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 ?
In a high percentage of cases the Subchapter S corporation and the LLC is used in entrepreneurial business formation often for the reason of liability protection.
By contrast, LLC owners and Subchapter S corporations avoid this double taxation on a sale of assets because the business's tax liabilities are passed through them; the LLC or S corporation does not pay a tax on its income.
That is, the various states in which ECC does business exempt Subchapter S corporations from state income tax.
ICBA is proud to have supported, from their inception, the Subchapter S corporation provisions included in the American Jobs Creation Act," said Camden R.
Of course, both the Subchapter S corporation and limited partnership variations were efforts to obtain insulation from business liabilities while mitigating the socalled double tax that results when a C corporation pays federal income taxes on its profits and the shareholders pay federal income taxes a second time when those profits are distributed to them as dividends.
As a result, the only firms represented are individual proprietorships, partnerships and Subchapter S corporations.
2) Indeed, Bittker and Eustice acknowledge the close similarity between the current investment adjustment system and the rules for Subchapter S corporations by stating that investment adjustment rules under the current consolidated return regulations "resemble the fluctuating basis rules for shareholders of Subchapter S corporations who likewise increase the basis of their stock for undistributed earnings and reduce basis for losses and distributions.
Cloutier presented ICBA's top recommendations for Subchapter S reform: * Allowing IRAs shares to be eligible Subchapter S corporation shareholders * Increasing the maximum number of Subchapter S corporation shareholders to 150 and counting family members as one shareholder * Allowing community bank Subchapter S corporations to issue certain preferred stock * Reforming the treatment of bank director shares * Excluding bank income from the passive income test.
Part of the problem with the Census Bureau report is its use of administrative data which includes only individual proprietorships, partnerships and Subchapter S corporations.
2) Joint Committee on Taxation, Present Law and Proposals Relating To Subchapter S Corporations and Home Office Deductions (JCS-16-95), 5/24/95, Table 3.
This is because the Census counts only individual proprietorships, partnerships and Subchapter S Corporations, while excluding other legal forms of business organization, including Subchapter C Corporations.
If a corporation is an S corporation for its first taxable year beginning after December 31, 1996, the accumulated earnings and profits of the corporation as of the beginning of that year will be reduced by the accumulated earnings and profits (if any) accumulated in any taxable year beginning before January 1, 1983, for which the corporation was a subchapter S corporation.