S corporations have specific rules that have a significant impact on estate planning for its shareholders. The goal of making sure the corporation remains an S corporation in the event of a shareholder's death requires careful planning and understanding of the characteristics of and rules applicable to S corporations. Termination of S status can have adverse tax consequences since the tax attributes of the business no longer pass through to the shareholders.

The death of a shareholder is considered the termination of his or her interest in the S corporation. The corporate income is prorated between the decedent and the successor shareholder on a daily basis before and after death. Income allocated to the period before the death is included on the decedent’s final income tax return. Income allocated to the period after death is included on the successor’s income tax return.

The corporation may elect the interim closing of the books method. This divides the corporation’s taxable year into two separate years, the first of which ends at the close of the day the shareholder died. This election is available only if a shareholder terminates his entire interest in the S corporation, all the “affected shareholders” agree, and the corporation properly attaches the election to its tax return for the year. The interim closing of the books method can be used as a tax strategy to reduce taxable income.