March 11, 2026 | by Atherton & Associates, LLP

S-corporations are one of the most frequently discussed (but often misunderstood) tax structures for small business owners. You’ve likely heard that they can help reduce taxes, especially self-employment taxes. And in some cases, that’s true. But the rules are nuanced, and the benefits aren’t automatic.

An S-corporation (or S-corp) isn’t a separate type of business entity. It is a tax classification that eligible businesses can elect by filing Form 2553 with the IRS. 

Many small businesses are already taxed as pass-through entities, meaning their income is reported on the owners’ personal tax returns and taxed at individual rates. Electing S-corp status doesn’t change that pass-through treatment. What it changes is how the income flowing through is characterized for tax purposes, particularly for owners who are actively involved in the business. 

This is a 101-level overview designed to answer common questions and clear up misconceptions about S corporations. It’s not a substitute for tax or legal advice. The goal is to help you understand the basics so you can have a more informed, productive conversation with your advisor if you’re thinking about making the election.

What is an S-corporation? 

An S-corporation isn’t a separate type of legal entity. It’s a tax election made under Subchapter S of the Internal Revenue Code. Both corporations and limited liability companies (LLCs) can apply for S-corp status if they meet eligibility requirements.

With an S-corp election, a business is treated as a pass-through entity for federal income tax purposes. But unlike a sole proprietorship or default LLC, an S-corp allows owner-employees to split income between:

• Wages (subject to payroll/FICA taxes), and 
• Distributions (which avoid FICA taxes and are generally not subject to income taxes unless they exceed the shareholder’s stock basis)

This structural split is what creates potential tax advantages, particularly for profitable businesses with actively involved owners.

Can I convert my LLC to an S-corp?

Many business owners start out as single-member LLCs and later elect S-corp status once the economics make sense for their situation. You’re not changing your legal entity; just how it’s taxed. 

There’s no hard threshold for when to make the switch, but the structure typically starts making sense when:

• You’re consistently earning net profit above what would be considered a reasonable salary
• You’re actively working in the business and prepared to take reasonable compensation as wages for your services
• You’re ready to take on the added responsibilities of running payroll and filing a separate corporate return (Form 1120-S)

If your income is modest, inconsistent, or your reasonable salary would consume most of your profit, it may make sense to wait before making the election.

Quick note on LLCs: “LLC” refers to a legal entity under state law, but for federal tax purposes, an LLC can be treated as a sole proprietorship (single-member), a partnership (multi-member), or a corporation (if an election is made). Most examples in this article assume a single-member LLC scenario to keep the math simple. If your LLC is taxed as a partnership, the same concepts apply, but the mechanics can differ – so you’ll want to model the election with your advisor. 

Why do some business owners elect S-corp status? 

The primary reason for electing S-corp status is the opportunity to reduce self-employment taxes, though the actual benefit depends heavily on the nature and profitability of the business. 

This is especially true for business owners who are currently taxed as sole proprietors or default LLCs, where all net income is subject to self-employment tax. 

If your business is taxed as a C-corporation, the motivation can be different: C-corps generally pay tax at the corporate level, and shareholders can pay tax again when profits are distributed as dividends. An S-corp election (for eligible corporations) is one way to shift from a “two-level” tax structure to a pass-through structure, where income is generally taxed once at the shareholder level. For many closely held corporations that expect to distribute most of their profits to owners, that shift (moving away from double taxation) can be a primary reason to elect S-corp status. 

Understanding FICA taxes

To understand an S-corp, it helps to understand how FICA (Federal Insurance Contributions Act) taxes work. These taxes fund Social Security and Medicare and work the same way whether you’re an employee or self-employed – but who pays them differs.

For W-2 employees, FICA taxes are split: the employee pays 7.65% (6.2% for Social Security, 1.45% for Medicare), and the employer matches that with another 7.65%.

For self-employed individuals (sole proprietors and single-member LLC owners), you pay both the 7.65% employee and employer shares, since you are considered both the employee and the employer, resulting in a total of 15.3% self-employment tax.  

Note: Social Security tax applies only to wages up to an annual cap ($184,500 for 2026), while Medicare tax applies to all earnings. An additional 0.9% Medicare surtax may apply to higher earners.

