In order to become an "S" Corporation, a corporation must meet certain requirements of law, as determined by the IRS. In addition, they must make an election under IRC Section 1361, where the company chooses "S" Corporation status for itself.
Advantages of an "S" Corporation
Once a Corporation qualifies as an "S" Corporation, it is treated for tax purposes as a "pass through entity." This means that the income of an "S" Corporation flows through to the shareholders, and is only taxed at the shareholder (individual) level.
For corporations who qualify, "S" Corporation status precludes the possibility of "double taxation" that a "C" Corporation faces.
In addition, the "S" Corporation retains the same limited liability features of a standard "C" Corporation. As long as the corporate form is respected, the shareholders of an "S" Corporation can not be held personally liable for its debts and obligations.
Disadvantages of an "S" Corporation
The primary disadvantages of an "S" Corporation stem from the requirements and restrictions that the law imposes for "S" Corporation status. A brief list of some of these requirements and restrictions include:
- It may not have more than 75 shareholders (a husband and wife are treated as a single shareholder).
- Corporations, partnerships, and limited liability companies may not be shareholders of an S corporation.
- The corporation may not have more than one class of stock.
- The corporation must be a domestic corporation.
- The corporation may not be an insurance company.
- The corporation may not be a financial institution that uses the reserve method of accounting for bad debts.
- The corporation may not have been formerly treated as a domestic international sales corporation (DISC).
- The corporation may not have elected special tax treatment under IRC +936 for income earned in Puerto Rico or the Virgin Islands.
- California also imposes certain requirements on shareholders who are not California residents; each such shareholder must file a consent to be taxed by California on his or her pro rata share of the corporation's income from California sources.
Conclusion
For those companies who are not bothered by the restrictions listed above, and who are bothered by the double-taxation possibilities that arise with a "C" Corporation status, electing to be treated as an "S" Corporation may be of benefit.
We invite you to contact our offices to discuss your business and legal needs in greater detail.
