The Look-Through Company Election
Priya and her brother Dev own a small engineering consultancy through a company, PD Engineering Ltd, which has two shareholders and no other shareholders. The company earns $300,000 a year. Priya is on the 33% marginal rate and Dev is on the 39% rate. They are considering electing look-through company status so that profits and losses flow through to them personally. The company has a $150,000 loan from a bank and a $40,000 loss carried forward from a previous year. Priya wants to use the loss against her salary income. Dev is worried about the compliance burden and the loss of limited liability.
1. Explain the eligibility and tax consequences of electing look-through company status.
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An LTC must be a company with five or fewer shareholders, and it must elect into the regime with the consent of all shareholders. The company's income, expenses, gains, and losses are treated as the shareholders' in proportion to their effective interests. The company does not pay tax; the shareholders do. Losses can be used by shareholders, but only to the extent of their basis in the company, which includes share capital and certain loans. Priya cannot simply offset the $40,000 loss against her salary unless she has sufficient basis and the loss is not restricted. The carried-forward loss may be subject to the continuity rules. The bank loan is a company liability; LTC status does not remove limited liability, which is a company-law matter, not a tax one.
2. Advise on the loss limitation and whether the LTC election suits Priya and Dev.
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Losses are limited to each shareholder's basis, calculated as share capital plus loans plus undistributed profits less distributions. If Priya's basis is small, her deductible loss is capped and the excess is carried forward. Dev, on 39%, gets more value from deductions than Priya at 33%, but the LTC allocates profits in proportion to effective interests, not by agreement, so they cannot simply direct profits to Dev. The election also means the company's imputation credit account is not used in the same way, and the shareholders must file returns showing their share of income. The $40,000 carried-forward loss may be usable if the continuity rules are met. On balance, the LTC may suit them if they want losses to flow through, but they must weigh the compliance cost and the loss of the company tax rate of 28% on retained profits.