How an S-corp changes the tax structure

An S-corp allows owners who actively work in the business to pay themselves a reasonable W-2 salary and then take additional profits as distributions. Here’s how that affects FICA taxes:

• The salary is treated just like any other employee’s wages – subject to payroll tax (FICA), split between the employee and employer (though both portions are ultimately paid from your business).
• The distributions, however, are not subject to FICA taxes.

This allows a business owner to limit FICA exposure to only the portion of income paid as wages, potentially reducing total payroll tax liability, as long as the salary is reasonable for the work performed.

Side-by-side comparison

Let’s say a business generates $150,000 in net income, and the owner is actively working in the business.

Sole Proprietor/Default LLC:

• Entire $150,000 subject to self-employment tax (15.3%)
• Self-employment tax: $22,950
• The full $150,000 is also included in the owner’s taxable income and subject to federal (and possibly state) income tax, based on the owner’s individual tax situation. 

S-Corporation (with $100,000 reasonable salary):

• $100,000 salary subject to payroll tax (15.3%): $15,300
• $50,000 distribution: $0 in FICA taxes
• The full $150,000 is still included in the owner’s taxable income, just as it would be in the sole proprietor scenario. 

Payroll tax savings (before other adjustments): approximately $7,650.

Note: sole proprietors generally receive an above-the-line deduction for half of their self-employment tax, which can slightly reduce taxable income and narrow the net difference when comparing total tax cost. 

This split doesn’t necessarily reduce income tax; it changes how payroll taxes apply. That distinction can create planning opportunities for businesses that consistently earn more than what would be considered a reasonable wage for the owner’s role. 

Reasonable compensation is non-negotiable

If you’re an S-corp owner who actively works in the business, the IRS expects you to pay yourself a reasonable salary before taking any distributions. This is one of the most important (and most scrutinized) requirements of the S-corp structure.

But what exactly counts as “reasonable”?

The IRS doesn’t provide a fixed formula or salary table. Instead, it expects business owners to base compensation on what they would pay someone else to do the same job under similar circumstances. Factors to consider include:

• Industry standards for comparable roles
• Geographic location and cost of living
• The size, complexity, and profitability of the business
• Your role and responsibilities
• Time spent actively working in the business

For example, a solo consultant generating $150,000 in net income might reasonably take a salary of $70,000–$90,000, depending on their experience, hours worked, and market norms. But a physician earning the same amount may be expected to take a significantly higher salary due to specialized training and licensing. 

There’s no bright-line test, but undercompensating yourself increases the risk of IRS scrutiny. If the IRS determines that your salary is unreasonably low, it can reclassify prior distributions as wages, assess back payroll taxes, and impose penalties.

Determining your reasonable salary

To support your salary, it’s helpful to research market compensation using resources like the Bureau of Labor Statistics (BLS), Glassdoor, or industry-specific surveys – and to document factors such as your role, hours worked, credentials, and the complexity and profitability of your business. A CPA can help you develop a defensible salary figure that balances tax efficiency with compliance. 

How do I pay myself from an S-corp? 

When paying yourself from an S-corp, you’ll need to run payroll, just like a regular employer – even if you’re the only employee. That means withholding federal and state income and unemployment taxes, Social Security and Medicare taxes, and issuing yourself a W-2 at year-end. Most S-corp owners use a payroll service to manage this.

After your salary is paid, any remaining business profit can be taken as distributions. These are not subject to self-employment tax, but they do reduce your basis in the S-corp.

Distributions are generally a return of previously taxed earnings and don’t trigger additional tax unless they exceed your basis. Here’s what that means: 

Your basis in an S-corp starts with your initial investment and increases when the company earns income (which you pay taxes on) or you contribute additional capital. It decreases when you take distributions or the company has losses. If you take out more than your basis, the excess is taxed as a capital gain. 

What are the limitations of an S-corp? 

While S-corps can offer tax planning opportunities in the right context, the structure isn’t suitable for every business. There are several important limitations to be aware of. 

