S Corporation

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S Corporation

A type of corporation that is taxed under subchapter S of the Internal Revenue Code (26 U.S.C.A. § 1 et seq.).

An S corporation differs from a regular corporation in that it is not a separate taxable entity under the Internal Revenue Code. This means that the S corporation does not pay taxes on its net income. The net profits or losses of the corporation pass through to its owners.

An S corporation must conform to a state's laws that specify how a corporation must be formed. At minimum, articles of incorporation must be filed with the Secretary of State. An S corporation must also file a special form with federal and state tax authorities that notifies them of the election of the subchapter S status.

A corporation may be granted S status if it does not own any subsidiaries, has only one class of stock, and has no more than seventy-five shareholders, all of whom must be U.S. citizens or U.S. residents. A corporation may elect S status when it is incorporated or later in its corporate life. Likewise, a corporation may elect to drop its S status at any time.

An S corporation status is attractive to smaller, family-owned corporations that want to avoid double taxation: a tax on corporate income and a second tax on amounts distributed to shareholders. This status may also make financial sense if a new corporation is likely to have an operating loss in its first year. The losses from the business can be passed through to the individual shareholder's tax return and be used to offset income from other sources.

An S corporation also avoids audit issues that surround regularly taxed corporations, such as unreasonable compensation to office-shareholders. Finally, S status may avoid problems raised by corporate accounting rules and the corporate alternative minimum tax. These problems are eliminated because the income is taxed to the shareholders.

An S corporation can deduct the cost of employee benefits as a business expense. However, shareholders who own more than two percent of the stock are not considered employees for Income Tax purposes and their benefits may not be deducted. Tax advantages can be achieved in some cases because income can be shifted to other family members by making them employees or shareholders (or both) of the corporation.

Appreciation of the business also can be shifted to other family members as a way to minimize death taxes when an owner dies. When an S corporation is sold, the taxable gain on the business may be less than if it had been operated as a regular corporation.

Further readings

Internal Revenue Service. 1996. Tax Information on S Corporations. IRS Publication 589. Washington, D.C.

Hupalo, Peter I. 2003. How to Start and Run Your Own Corporation: S-corporations for Small Business Owners. St. Paul, Minn,: West.

References in periodicals archive ?
Both businesses are doing extremely well and the two businesses operating under a single s-corp.
In addition, S-corp banks, which are banks organized under Subchapter S of the Internal Revenue Code, might hold more capital to pay shareholder dividends because shareholders are individually responsible for taxes on bank profits.
DCF s employee stock ownership plan (ESOP) corporate finance experience was leveraged to assist in analyzing several factors affecting the Company s future cash needs including obligations related to the Company s S-Corp ESOP structure and synthetic equity positions.
2343, the active shareholders of an S-Corp would be required to pay payroll taxes on all their income from the business--wage and business earnings alike--if the shareholder is a partner in a professional service business or if 75 percent or more of the gross income of the S-Corp is attributable to the service of three or fewer shareholders.
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Not so if the advisor decides initially to set up as an S-corp.
Entrepreneurs beginning a small business with little expectation for massive growth should create a S-elected LLC or a S-Corp for tax purposes.
Is the sole shareholder of an S-Corporation subject to federal self-employment tax if the person characterizes the income as an S-Corp distribution (that generally is not subject to employment taxation)?
Content include information on: new S-Corp eligibility rules; new deduction for US production activities; new rules for deducting start-up costs; new basis adjustment rules; the various types of entities available; planning strategies in entity selection; pros and cons of each entity; ownership issues; requirements of formation, taxation and conversion; exit strategies and opportunities; and, case law.
Grog Jolivette (R-Hamilton) was expanded in the Senate and approved in the House to include, among others, changes in the taxation of S-Corp.
Although it is fairly easy to move from an S-Corp to a C-Corp, doing the reverse is more difficult.
For an S-corp shareholder with insufficient basis to deduct corporate losses, a distribution from a qualified plan (or an IRA) could be loaned to the corporation and free up at-risk losses with the only tax cost being the 10-percent penalty.