The Skinny On “S” Corporations

Lisa,

I have heard of a type of corporation called an “S” corporation. What is an “S” corporation and how is it different than a regular corporation?  - Laura    

Dear Laura:     

An “S” corporation is also known as a “small business corporation." It is formed the same way as any other corporation is formed – by filing Articles of Incorporation with the Secretary of State. The primary reason that people choose “S” corporations is because these corporations may provide income tax benefits that are unavailable to large corporations. “S” corporations are given these income tax benefits (which will be discussed below) as a matter of public policy to foster the growth of small businesses.

To become an “S” corporation, you must file an election form with the Internal Revenue Service. There are several important requirements that must be met in order for the Internal Revenue Service to approve your “S” corporation election.  The basic requirements for a corporation to qualify as an “S” corporation are as follows:

1. It must be a domestic (U.S., not foreign) corporation.
2. The corporation can only have certain types of shareholders. Allowable shareholders include individuals, certain types of trusts and estates. Note that partnerships, corporations and non-resident aliens cannot be shareholders in an “S” corporation.
3. The corporation cannot have more than 100 shareholders.
4. There can only be one class of stock in an “S” corporation (so, for instance, you cannot have both common and preferred stock).
5. The corporation cannot be an “ineligible” corporation, such as certain financial institutions, insurance companies and domestic international sales corporations.

So what are the main tax advantages to becoming an “S” corporation?   An “S” corporation does not pay corporate taxes (at least at the Federal level – some States impose a tax on “S” corporations).  Rather, any income or loss generated by the “S” corporation is “passed through” to the shareholders and reported on their tax returns.  Therefore, you may be able to use any losses in the “S” corporation to offset income that is reported on your personal income tax return.  You may also be able to minimize certain payroll taxes since profits from an “S” corporation are not subject to income tax. Note, however, if the “S” corporation pays you a salary, that salary will be subject to payroll taxes.

There are other significant considerations and factors related to the “S” corporation that must be analyzed by an experienced business attorney, and possibly a Certified Public Accountant before you decide to operate as this type of corporation. This column is only intended to provide a bird’s eye view of an “S” corporation.   

If you would like to discuss “S” corporations in greater detail, please feel free to contact me. I provide a one-hour consultation at no charge to you.

If any reader would like to ask me a legal question, post it on the Lake Zurich Patch website or send your question to me at lehmanlawoffices@aol.com.

Laura, thanks for your question.

My Best Regards,

Lisa

Disclaimer:  Please be aware that this column provides only legal advice of a general nature and it is not intended as legal advice for any person or group of persons. You must always consult with an attorney with respect to your particular legal situation.