A Subchapter S Corporation: Everything You Need to Know
A subchapter S corporation is a legal entity that combines aspects of corporations with pass-through business structures. 3 min read
2. S Corporation Qualifications
3. Filing Requirements for S Corporation and Its Shareholders
4. Reasons in Electing a Subchapter S Status
A subchapter S corporation is a legal entity that combines aspects of corporations with pass-through business structures. S corporations will allow its owners to avoid double taxation, but the S corporation retains much of the structure of C corporations.
As a corporation, the business needs to affirmatively choose to be a S corporation based on the federal tax code.
As a S corporation, the owners will catalog and pay the business' income and losses on their own individual taxes rather than the business' taxes. The S corporation will avoid taxing the income at both the corporate level and personal level.
The S corporation does not pass-through all its business activity, as the entity will still have some tax liability for various types of revenue.
A company can become a S corporation either by registering as one soon after formation or by transforming into one during an open period. Either way, it is done by filing out a registration form for small business corporations with the IRS.
S corporations can also lose their status either accidenally or purposefully. If the S corporation no longer fulfills the requirements of S corporations, it will cease to be one.
A S corporation can also choose to no longer be a S corporation by filing a form with the IRS within the first two and a half months of the year.
The company will turn into a regular C corporation if it either voluntarily or involuntarily ceases to be a S corporation.
S Corporation Qualifications
There are a variety of criteria that are required to become a S corporation. They are as follows:
• The company must be based in the United States.
• The company's shareholders must be only persons, as well as specific types of trusts and estates.
• The company's shareholders cannot include non-residents, other corporations, or partnerships.
• The business must have one-hundred or less stockholders.
• There can only be one type of class for the stock.
• The company needs to be in a sector that isn't explicitly banned. Companies in financial services, insurance, etc., cannot be S corporations.
Filing Requirements for S Corporation and Its Shareholders
S corporations will need to file various IRS forms even though much of the income and loss passes through to the owners. These income forms, part of the 1120 set, will have a "S" at the end.
Tax estimates for the future will be filed through Forms 8109 as well as 1120-W. S corporations also will need to file various forms for their employment tax. These include forms for social security and unemployment.
Excise tax also may need to be collected, which requires a separate process. The S corporation's owners will report the business' income or loss on their personal tax return. These include the 1040 standard form as well as K-1 schedules.
If filing forms for estimated tax, stockholders should use the designated form as well.
Reasons in Electing a Subchapter S Status
S corporations' main benefit is that they avoid double taxation. For regular C corporations, called as such due to being categorized under the IRS' Chapter C, the company pays taxes on its income initially and then shareholders pay income when they receive dividends.
This results in both the company being taxed and the owners being taxed again at the personal level. S corporations avoid these two levels of tax by allowing the company's profits and losses to be considered as part of its owners' income.
S corporations used to be an almost universally attractive option, particularly when corporate income tax rates were above individual income tax rates.
However, due to changes in the tax code, the old equation for S corporations no longer always works.
S corporations usually only result in significantly lower taxation when the corporate rate is higher than the individual rate.
In recent years, individual income tax rates are now higher than the corporate rate. Depending on the exact circumstances, S corporations may thus result in higher taxation than the double taxation of C corporations, thus requiring careful analysis of potential taxes.
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