Subchapter S Corporations

A Subchapter S Corporation is a general corporation that has elected a special tax status with the IRS after the corporation has been formed.

Subchapter S election allows “pass through” of income, expenses, depreciation, profits and loses directly to the shareholder(s) without taxation at the corporate level.

For instance, when a general corporation makes a profit, it pays a federal corporate income tax on that profit. If the company also declares a dividend, the stockholders must report the dividend as personal income and pay more taxes.

S Corporations avoid this “double taxation” (once at the corporate level and again at the personal level) because all income or loss is reported only once on the personal tax returns of the stockholders.

If IRS Form 2553 is filed within 75 days after incorporation and the corporation meets the IRS requirements to become an S corp, the corporation will be treated as an S corporation for tax purposes.

For many small businesses, the S Corporation offers the best of both worlds, combining the tax advantages of a sole proprietorship or partnership with the limited liability and enduring life of a corporate structure.

To elect S Corporation status, your corporation must meet specific guidelines.

1. All stockholders must be citizens or permanent residents of the United States.
2. The maximum number of stockholders for an S Corporation is 75.
3. If an S Corporation is held by an “electing small business trust,” then all beneficiaries of the trust must be individuals, estates or charitable organizations. Interests in the trust cannot be purchased.
4. S Corporations may only issue one class of stock.
5. No more than 25 percent of the gross corporate income may be derived from passive income.

Not all domestic general business corporations are eligible for S Corporation Status.

Exclusions:

1. a financial institution that is a bank
2. an insurance company taxed under Subchapter L
3. a Domestic International Sales Corporation (DISC)
4. certain affiliated groups of corporations

HOW TO FILE AS A SUBCHAPTER S CORPORATION

1. Form a general corporation in the state of your choice.
2. Complete and file Form 2553, Election by a Small Business Corporation with the IRS.

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