First, only U.S. citizens or resident aliens can be shareholders. S-corps are also limited to a maximum of 100 shareholders and may only issue one class of stock, which can limit flexibility in ownership structures and profit-sharing arrangements. Certain types of businesses, such as some financial institutions and insurance companies, are not eligible to elect S-corp status at all.

Beyond these eligibility restrictions, the S-corp structure may not be a good fit for businesses that are operating at a loss, because losses can only be deducted to the extent of your basis, which does not include entity-level debt. 

If your business is still ramping up, operating at a loss, or reinvesting heavily in growth, the tax benefits of an S-corp may be limited or nonexistent in the short term. 

Administrative requirements

S-corps require maintenance, including: 

• Monthly or quarterly payroll processing
• Separate corporate tax return (Form 1120-S) in addition to your personal return
• Stricter bookkeeping and accounting requirements, including maintaining corporate records such as meeting minutes
• Potential state-level taxes or fees in some jurisdictions

These ongoing costs and complexity mean S-corp status only makes financial sense when the tax savings outweigh the additional administrative burden. 

Is an S-corp right for you? 

S-corps offer a unique blend of pass-through taxation and structured compensation. But they’re not automatically advantageous, and they’re not designed for every business.

If you’re earning strong profits, actively involved in your business, and ready to formalize how you pay yourself, it may be worth exploring the switch. But like most tax strategies, it’s not one-size-fits-all.

Before you file anything with the IRS, contact one of our expert advisors. We’ll help you run the numbers, weigh the trade-offs, and determine whether an S-corp election makes sense for your goals. 

February 02, 2026 | by Atherton & Associates, LLP

It’s the start of a new year, which means it’s time to get your 1099s in order. If you paid any contractors in 2025, paid office rent, or received royalties, there’s a good chance you’ve got some forms to file. The rules aren’t complicated once you break them down – but waiting too long can lead to mistakes, missed deadlines, and penalties. So let’s walk through the basics of who gets a 1099, which forms to use, and what deadlines you need to meet.

Who gets a 1099, and which form?

There are more than a dozen types of 1099s, but most small businesses deal with just a few. The most common are the 1099-NEC for nonemployee compensation, the 1099-MISC for rent and other miscellaneous payments, and the 1099-K for payments processed through third-party networks.

While the deadline for issuing most 1099s is usually January 31st, that date falls on a weekend, so the deadline has been pushed back to February 2, 2026.

1099-NEC: nonemployee compensation

You’ll likely need to issue a 1099-NEC if your business paid $600 or more to a nonemployee, like a freelancer, consultant, contractor, or service provider.

This form applies when:

• The service provider is not your employee,
• The payment was made in exchange for services, and
• The payee is an individual, sole proprietorship, or partnership. If you’re unsure how they’re taxed, check their W-9 to confirm.

You typically don’t issue a 1099-NEC to C or S corporations, but there are some exceptions. For example, if your business paid an attorney or law firm for legal services, you may still need to issue a 1099-NEC, even if they’re incorporated.

LLCs can also be tricky. If the contractor’s LLC is taxed as a sole proprietorship or partnership and they meet the $600 threshold, you must issue a Form 1099-NEC. If they’re taxed as a corporation, you typically do not, unless a rare exception applies.

1099-NEC forms must be delivered to both the recipients and the IRS by February 2, 2026.

1099-MISC: miscellaneous income

You’ll use Form 1099-MISC to report certain business payments that don’t fall under nonemployee compensation. This typically includes rent payments of $600 or more for office space or equipment leases, royalty payments of $10 or more, and prizes or awards.

Just like with the 1099-NEC, you usually don’t need to issue a 1099-MISC to a C or S corporation, but there are important exceptions. One of the most common exceptions is for business-related medical or healthcare payments. For example, if you paid for employee drug testing or occupational health visits, that will probably require a 1099-MISC.

You’ll need to provide recipients with their 1099-MISC by February 2, 2026. However, there are different deadlines for filing with the IRS. For paper filing, the deadline is March 2nd; for electronic filing, it’s March 31st.

1099-K: Third-party payment processors

If you pay a vendor through a third-party platform such as PayPal, Venmo Business, Square, or a credit card, you generally do not issue a Form 1099 for those payments. Instead, the payment processor is responsible for issuing Form 1099-K.

