The definition of small business corporation is a corporation with 75 or fewer shareholders that also satisfy Internal Revenue Code requirements that allow a subchapter S determination.

A corporation is a legal entity that stands alone. It is legally separate from the owners and can make its own contracts and incur debts. The owners of a small business have limited liability, so their personal property is protected from any liability associated with the company. If the company chooses to adopt a subchapter S, individual shareholders would report profits and losses on their personal tax returns.

26 CFR 1.1244(C)-2-small Business Corporation Defined

A small business corporation is a domestic corporation that does not receive capital receipts and stocks over $1,000,000, despite stock distributions that may be considered capital. If they exceed the $1,000,000 limitation, the corporation must designate certain shares of common stock for sale according to the appropriate tax codes. Dates of receipts are important as there are additional regulations pertaining to pre-November 1978 and June 30, 1958 stocks and surplus limitations based on date as well.

Qualifying As a Small Business Corporation for AMT Purposes

Small business corporations do not qualify for the Alternative Minimum Tax (AMT) like individual taxpayers, although a corporation is treated as such. It is actually less of an administrative drain and less tax liability to file as a small business corporation than with the AMT. In order to qualify as a small business corporation, the business must qualify according to the following requirements:

  • Must show 3-year average annual income with less than $5 million in the first year and less than $7.5 million for the remaining two years.
  • Gross receipts must meet the average annual requirement. Any overage will remove the small business corporation exemption indefinitely, even if future years would meet the annual allowable amount.
  • Businesses are able to defer income on calculations prior to year-end in order to keep the average within the allowable limits and remain eligible as a small business corporation.

Losing the Small Business Corporation Exemption From AMT

Once a corporation loses the small business corporation designation due to the annual income threshold, it becomes subject to the AMT for every future year in business. The computations for adjustments vary based on the type of business and the date of the change of status. Those modifications are mainly in place for any date or transaction occurring after the change in designation.

How Tax Reform Can Affect Small Businesses and Their Owners

The US Treasury Department issued a report in August 2011 to discuss defining a small business and to gauge the impact of tax laws on the businesses and owners. They listed additional data sources for a more methodical way of identifying the businesses, and add to the ongoing discussions of reforms and how they can impact, positively or negatively, businesses and owners. This should better enable lawmakers to craft laws designed to improve the small business sector and to determine the impact of individual tax rates on this area.

This new methodology also creates another category of taxpayers, calling them non-businesses rather than including them with the small businesses. Since small businesses are considered to be job creators, lawmakers are more inclined to focus on this sector while planning for economic stimulation and job growth.

With less than half of small businesses still standing after five years, there is a high employee turnover, and fewer dollars are spent on training in these companies. But even with such turmoil, the small and medium-sized companies are still over half of the workforce in the US and have created 64 percent of new jobs over the last 15 years.

Reasons for Forming a Small Business Corporation:

  • You would like to issue stocks to keep and attract good employees.
  • You have a profitable business and would like to keep some of the money in the business.
  • You have a family business, and you want to gift shares for estate planning. Gifting shares will allow you to keep ownership and control of the business.
  • You have clients or partners who require incorporation in order to work with you.

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