Is your Business an S Corporation?

Calculating numbers for income tax return with pen and calculatorThe S Corporation structure has become increasingly popular in recent years due to the advantages it provides to shareholders. Namely, a business can qualify for “pass-through” tax treatment by electing Subchapter S status. Pass-through taxation allows the profits and losses of the S Corporation to flow directly to the shareholders, where they are only taxed once. In contrast, the profits of a traditional C Corporation are taxed at the corporate level and then again when profits are distributed to the individual shareholders. This is referred to as double taxation. Because the main feature of S Corporation status is a passing through of the corporate items of income, loss, deduction, and credit to the stockholders for taxation at their individual level only, an S Election is most advantageous whenever (1) substantial dividends are anticipated or (2) the stockholders’ individual tax rates are lower than the corporation income tax rates.

In order to establish and maintain S Corporation status, the following elements must be satisfied:

(1)   The organization must be a domestic corporation (i.e., cannot be foreign).

(2)   May not be an ineligible corporation (e.g., certain financial institutions, insurance companies, and domestic international sales corporations).

(3)   Have no more than 100 shareholders.

(4)   Shareholders must be U.S. citizens or resident alien individuals or certain qualified estates and trusts. Shareholders may NOT be partnerships, corporations or non-resident aliens.

(5)   Have no more than one class of stock outstanding.

Meeting the above requirements does not automatically make an organization an S Corporation. A Subchapter S election is made by filing the proper form prescribed by the Internal Revenue Service (IRS) and attaching a statement indicating the consent to the election of each shareholder within the corporation.

Author: Attorney Thomas J. Leonard