S Corporation

In the United States, an S Corporation or "S-Corp" is a form of corporation that meets the IRS requirements to be taxed under Subchapter S of the Internal Revenue Code. Also called a S Corp, like the traditional tool.

Taxation of S Corporations

Unlike a regular C corporation, an S Corporation generally pays no corporate income taxes on its profits. Instead, the shareholders in the S corporation pay income taxes on their proportionate shares, called distributive shares, of the S corporation's profits. Shareholders pay the tax regardless of whether the S Corporation pays out money or not. The FICA tax need only be paid on employee income and not on profit distributions.

Additionally, employees must be paid a reasonable wage for their position within the company to avoid any potential tax implications.

S Corporations that have previously been C Corporations may also in certain circumstances pay income taxes on profits that were earned when the corporation operated as a C Corporation.

Qualification for S Corporation Status

In order to qualify, the following requirements must be met:

Must be an eligible entity (a domestic corporation, a partnership or a single-member or multiple member limited liability company).

Must not have more than 100 shareholders.

Shareholders must be U.S. citizens or residents, and must be natural persons, so corporate shareholders must be excluded.

Must have only one class of stock.

Profits and losses must be allocated to shareholders proportionately to each one's interest in the business.

If a corporation meets the foregoing requirements, its shareholders may file Form 2553: "Election by a Small Business Corporation” with the IRS the Form 2553 must be signed by all of the corporation's shareholders. If a shareholder resides in a community property state, the shareholder's spouse must also sign the 2553.

Caution: Some states such as New York and Pennsylvania require a separate state-level S election.

If a corporation that has elected to be treated as an S Corporation ceases to meet the requirements, the corporation will lose its S Corporation status and revert to being a regular C corporation.

For example, because of stock transfers, the number of shareholders exceeds 100 or an ineligible shareholder such as a nonresident alien acquires a share.