Purging Old C Corporation E&P: The Deemed Dividend Election
Make sure what can terminate your S election and how to fix it
A lot of farm corporations started life as C corporations, elected S status somewhere along the way, and never gave another thought to the accumulated earnings and profits (E&P) they dragged along with them. That leftover E&P sits quietly on the books until it bites. If your operation was ever a C corporation, the deemed dividend election is a tool worth knowing about.
Why old E&P matters
An S corporation that was always an S corporation has no E&P, and life is simple. A former C corporation, though, carries forward whatever E&P it piled up in its C years, and that E&P creates two problems:
The passive income “sting tax.” Under Section 1375, an S corporation that has E&P and passive investment income (rents, dividends, interest, certain royalties) exceeding 25% of gross receipts pays a corporate-level tax — at the 21% rate — on its excess net passive income.
Loss of the S election. Under Section 1362(d)(3), if that same combination — E&P plus passive income over 25% of gross receipts — runs for three straight years, the S election terminates automatically.
For a farm that has leased out ground, put up a cell tower, or sold the row-crop operation and kept the land, passive income can quietly creep past 25%. The E&P is what arms the trap. Clear out the E&P and both problems go away.
