporations, other than S corporations, “at-risk” rules limit the taxpayer’s ability to incur losses to the amount “at-risk”. “At-risk” generally equals (a) money and adjusted basis of property contributed by the taxpayer and (b) money borrowed for the activity. Information regarding the “at-risk” rules are filed on Form 6198.
- Compensation to corporate officers: The IRS has scrutinized compensation matters when auditing closely held corporations, including S corporations. Both excessive and insignificant salaries can pose risk of an audit.
- Risk of being too high: If salaries are deemed too high, they can be reclassified as dividends, which can come with penalties, or treated as “ineligible” for tax deductions.
- Risk of being too low: Can lead to understating employment related taxes which can lead to penalties in interest.
The takeaway: Whether you are forming a new closely held corporation or have been in business for many years, now is as good a time as any to make sure that you are considering and in compliance with the above provisions as they pertain to closely held corporations.
Disclaimer: The information provided herein is intended solely for informational purposes and no person(s) or other third-party may rely upon it as financial, tax, or legal advice or use it for any other purposes. As a result, Royal Financial, and any affiliates, assume no responsibility whatsoever to readers, or any other persons for that matter, as a result of the information contained herein.