by Michael W.

Created on: July 21, 2009

S Corporations

An S Corporation, for federal income tax purposes, is simply a corporation that makes a valid election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code.

For those of you that do not know, federal tax laws distinguish between two types of corporations. A regular corporation (mostly called a "C corporation") is treated as a tax-paying entity separate from its investors and subject to paying corporate federal income tax. A corporation that elects to do business as an "S Corporation" is not subjected to paying federal income taxes as a corporation; instead, income taxes are paid by the corporation's owners through their individual taxes.

A business that has chosen to operate as an S Corporation gets the best of both worlds by being able to have the limited liability of a corporate shareholder, but pay income taxes on the same basis as a sole proprietor or a partner. Among a few other things, this means that as long as a person actively participates in the business of an S Corporation, business losses can also be used on their individual taxes, in order to offset their income, which may, in turn, reduce, or even eliminate their tax burden. While the corporation itself does not need to pay taxes, it still must file an informational tax return telling what each shareholder's portion of the corporate income is.

Like a C Corporation, an S Corporation is recognized as a legal corporation under the laws of whatever state it is organized in. S Corporations are separate legal entities from their shareholders, therefore, they provide their investors the same limited liability protection granted to the shareholders of, its sister business structure, C Corporations. However, for the purposes of federal income taxes, S Corporations more likely resemble the business structure of a partnership rather than a corporation. Basically, as with partnerships, the S Corporation's income, deductions, and even tax credits pass straight through to its shareholders on an annual basis and this is whether or not distributions were made to any or all of those shareholders. Therefore, all taxable income is taxed at the shareholder level rather than the corporate level.

Now, there are a few basic requirements that must be met by a company in order to make an election to become an S Corporation. First, the corporation must be an eligible entity by being either domestic or a LLC. The company must have only one class of stock. The corporation can not have more than 100 shareholders. All shareholders of the corporation must be U.S. citizens or residents, as well as being an actual person and not another corporation or partnership. And lastly, all profits and losses must be allocated to the corporation's shareholders equal to the amount of their interest in the business. Once the company meets all of these requirements, it needs to then file Form 2553, after being signed by each shareholder, with the IRS.

So, in conclusion, an S Corporation is simply a business structure that combines the legal environment of, its sister structure, C Corporations with federal income taxation advantages that resemble those of partnerships.

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