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 ?
336(e) election is available to both domestic C corporation and S corporation shareholders for qualifying transactions occurring on or after May 15, 2013.
In dispositions where T is an S corporation, all of its shareholders must also make the election, whether or not they are selling their stock, for the election to be effective.
A corporation electing under IRC section 1362 to be taxed as an S corporation is subject to various ownership restrictions, including the requirement that shareholders must be individuals (section 1361(b)(1)(B)).
1377(a)(2) applies to situations in which a shareholder terminates his or her complete interest in the S corporation.
S is an S corporation in the business of tax return preparation.
1502-32 is adapted from the method of calculating basis adjustments for partnership interests and shares in a Subchapter S corporation.
In the first, X was an S corporation that owned 100% of the stock of Sub1, which X elected to treat as a qualified subchapter S subsidiary (QSub) under Sec.
Further, it provided that an S corporation that wholly owns another domestic corporation can elect to treat such subsidiary as a QSub, allowing flowthrough treatment of the QSub's tax items.
TC Memo 1996-303, the court considered the accountant's testimony and advice regarding the reasonableness of the taxpayer's (an S corporation president's) compensation, even though the CPA was not a compensation expert; see also Est.
1367(a)(2), an S shareholder's basis in an S corporation is decreased by each of the following items:
It is not uncommon for an S shareholder with zero stock basis to loan money to the S corporation to use either current year or suspended losses.
The rules are similar to those for determining basis in partnership interests and basis in stock in S corporations.