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 ?
S corporations are flowthrough entities, and pertinent items of income and expense are allocated to shareholders on a per share per day basis.
1377(a)(2) applies to situations in which a shareholder terminates his or her complete interest in the S corporation.
1368-l (g) election is its availability in situations other than when a shareholder is getting out of the S corporation (i.
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.
Prior to 1997, S corporations were prohibited from owning 80% or more of another corporate entity.
An S corporation may acquire a C corporation in a taxable stock acquisition.
The rules are similar to those for determining basis in partnership interests and basis in stock in S corporations.
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)).
The letter ruling describes three shareholders who planned to restructure their ownership of an S corporation with the same series of transactions.
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.
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.
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.