Is An S Corp Considered a Corporation?
Is an S corp considered a corporation? An S corp begins existence as a general type of for-profit C corporation.3 min read
Is an S corp considered a corporation? An S corp begins existence as a general type of for-profit C corporation. The shareholders sign Form 2553. When your company is established, you or your representative can contact the IRS and notify them that you wish to be treated as an S corp using Form 2553, Election by a Small Business Corporation. You have approximately 75 days after formation to make this decision. The S corp may also choose to form a limited liability company (LLC) to protect the shareholders' personal assets.
Considering an S Corporation Structure
To decide if the S corporation structure is right for your business, consider how the Internal Revenue Service (IRS) classifies businesses. The taxing authority recognizes S corporations, C corporations, sole proprietorships, and partnerships. Note that LLC is not a tax designation. By default, single-member LLCs are treated as sole proprietorships. Multimember LLCs are treated as partnerships.
However, the LLC does not have to accept the default designation. The company can elect taxation as an S corporation or a C corporation. If the business chooses the S corp designation, it can save money on Medicare and Social Security taxes. An LLC that chooses to be taxed as an S corp pays the owner's salary as a business expense. The owner reports that income and any other business profit on the personal tax return. The owner only pays taxes on the salary, not on Social Security or Medicare.
Characteristics of an S Corporation
- S corporations have a maximum of 100 shareholders. Married couples and their estates are considered one shareholder. A family member can count all other family members as one as well. All others are counted separately and individually. They can be individuals, some types of trusts, estates, and some types of exempt organizations.
- An S corporation must be a domestic corporation or an eligible domestic entity filing Form 2553.
- S corporations cannot have nonresident alien shareholders. Only those who are citizens of the United States or resident aliens may hold corporate shares.
- S corporations can only offer one class of stock. That means that all outstanding shares of stock offer the same rights to the proceeds from distribution and liquidation.
- Shareholders in an S corporation are required to pay themselves reasonable compensation, as defined by the IRS. If the business doesn't follow those rules, the IRS has the option of reclassifying those earning as wages.
- Each shareholder must agree to the election of the S corporation structure.
- An S corporation cannot be:
- A bank or thrift institution using the reserve method of accounting for bad debt under section 585.
- Currently or formerly a domestic international sales corporation (DISC).
- An insurance company subject to taxation under subchapter L of the Code.
- A corporation that chooses to be treated as a possessions corporation under section 936.
- An S corporation must operate on or change to one of the six types of tax year approved by the IRS. The tax year must:
- End December 31 of each year.
- Coincide with a natural business year for the industry.
- Be defined as an ownership tax year.
- Be chosen in accordance with section 444.
- Be a 52-53-week tax year in coordination to one of the options listed above.
- Be defined as any other tax year established for a legitimate business reason.
S Corporations and Taxes
Internal Revenue Code, Chapter 1, Subchapter S, describes how S corporations pass profits and losses along to the shareholders in the business. Profits are reported on the individual's Form 1040 and taxed at the appropriate rate. In this manner, they are only taxed once.
This is different from regular corporations, often called C corporations taken from Subchapter C of the Internal Revenue Code. C corporations are taxed as independent business identities. Dividends paid to shareholders in a C corporation are taxed twice, once on the corporation's Form 1120 and again on the individual shareholder's Form 1040.
In some circumstances, shareholders in an S corporation are taxed on income they never received. This can happen when the company decides to retain the profits as part of the operating capital. The IRS, however, still considers this to be a distribution to the shareholders and taxes it as such. This doesn't happen with a C corporation because dividends are only taxed when they are taken out of the business.
If you need help with determining whether an S corp is considered a corporation, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.