Key Takeaways

  • A small business corporation is generally a domestic corporation with 75 or fewer shareholders that may elect S corporation status under the Internal Revenue Code.
  • IRS regulations impose income and stock issuance limits that determine whether a corporation qualifies for certain tax treatments.
  • For AMT (Alternative Minimum Tax) purposes, corporations must meet gross receipts thresholds over a three-year average to retain exemptions.
  • Changes in tax law, like the 2017 Tax Cuts and Jobs Act, and regulatory updates such as the Corporate Transparency Act, directly affect small business corporations.
  • Benefits of forming a small business corporation include liability protection, flexible stock issuance, estate planning advantages, and credibility with clients and partners.
  • State business corporation acts, such as Florida’s, frequently update rules on governance, shareholder rights, and compliance, which affect how small corporations must operate.

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.

Small Business Corporation Law and Legal Definition

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.

Compliance and Reporting Requirements

Small business corporations must comply not only with state corporate law but also with evolving federal reporting obligations. For example, the Corporate Transparency Act (CTA) now requires certain small corporations to disclose information about their beneficial owners to the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN). The purpose of this reporting is to prevent the misuse of small corporations for money laundering, terrorism financing, or tax evasion.

Corporations subject to these rules must report identifying details of individuals who exercise substantial control or own at least 25% of the company. Failure to comply can lead to significant civil and criminal penalties. This highlights the importance of ongoing compliance beyond initial incorporation.

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.

State Law Considerations for Small Corporations

In addition to federal tax regulations, states have their own statutes governing corporations. For instance, the Florida Business Corporation Act (FBCA) was substantially revised in 2020 to align more closely with the Model Business Corporation Act. These updates affected voting rights, shareholder notices, appraisal rights, and corporate governance practices.

Small business corporations must stay aware of state-level changes because they impact day-to-day management, shareholder relations, and the procedures for mergers or dissolutions. While federal law determines tax status, state law dictates how corporations are structured and operated legally.

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.

Choosing the Right Structure for a Small Business Corporation

The choice of entity has long-term consequences for taxes, liability, and operational flexibility. According to the U.S. Small Business Administration (SBA), corporations offer strong liability protection and credibility with investors, but they involve more paperwork and costs compared to sole proprietorships or partnerships.

When deciding whether to incorporate as a small business corporation, owners should weigh:

  • Liability Protection: Shareholders’ personal assets are generally protected.
  • Tax Treatment: S corporations avoid double taxation by passing income and losses to shareholders.
  • Compliance Burden: Corporations must adopt bylaws, issue stock, hold annual meetings, and file regular reports.
  • Future Growth Needs: Corporations make it easier to raise capital and issue stock to employees.

Selecting the right structure may require balancing immediate tax advantages against future scalability.

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.

Frequently Asked Questions

  1. What qualifies as a small business corporation under federal law?
    A small business corporation generally has 75 or fewer shareholders, is domestic, and meets requirements to elect S corporation status under the Internal Revenue Code.
  2. How does the Corporate Transparency Act affect small corporations?
    The Act requires corporations to disclose their beneficial owners to FinCEN to increase transparency and prevent illegal financial activity.
  3. Can a small business corporation lose its AMT exemption?
    Yes. If gross receipts exceed IRS thresholds over a three-year average, the corporation becomes subject to the Alternative Minimum Tax permanently.
  4. How do state laws impact small business corporations?
    States regulate governance, shareholder rights, and compliance. For example, Florida’s 2020 revisions to its Business Corporation Act modernized corporate governance rules.
  5. Why form a small business corporation instead of another structure?
    Benefits include liability protection, credibility, easier capital raising, estate planning flexibility, and the potential for S corporation tax treatment.

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