Are capital gains from an S Corp subject to NIIT?
S corporations are not subject to the net investment income (NII) tax, but S corporation shareholders may be subject to the tax on income items related to their investments in the corporation.
Depending on the level of involvement in the S-corporation, the selling shareholder(s) may also be subject to the 3.8% net investment income (NII) tax on passive activity. If a shareholder can show active participation in the company, then the gain is exempt from NII tax.
Net investment income generally does not include wages, unemployment compensation, Social Security Benefits, alimony, and most self-employment income. Additionally, net investment income does not include any gain on the sale of a personal residence that is excluded from gross income for regular income tax purposes.
The capital gains tax rate varies based on how long you've owned the S Corp. If you've owned the business for more than one year, the sale will be considered a long-term capital gain, and the tax rate will be either 0%, 15%, or 20%, depending on your income level.
First, the gain is taxed at the corporate level at the federal corporate rate of 21%. Then, the net cash proceeds are distributed to the shareholders who are taxed at the dividend rate plus the net investment income tax in many cases (collectively 23.8%).
While selling an S-corp does have tax consequences and the sale of S-corp stock may cause shareholders to pay capital gains taxes, you would have to pay taxes, regardless of the type of business you sell – and those taxes are likely to be much higher than the taxes on the sale of business S-corp.
In a stock sale, the buyer purchases the S corp stock, taking on all the assets and liabilities of the company. With this process, the ownership of the stock changes, but the company essentially remains the same.
A Medicare surtax of 3.8% is charged on the lesser of (1) net investment income or (2) the excess of modified adjusted gross income over a set threshold amount. The threshold is $250,000 for joint filers, $125,000 for married filing separately, and $200,000 for all other filers.
All gains from the sale of property are generally included in net investment income under Reg. Section 1.1411-4(a)(1)(iii). Included within the purview of “three little i” gains are long-term and short-term capital gain, Section 1231 gain, Section 1245 ordinary income recapture, and unrecaptured Section 1250 gain.
Gains from the sale of assets used in a nonpassive qualified trade or business are not included in net investment income. Under the proposed regulations, each asset must be separately valued, including goodwill, and a determination must be made whether the asset is used in a qualified trade or business.
How does an S corp avoid capital gains tax?
An S corp is an entity that allows its earnings, deductions, and credits to pass through to its shareholders to be taxed at an individual level. When a non-dividend distribution is given to a shareholder, it is tax-free as long as it does not exceed his or her stock basis.
In general, an S corporation is subject to the built-in gains tax when it converted from a C corporation and the S corporation recognizes an item of income/gain that is attributable to tax years when the company operated as a C corporation.
Individuals, trusts, and estates are subject to a 3.8-percent tax on the lesser of their net investment income, or the excess of their modified adjusted gross income (MAGI) over a threshold amount ( ¶117).
The 3.8% Net Investment Income Tax (NIIT) surtax on investment income from the sale of S Corp stock by individuals, trusts, and estates has been in effect since 2013.
Net investment income includes:
Rental and royalty income. Passive income from investments you don't actively participate in. Business income from trading financial instruments or commodities. Taxable portion of nonqualified annuity payments.
Single taxation level on business sales: When owners sell an S corporation, they are taxed on the distribution. With C corporations, the corporation pays taxes first, and shareholders pay taxes again once they receive their proceeds.
If you take the property out of the S-corporation for any reason, you will trigger taxes on the built-in capital gain of $100,000. At current rates, that's a tax bill of $15,000. That tax bill could have been deferred if the property had been held in a partnership (or an LLC taxed as a partnership.)
Your shareholder basis is your company's earnings and deposits minus withdrawals. Think of your stock basis like a bank account. You can't take out more money than you have — the stock basis must always remain above $0. Typically, your initial stock basis is what you paid in cash for shares in the S corporation.
S corporation shareholders or owners can take these distributions tax-free to the extent that they have basis in the company, as in how much they've invested, so their share of the S corporation. Any distributions in excess of a shareholder's stock basis would be subject to long-term capital gains tax.
1411(c)(1)(A)(iii), so it is not subject to the net investment income tax. Furthermore, personal goodwill is created by personal service activities, and, therefore, income from the disposition of goodwill should not be treated as passive.
What happens with the money in an S corp at the end of the year?
At the end of each year, all S corporation profits are allocated to the corporation's shareholders. Even if you and your fellow shareholders choose to leave some or all of the profits in the corporation, taking nothing as distributions or salaries, you will still be required to pay tax on those profits.
Transferring property from an S corp to an LLC
This can be done one of two ways: by converting your S corp to an LLC or transferring the property.
Many investors selling real estate or other high value investments are often surprised to find out that their tax liability could be subject to an extra 3.8% surtax in addition to the applicable short-term or long-term capital gains tax rates.
Yes NIIT includes capital gain regardless of duration (but not the excluded amount on sale of your home), and no Additional Medicare Tax (like normal FICA/SECA) does not include any investment income.
Sell investments at a loss to offset investment gains. Defer capital gain, such as selling the investment in the future instead of selling it now. Use Section 1031 like-kind exchange which is selling an investment property and using that money to buy another investment property.
