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A subchapter S corporation is a standard corporation that has elected a special tax status with the Internal Revenue Service (IRS). S corporations carry the same benefits as C corporations, such protecting the shareholders’ (or owners’) personal assets from the debts and liabilities of the business, unlimited life and tax deductibility of certain business expenses. The primary differences between S corporations and C corporations are the way they are taxed and also the ownership restrictions S corporations face.
When deciding which entity structure is most appropriate for their business, small business owners often view the potential double taxation of profits associated with C corporations as the primary disadvantage to forming a standard corporation. With C corporations, the profits are taxed first at the corporate level, and then taxed again at the individual level if they are distributed to shareholders in the form of dividends. Shareholders must report dividends as personal income and pay taxes on that income.
Double taxation can be eliminated by completing the S corporation election with the IRS. S corporations are taxed as pass-through taxation entities, similar to general partnerships and most limited liability companies. While the profits of an S corporation are reported at the corporate level, taxes are not paid at the corporate level. Instead, the profits are passed-through to the individual tax returns of the shareholders and are taxed at the individual rate. If the S corporation reports a loss, the amount of the loss is also passed-through and reported on tax returns of the shareholders.
Keep in mind, not all C corporations can make the S corporation election with the IRS, as the IRS has placed restrictions on S corporations. Current restrictions include:
- Shareholders must number fewer than 75, and all shareholders must consent in writing to the S corporation election.
- Shareholders must be individuals, estates, or certain qualified trusts.
- Shareholders cannot be non-resident aliens.
- S corporations can have only one class of stock(disregarding voting rights).
To be classified as an S corporation, a corporation must make a timely filing of Form 2553 with the IRS. IRS instructions indicate that the form must be completed and filed:
- At any time before the 16th day of the 3rd month of the tax year if filed during the tax year the election is to take effect, or
- At any time during the preceding tax year. An election made no later than 2 months and 15 days after the beginning of a tax year that is less than 2 ½ months long is treated as timely made for that tax year.
An election made after the 15th day of the 3rd month but before the end of the tax year is effective for the next year. For example, if a calendar tax year corporation makes the election in April 2005, it is effective for the corporation’s 2005 calendar tax year.
For questions on whether the S corporation structure is best for your particular business, it is best to seek the advice of an attorney or accountant.
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