This avoids double-reporting the same income. Make sure your bookkeeping distinguishes between payments made directly to a vendor and payments made through third-party payment processors so you don’t issue duplicate forms by mistake.

Tips for a smoother 1099 season

A successful 1099 season starts with good recordkeeping.

First, make sure you have a current W-9 for every vendor or contractor you’ve paid in 2025. Pay close attention to how LLCs are taxed on their W-9, because you may not need to issue 1099s for those taxed as corporations.

Second, ensure your vendor records are up-to-date. Confirm business names, mailing addresses, and taxpayer identification numbers. A quick check now can prevent notices and complications later.

Finally, it helps stay organized. Create a checklist of which vendors need 1099s and for which types of payments. This may even help you get a head start on the 2026 tax year.

Plan ahead to avoid penalties

IRS penalties for late or incorrect 1099s can add up quickly, ranging from $60 to $330 per form, depending on how late they are filed.

Avoid the scramble by reviewing your records now, confirming who needs a form, and getting everything in order before February 2, 2026.

If you need help issuing 1099s or reviewing vendor classifications, please contact one of our expert advisors. We’re always happy to help.

October 27, 2025 | by Atherton & Associates, LLP

High-income business owners face a unique challenge: their personal and business finances are deeply intertwined, and taxes often feel like the single largest expense both personally and for the business. While most people think of tax savings in terms of deductions, business owners have opportunities to spend pre-tax dollars by structuring expenses through their entities.

It’s important to note that some strategies are pure pre-tax opportunities, where dollars never touch taxable income. Others are technically deductions, but when routed through a business structure, they function much like pre-tax spending. The real difference isn’t just classification; it’s timing and intent. Owners who plan ahead can position their spending to capture the maximum tax benefit. Those who wait until year-end to see “what can be written off” are usually too late.

This is a concept referred to as pre-tax arbitrage, and it’s about intentionally structuring your spending to convert what would normally be after-tax personal expenses into pre-tax benefits. When done consistently, this doesn’t just reduce a tax bill in the current year; it reshapes the cost of recurring expenses and compounds savings over time.

Some of the most effective strategies fall squarely within business planning: electing to pay state taxes at the entity level, reimbursing healthcare through a corporation, funding education as a business benefit, or contributing to retirement plans where the dollars are deductible to the company and pre-tax to the participant. Each strategy stands on its own, but together they can create six-figure annual savings for high earners.

PTET: converting state taxes into business deductions

For years, one of the most frustrating limits for high earners has been the federal cap on state and local tax (SALT) deductions. Even business owners with significant state tax liabilities were limited to deducting just $10,000 at the individual level.

The One Big Beautiful Bill Act (OBBBA), enacted in July 2025, raised that cap to $40,000 through 2029. On the surface, that’s good news. But for many high-income business owners, $40,000 still falls well short of actual state tax obligations, and the cap begins phasing out once income passes $500,000. By 2030, the limit reverts back to $10,000.

That’s where the Pass-Through Entity Tax (PTET) election remains a powerful planning tool. PTET allows certain businesses, like partnerships and S corporations, to pay state income taxes at the entity level. Because the payment is made by the business, it’s treated as a fully deductible business expense on the federal return, bypassing the individual SALT cap entirely.

For a high-income partner in a state like California or New York, this election can mean deducting tens or even hundreds of thousands in state tax payments that would otherwise have been nondeductible. Even with the OBBBA’s temporary SALT relief, PTET elections can provide more consistent, higher-value savings, especially for owners whose income exceeds the new phaseout thresholds.

However, PTET election windows, owner eligibility, credit mechanics, and estimated payment timing differ by state. Modeling needs to happen before the election deadline and with full owner-by-owner analysis to avoid cash-flow surprises. The key takeaway is that planning ahead is necessary, but, in doing so, you may be able to shift how state taxes are paid to the tune of considerable savings.

Healthcare through the business

Healthcare is one of the most significant recurring expenses for families, which makes it an obvious target for pre-tax arbitrage. For business owners, entity type determines how much flexibility you have in covering these costs with pre-tax dollars.

