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 ?
The letter ruling describes three shareholders who planned to restructure their ownership of an S corporation with the same series of transactions.
Since for federal tax purposes, the LLC is "disregarded," the shareholder is deemed to own all of its S corporation stock; therefore, it is the sole owner of the limited partnership.
1368-l (g) election is its availability in situations other than when a shareholder is getting out of the S corporation (i.
Because these elections allocate only the total earnings of the tax year from the dates shares are owned, the future income/loss is being allocated to those shareholders, and only those shareholders, who still have ownership in the S corporation after the transfer date.
Some cases have held that when a sole shareholder of an S corporation is the "central worker" of the corporation and performs more than minor services for the corporation, the sole shareholder should be treated as an employee; see Nu-Look Design, Inc.
The second situation was the same as the first, except that X transferred--by either sale or tax-free reorganization other than an F reorganization--all of its assets, including the Sub1 stock, to M, another S corporation.
It concluded that U was thus treated as an S corporation immediately after the merger, and the reorganization did not terminate X's election to treat Sub1 as a QSub.
An S corporation may acquire a C corporation in a taxable stock acquisition.
If an S corporation wants to treat its wholly owned domestic subsidiary as a flowthrough entity, it could elect QSub status for the subsidiary on Form 8869, Qualified Subchapter S Subsidiary Election.
Example 1: Individual S is a shareholder in an S corporation.
If the S corporation has E&P from C corporation years, the character of the distribution is determined under Sec.
And the shareholder can structure the loan to be made at or near year-end, with repayment early in the subsequent year, resulting in minimal economic loan costs to the shareholder (the shareholder can use his own cash or borrow the funds to loan to the S corporation for a short period of time).