Since the 35% federal penalty tax on excessive passive investment income and threat of termination of the S election only apply when the S corporation has undistributed C corporation earnings and profits, these issues can be eliminated by distributing those earnings and profits. The distribution can be "deemed" to be made without making a distribution of cash or assets by election of the S corporation's shareholders. A low 15% federal tax currently applies to these distibutions, scheduled to increase to up to 43.4% after 2012.
Tax and financial advice from the Silicon Valley expert.