• Self-Employed/Partnerships: Health insurance premiums are generally deductible above the line. This helps, but out-of-pocket costs are still typically after-tax.

• C Corporations: C corps offer the broadest planning opportunities. By establishing a Health Reimbursement Arrangement (HRA), the business can reimburse medical expenses for the owner, spouse, and dependents. What would otherwise be a personal cost becomes a deductible business expense.

• S Corporations: Owners holding more than 2% of an S corp face limitations. They can deduct premiums, but cannot receive pre-tax benefits through cafeteria plans or HRAs in the same way as C corp owners. Still, premiums alone are a meaningful deduction.

• Section 125 Cafeteria Plans: For businesses with employees, cafeteria plans allow staff to pay health, dental, vision, and dependent care expenses with pre-tax dollars. The business benefits, too, by reducing payroll taxes.

The point is not just that healthcare costs can be deducted, but that the right business structure determines how far you can push those dollars into the pre-tax category. A C-corp owner with a well-designed HRA could turn $20,000 in family medical expenses into a fully deductible cost of doing business. Yet, these benefits are not plug-and-play. You need the right plan documents, adoption dates, and may need nondiscrimination testing for certain types of benefits.

Education funding as a business benefit

Education is another area where business structures create unique opportunities. Under Section 127 of the Internal Revenue Code, employers can provide up to $5,250 per year in tax-free educational assistance per employee, and the business gets a deduction for the expense. The OBBBA expanded this benefit by making permanent the ability for employers to apply the same $5,250 toward student loan repayments.

A properly documented, nondiscriminatory Section 127 plan can provide up to the annual limit tax-free to employees and certain owners, provided no more than 5% of total benefits go to >5% owners (and their spouses/dependents).

Like the other pre-tax strategies we’ve discussed, a Section 127 plan requires a written program, eligibility terms, nondiscrimination testing, and coordination with other benefits. It must be established before benefits are provided because you can’t “re-label” wages after year-end.

Retirement plans as pre-tax engines

Retirement plans are often discussed as personal savings vehicles, but for business owners, they’re also a way to convert compensation into deductible business spending.

• Defined Contribution Plans: Traditional 401(k)s and profit-sharing plans allow owners to defer income, lowering both personal taxable income and the company’s taxable profit.

• Cash Balance and Defined Benefit Plans: For high-income owners, these advanced plans allow six-figure contributions that are deductible to the business and pre-tax to the participant. They are especially powerful for professional practices or closely held businesses with predictable cash flow.

This creates immediate arbitrage: saving on taxes today, then withdrawing funds years later, often at much lower effective rates. Retirement contributions also integrate with other strategies like Roth conversions in low-income years, or charitable planning through Qualified Charitable Distributions (QCDs).

Putting it all together

Individually, each of these strategies delivers measurable savings. Together, they can transform how a business owner manages both taxes and wealth.

For illustration only, consider a professional services firm organized as an S corporation reporting $1.2 million in annual income. The owners elect PTET, shifting $80,000 of state income tax from nondeductible to deductible at the business level. A defined benefit plan, designed by an actuary, enables approximately $150,000 in owner contributions, deductible to the business and pre-tax for the participants.

In total, these deductions and pre-tax spending reach about $230,000. The actual federal tax reduction equals the marginal rates those dollars span on your return, plus any state-level effects.

This is, of course, a simplified scenario. Every business has unique variables that determine what’s possible. And, many strategies require thorough documentation, compliance, and testing. But the principle holds true: layering pre-tax strategies through the business can reduce taxable income by tens or even hundreds of thousands annually, creating efficiency today and compounding benefits over time.

Making every dollar work harder

These strategies aren’t about cutting back. They’re about structuring your business and personal finances so every dollar works harder. For business owners, that’s where the real advantage lies.

The key is timing. Pre-tax arbitrage doesn’t happen at year-end when the return is filed. It requires proactive design, implemented throughout the year, often in collaboration with your advisor.

If you’re wondering how these opportunities apply to your situation, we invite you to connect with our office. Together, we can identify where your business structure can be leveraged to capture efficiencies, reduce unnecessary tax exposure, and position your wealth for maximum long-term impact.

