Definition
A Subchapter S Corporation (S Corporation) is a type of corporation that meets specific Internal Revenue Code requirements, allowing it to pass income directly to shareholders without being subject to corporate income tax. S Corporations avoid double taxation by allowing profits (and some losses) to be passed through directly to shareholders’ personal income without being subject to corporate tax rates. However, S Corporations must adhere to specific IRS requirements, including having a limited number of shareholders.
Key Characteristics
- Pass-through Taxation: Shareholders report income and losses on their personal tax returns and are taxed at their individual income tax rates.
- Limited Liability: Shareholders are protected from personal liability beyond their investment in the corporation.
- Single Class of Stock: S Corporations can only issue one class of stock.
- Eligibility Requirements: Must have no more than 100 shareholders, who must be U.S. citizens or residents, and all shareholders must be individuals (not corporations or partnerships).
Examples
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Example Corporation: A small local business with three owners decides to incorporate as an S Corporation. This allows the business to benefit from pass-through taxation where profits and losses are reported on the owners’ personal income tax returns.
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Software Development Firm: A tech startup with multiple investors could choose an S Corporation structure to avoid double taxation and provide limited liability protection to its shareholders while ensuring all income passes through to the shareholders’ tax returns.
Frequently Asked Questions (FAQs)
Q1: What are the main advantages of an S Corporation?
A1: The main advantages include avoiding double taxation, providing limited liability protection, and potentially reducing self-employment taxes.
Q2: Can an S Corporation have more than 100 shareholders?
A2: No, an S Corporation is restricted to a maximum of 100 shareholders.
Q3: How does one form an S Corporation?
A3: To form an S Corporation, you must first incorporate your business as a general corporation (C Corporation) and then file Form 2553 with the IRS to elect S Corporation status.
Q4: Can an S Corporation have foreign shareholders?
A4: No, shareholders must be U.S. citizens or residents.
Q5: Are there restrictions on the type of stock an S Corporation can issue?
A5: Yes, an S Corporation can only issue one class of stock.
Related Terms
- C Corporation: A standard corporation subjected to corporate income taxes, with profits taxed at both the corporate and individual levels when distributed as dividends.
- Limited Liability Company (LLC): A flexible business structure that provides limited liability protection without the eligibility restrictions of an S Corporation.
- Pass-through Entity: A business structure where the entity’s profits and losses are passed through to the owners’ personal tax returns.
- Internal Revenue Code (IRC): The comprehensive source of federal tax laws in the United States.
Online References
- IRS S Corporation
- Investopedia on S Corporations
- Small Business Administration (SBA) on S Corporations
Suggested Books for Further Studies
- “S Corporation Taxation (2021)” by Robert W. Jamison
- “S Corporations: Tax Practice and Analysis” by Michael Schlesinger
- “S Corporations: A Comprehensive Guide” by Peter Thiel
- “S Corporations: Health Care Firms’ Tax Advisory Publication” by Little Finch
Fundamentals of Subchapter S Corporation: Business Law Basics Quiz
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