For smaller businesses, or for those businesses who choose not to deal with the hassle of year-end tax maneuvers to minimize double taxation of a C corporation, there is an alternative known as the S corporation.
For Federal tax purposes, the S corporation is not taxed at the entity level.
It passes through all of its income to the individual shareholders, who report the income on their individual returns.
This is accomplished by filing an S corporation election with the Internal Revenue Service within the time required by law.
Disadvantages of the S Corporation
While an S corporation avoids the double-taxation of a C corporation, there are a number of restrictions and regulations which may weigh against choosing the S corporation election.
- Generally, an S corporation may not have more than 75 shareholder
- It may not have more than one class of stock
- Corporations, partnerships, and LLC’s may not be shareholders of an S corporation
- At the death of a shareholder, there is no step up in basis in the value of the shareholder’s stock
- In addition, the shareholder’s basis is not increased by the debt of the corporation.
While these disadvantages may be deal breakers for some business owners, for others (especially those not entitled to organize as an LLC), the S corporation format may be the best alternative.