S Corporation

From Wikicpa

An S Corporation or "S-Corp" is a form of corporation that meets the IRS requirements to be taxed under Subchapter S of the Internal Revenue Code.

1 Taxation of S Corporations
2 Qualification for S Corporation Status
3 See also
4 External Links

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Taxation of S Corporations

An S Corporation is taxed very much like a partnership, while at the same time it enjoys the benefit of incorporation. This means that while the S Corporation itself pays no federal income tax, the shareholders of the S Corporation pay federal income tax on their proportionate share of the S Corporation's income. In other words, the income of the corporation will not be taxed at the corporate level, but instead will be taxed only at the level of the individual shareholders.

Unlike C-Corp dividends which are taxed to the shareholders at the federal rate of 15.00%, S-Corp Dividends (more properly titled 'Distributions') are not taxed when they are paid to the shareholders.

However, the C-Corp Dividend is subject to the 'double-taxation'. The income is first taxed at the corporate level before it is distributed as a dividend. The dividend is then taxed at the personal capital gains rate (currently 15%) when issued to the shareholder.

S-Corp Distributions (sometimes referred to as S-Corp Dividends) are taxed at the marginal rate of each shareholder, and they are taxed when the C Corporation earns them, not when the shareholders receive a distribution. An S-Corp shareholder will pay taxes on the S-Corp earnings whether or not a distribution is made. Example: Widgets Inc, an S-Corporation, makes 10,000,000 in taxable net income for the year and is owned 51% by Bob and 49% by John. On Bob's personal tax return, he will report 5,100,000 in income and John will report 4,900,000. If for some reason, Bob (as the majority owner) decides not to distribute the money, both Bob and John will still owe taxes on the earnings, even though neither received any cash distribution. This is a classic 'squeeze-play' to force out a minority partner.

Having S corporation status can prove a huge benefit for a corporation. The corporation can pass income directly to shareholders and avoid the double taxation that is inherent with the dividends of public companies, while still enjoying the advantages of the corporate structure.

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Qualification for S Corporation Status

In order to qualify, a corporation must be a small business corporation. This means the following requirements must be met:

Must be a domestic corporation.
Must not have more than 100 shareholders.
Shareholders must be U.S. citizens or residents, so corporate shareholders are not allowed.
Must have only one class of stock.
Profits and losses must be allocated to shareholders proportionately to each shareholder's interest in the business.

If a corporation meets these requirements, it may elect to be treated as an S corporation by filing Form 2553: "Election by a Small Business Corporation" [1] [2] with the IRS. The Form 2553 must be signed by all of the corporation's shareholders. If a corporation that has elected to be treated as an S Corporation ceases to meet any of these requirements (for example, if as a result of stock transfers, the number of shareholders exceeds 100), the corporation will lose its S Corporation status.

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