September 15, 2025 | by Atherton & Associates, LLP

What’s Your Business Really Worth Before You Sell?

If you’re a business owner thinking about selling in the next few years, you might already be asking yourself: What’s my business really worth? It’s a question that’s easier to guess at than to answer—yet getting it right can make a huge difference in your financial future.

Many owners overestimate their business value by relying on revenue multiples or gut instincts. While these quick estimates can be helpful as starting points, they often miss key factors that buyers consider—and that directly affect your sale price. The best way to understand your true business worth? A certified business valuation.

Why Owners Overestimate Value

It’s natural to feel your business is worth more than any outsider might think. After all, you’ve built it, nurtured client relationships, and invested countless hours. But value isn’t just about sales or profits; it’s about risk, market conditions, and how attractive your business appears to buyers.

Relying on rough multiples or informal guesses can lead to unrealistic expectations, causing deals to stall or fall through. Overpricing your business may scare off potential buyers or prolong the sale process, while underpricing means leaving money on the table.

What a Certified Valuation Can Do for You

A certified valuation provides an objective, thorough assessment of your business’s fair market value. It goes well beyond simple revenue calculations by examining multiple factors and applying industry-accepted valuation methods. Here’s what it offers:

1. A Realistic Sale Price Benchmark

You get a defensible, market-based number that reflects what buyers are willing to pay today—not what you hope for.

2. Time to Improve Key Value Drivers

With a clear understanding of your current value, you can focus on areas that boost it, such as improving profit margins, diversifying your customer base, or increasing recurring revenue streams.

3. Insight Into Buyer Perspectives

A valuation highlights your business’s risk profile and potential red flags from a buyer’s viewpoint—helping you address issues before they become deal-breakers.

4. “Clean-Up” Before You List

The valuation process uncovers financial irregularities or adjustments you can make—such as normalizing earnings, removing non-operating assets, or adjusting owner compensation—to present your business in the best light.

5. Use Valuation as an Annual Planning Tool

Starting 2 to 5 years before your planned sale, annual valuations can track your progress, highlight improvements, and refine your exit strategy—ultimately positioning you for a higher sale price and smoother transition.

Planning Ahead Pays Off

Selling a business is one of the most important financial decisions you’ll make. A certified valuation equips you with knowledge and insight to make informed decisions—not based on guesswork but on facts.

Thinking about selling? Start with facts. We can help you understand your value today—and how to increase it before you list.

September 02, 2025 | by Atherton & Associates, LLP

You may think you don’t own a particular business interest, but the IRS might disagree. Under what’s known as the constructive ownership rules, the tax code can attribute ownership to you based on family relationships or the way entities are structured. 

This isn’t just a technical issue for large conglomerates. Attribution rules show up in everyday tax situations, especially for business owners with family ties, legacy trusts, or layered ownership structures. The rules are complex, but the consequences are simple: if constructive ownership applies and you didn’t plan for it, you could lose access to exclusions, deductions, or favorable tax treatment. These rules can also trigger compliance failures or create unexpected tax liabilities, making them very important to understand. 

What are attribution rules?

Attribution rules, also referred to as constructive ownership rules, are designed to look beyond formal ownership to determine who really has control or economic benefit in a business interest. Under these rules, you may be treated as owning stock or partnership interests held by certain family members, trusts, or other entities.

In other words, ownership is not always about what’s on paper. The IRS looks through corporate structures, family trees, and related-party arrangements to decide whether someone is effectively a stakeholder.

The high stakes: why this matters more than you think

Attribution rules affect a range of tax provisions. Some of the most financially significant include:

• Section 1202: Constructive ownership can disqualify shareholders from the QSBS gain exclusion, eliminating up to $15 million in potential gain exclusions per business.
• Section 267: Losses on sales between related parties are denied. If attribution creates a related-party relationship, what appears to be a deductible loss may be permanently disallowed.
• Section 414: Retirement plan coverage and nondiscrimination testing must account for employees of commonly controlled entities. Attribution can bring an otherwise unrelated business into a testing group.
• Section 1361: S-corporation status can be compromised if constructive ownership results in more than 100 shareholders, disqualified shareholders, or multiple classes of stock.
• Section 318: Stock attribution plays a role in corporate redemptions, controlled foreign corporation status, and other international tax provisions.
• M&A due diligence: Transactions can be delayed or derailed when attribution issues are discovered late in the process.

