S Corporations are yet another form of Corporation. Just like other Corporation types, S Corporations provide limited liability to shareholders. S Corporations do however enjoy the advantage of “flow-through taxation,” unlike C Corporations.
An S Corporation is a Corporation that elects to be taxed under Subchapter S. In doing so, S Corporations enjoy the benefit of what is termed “flow through taxation,” essentially meaning that unlike the C Corporations, S Corporations are able to avoid taxation at the corporate level. Thus, S Corporations generally pass taxable income and losses through to shareholders who must then pay taxes at individual income tax rates, but they do not have to pay taxes at the corporate level in most cases. For many businesses, flow-through taxation can be incredibly beneficial.
In order to elect to be an S Corporation, a company cannot have more than 75 shareholders. Each shareholder must be an individual, that is, no shareholder can be another Corporation. However, certain entities such as decedents’ estates, certain trusts and specified tax-exempt organizations are acceptable shareholders. No shareholder can be a nonresident alien either. Finally, an S Corporations can only have one class of stock.
Another interesting characteristic of S Corporations is that they do not accumulate earnings or profits. Instead, earnings and profits are usually eliminated through distributions to the shareholders. Therefore, even though an S Corporation may be earning money in a given year, only the S Corporation’s shareholders are going to realize income. While this is nice for some, being that there is no double taxation in an S Corporation, it is a burden at times. Flow-through taxation does not afford the Corporation the option of holding gains itself so that it may pass them on to a shareholder at a time that the shareholder is able to receive a more favorable tax rate on the distribution. That is to say, electing to be an S Corporation takes away the ability to defer distributions to a shareholder until such time that they have fallen to a lower tax bracket.
Overall, the decision as to whether to claim S Corporation status is an important one. There are many legal issues, as well as economic and tax issues, that must be taken into consideration. While the Gabriel Law Office, PLLC cannot help you determine whether an S Corporation is the right fit for your business in terms of taxability, we can advise you as to all of the legal and day-to-day issues that you should take into consideration. Should you and your accountant decide that an S Corporation is the right Corporation for you and your business entity, we can help you make sure that everything is set up right from the beginning.