Look Into S Corporation
The major factor which separates an S corporation from other types of corporations is the manner in which the corporation is taxed by the Federal Government. The income of S corporations is divvied among the shareholders according to their actual number or percentage of shares in the company and then that shareholder must report the income on their individual tax returns. S corporation advantages include the lack of taxation on the profits of that company.
In contrast with a C corporation, which includes double taxation at the point of the company and the shareholder, S corporation advantages include singular taxation at the point of each individual shareholder. S corporation shareholders also enjoy limited liability for the actions of the corporation because S corporations are individual entities, separate from the individual shareholders.
If, for example, there were three shareholders of an S corporation, each would receive dividends according to their percentage of ownership of shares in that corporation. That money would be distributed pre-tax to each employee and/or shareholder. Each of those individuals who make up that S corporation would then be responsible for the taxes on their dividends.
While S corporations are taxed, it only occurs one time, whereas many corporations receive double taxation: once on their profits and then again when the money is distributed. However, S corporations also enjoy the limited liability offered to many other corporations as an added benefit.
What is an S-Corporation?
An S-corporation is a business entity that, according to the United States Federal income tax law, is specially taxed by the Internal Revenue Service. An S-corporation, through this special taxation, is not forced to pay any Federal income taxes to the United States Government. That being said, an S-corporation’s income, debts, or losses are divided and passed onto its shareholders.
Through this division, the shareholders then must report the income or capital losses on their individual income tax returns. This concept, known as single taxation, enables an S-corporation to achieve a unique taxation model which will limit liability through the presence of diversified liability. In other words, the investors in the company face taxation liability concerning the company’s gains or losses.
When a company obtains S-corporation status, they are permitted to utilize a partnership taxation model. This taxation structure offers protection from creditors and spreads liability to individual investors.
All rules and regulations concerning an S-corporation are outlined in Subchapter S of Chapter 1 of the Internal Revenue Code. An S-corporation combines the legal implication of a C-corporation with the United States Federal income taxation model applied to that of partnerships.
Similar to a C-corporation, an S-corporation is considered to exist as a traditional corporation under the law of the particular state in which it is organized. That being said, S-corporations are separate legal entities from their shareholders and, through these specific state laws, will generally provide their shareholders with the same liability protective measures awarded to shareholders of C-corporations.
In regards to the Federal income tax levy, an S-corporation resembles a partnership. Similar to a partnership, all income accrued, all deductions realized, and all tax credits associated with the S-corporation will flow through (annually) to the shareholders of the entity. As a result of this characteristic, income earned by an S-corporation is taxed at the shareholder level and not at the corporate level.
How to Receive S-Corporation Status
To receive S-corporation status, the entity must be eligible and regarded as a domestic corporation, a limited liability company. This means the company must be elected to be taxed as a corporation. The underlying entity must possess only one class of stock. The entity must possess at least 100 shareholders—all spouses or families are typically regarded as a single shareholder. The shareholders must be legally recognized as citizens of the United States.
Additionally, the shareholders must be natural persons. This will exclude corporate shareholders and partnerships for shareholder consideration. All profits and losses incurred by the entity must be allocated to shareholders in proportion to each individual’s interest in the business’ operations.
If the underlying entity meets the aforementioned qualifications, it must file Form 2553, titled “Election by a Small Business Corporation” with the Internal Revenue Service. The form must be completed and signed by all of the entity’s shareholders and the election to finalize the corporation must be made by the 15th day of the third month of the taxable year in which the election was held.