These rules are designed to prevent taxpayers from shifting ownership in ways that appear to comply with the law but don’t reflect the substance of the arrangement.

How attribution works

Attribution rules don’t follow a single template. The definition of “constructive ownership” depends on which section of the tax code you’re dealing with. Each one defines family relationships, ownership thresholds, and even how ownership is traced through multiple entities differently. 

That said, most attribution rules fall into two general categories: family-based and entity-based. 

Family-based attribution

The tax code assumes that family members act in coordination, and it applies attribution accordingly. Specifically, ownership can be attributed between spouses, parents and children, and grandparents and grandchildren. However, not all family relationships are treated the same across the code. For example, siblings are not considered related parties for attribution under Section 318, but they are for Section 267. Cousins, aunts, and uncles are generally excluded, though there are exceptions in certain estate and trust contexts. 

If any of the direct family relationships exist, the IRS may treat your relative’s interest as your own, even if you had no involvement in the business.

Let’s say David owns 100% of MedTech Solutions. For estate planning, he gifts 20% to each of his two adult children and 10% to his spouse. Unfortunately, David still constructively owns 100%:

• Direct ownership: 50%
• Spouse attribution: 10%
• Children attribution: 20% + 20% = 40%
• Total constructive ownership: 100%

As a result, any related-party transactions are still subject to Section 267 (meaning losses are disallowed), and David remains a 100% owner for controlled group purposes.

Entity-based attribution

Attribution can also apply through corporations, partnerships, LLCs, trusts, and estates.

If you own 50% or more of a corporation or partnership, you are treated as owning a proportionate share of the business interests that entity owns. Similarly, if you are a beneficiary of a trust or an estate, your ownership may include a portion of the interests held by that trust or estate.

These rules can move in different directions:

• Upward: Your ownership may be attributed to an entity you control.
• Downward: Interests held by an entity may be attributed back to you.
• Sideways: Interests may shift across family members or related entities, creating control relationships that otherwise wouldn’t exist.

Let’s say Jennifer owns 60% of ABC Corp. Her wholly-owned LLC owns the remaining 40%. This means Jennifer constructively owns 100% of the corporation. If she reduced her LLC ownership below 50%, the attribution would break, potentially changing the tax treatment of corporate transactions. This fluidity creates opportunities for planning, but also risks if these relationships go unrecognized.

The key rules you need to know

A few sections of the Internal Revenue Code apply attribution rules with particular frequency and impact:

Section 267: Disallowed losses

Section 267 prevents you from deducting losses on sales to related parties. Sell stock to your spouse at a loss? No deduction. Your corporation sells property to your 60%-owned subsidiary at a loss? Also disallowed.

Planning point: Time sales transactions carefully and consider the related-party definitions before recognizing losses.

Section 318: Stock attribution for corporate actions

This section defines how ownership is attributed for corporate transactions. It is particularly relevant for C-corporation redemptions, passive foreign investment company (PFIC) determinations, and the classification of controlled foreign corporations. The 50% attribution test often determines whether a redemption qualifies for sale treatment.

Section 414: Retirement plan controlled groups

Section 414 creates controlled group definitions for retirement plan purposes. Companies under common control must be treated as a single employer for coverage testing requirements, contribution limits, and top-heavy testing. A seemingly unrelated family business can suddenly make your company part of a controlled group.

Section 1361: S-Corporation limits

S-corporations face strict eligibility requirements, and attribution can create hidden compliance risks. Constructive ownership may cause an S-corp to exceed the 100-shareholder limit, bring in an ineligible shareholder, or create what appears to be a second class of stock, any of which can invalidate the S-election.

One important exception to be aware of is the family aggregation rule under Section 1361(c)(1). For purposes of the 100-shareholder limit, certain family members can elect to be treated as a single shareholder if specific requirements are met. This election is not automatic. It must be filed with the IRS and properly maintained. Without it, each family member’s ownership is counted separately.

Additionally, if attribution causes ownership to be treated as flowing through an ineligible entity (such as a partnership or nonresident alien), the S-election can be jeopardized even if the shareholder list looks compliant at first glance.

International complications

Attribution rules also affect international tax provisions such as Subpart F (controlled foreign corporation status), Global intangible low-taxed income inclusions (GILTI), and related-party transaction rules for transfer pricing. 

Attribution in practice: common pitfalls

Surprise controlled group

A business owner may assume they’re operating independently, but attribution can tell a different story. Suppose an individual owns 60% of Company A directly. Their spouse owns 15% through an LLC, and their adult child owns 10%, received as a prior gift. When attribution rules under Section 1563 and Section 414 are applied for retirement plan purposes, ownership from the spouse and child may be constructively attributed to the individual.

In this case, the total attributed ownership reaches 85%, crossing the 80% threshold that defines a parent-subsidiary or brother-sister controlled group for qualified plan testing. The result: Company A may now be part of a controlled group, requiring it to aggregate employees and plan coverage with another entity – often one the owner didn’t realize was related under the tax code.

If this attribution is missed, the company’s retirement plan could fail IRS coverage or nondiscrimination testing, leading to disqualification risks, corrective contributions, or costly administrative fixes.

QSBS disqualification during sale

A business owner planning to exclude $8 million of gain under Section 1202 may be blindsided when their spouse’s interest in a related company is attributed back to them. This can trigger affiliated group status and invalidate the exclusion – often too late to adjust.

Retirement plan coverage failures

A company may fail its 401(k) coverage testing when attribution causes employees from the owner’s spouse’s business to be included in the calculation. This often results in costly corrections and, in some cases, the need to retroactively fund additional contributions.

Real estate recapture

When two brothers own separate real estate LLCs and one sells property to the other, attribution can cause the IRS to treat the transaction as occurring between related parties. This may convert what would have been capital gain into ordinary income.

Planning opportunities and risk management

Attribution issues often come down to one thing: awareness. Before executing any major transaction or making structural changes to a business, it’s worth examining how ownership is allocated and how the IRS might view it.

Start by mapping your ownership across individuals and entities, including spouses, children, and any trusts or partnerships. Consider preparing a visual chart to help identify relationships that could trigger attribution. If you’re making gifts or shifting ownership as part of an estate plan, assess how those transfers might shift constructive ownership.

Keep records that document the rationale for ownership structures and how decisions were made. This includes corporate minutes, shareholder ledgers, trust documents, and buy-sell agreements.

In particularly complex or high-dollar scenarios, it may be worth requesting a private letter ruling from the IRS. While expensive and time-consuming, a ruling can provide clarity and help avoid multimillion-dollar mistakes.

And finally, attribution planning works best when coordinated across your advisory team. Your estate planning attorney, ERISA counsel, tax professional, and investment advisor all bring a piece of the puzzle.

When to take a closer look

Attribution rules deserve attention if:

• You own multiple businesses or have family members who do
• Your business is preparing for a sale or corporate reorganization
• You’re implementing or updating a retirement plan
• You’ve made significant gifts or transferred ownership within the family
• You haven’t reviewed your entity structure recently

These rules don’t just apply at the moment of a transaction; they can reach back across years of decisions and across generations of ownership.

Prevention is cheaper than correction

Violating attribution rules, even unintentionally, can cost millions in lost tax benefits, penalties, and restructured transactions. Disqualifying a Section 1202 exclusion, triggering S-corp termination, or failing a retirement plan test all come with real, immediate financial consequences.

While these risks are significant, they are also largely avoidable. Attribution planning, when addressed early, can preserve key tax strategies, support corporate governance, and help ensure compliance with both federal and international rules. In most cases, the cost of reviewing and adjusting your structure is minor compared to the potential exposure.

Keep in mind that each section of the code applies attribution rules differently. No single framework applies across all planning scenarios, which is why context-specific analysis is key. 

If you’d like to evaluate your exposure to constructive ownership, please contact our office for a personalized review. 

This article provides general information and is not a substitute for professional tax or legal advice. Please consult with a qualified advisor for guidance specific to your situation.