1. What is a S Corp?
2. Shareholders of S Corps
3. S corps and the IRS
4. Steps to Becoming a S Corp
5. Is a S Corp Election a Good Idea for Your Corp?

S corp number of shareholders is no more than 100. This number has steadily increased from early in the 20th century when the number of shareholders that an S corp could have was only 10.

What is a S Corp?

“S corp” refers to the IRS tax code subchapter under which a certain type of corporation is taxed. S corps elect to be taxed in a way that is different than the way that a C corp is taxed.

The legal requirements to qualify as an S corp are:

  • Corporation must be a domestic corporation
  • Corporation must not have more than 100 shareholders
  • Corporation must have only shareholders who are eligible to hold shares in an S Corp
  • Corporation must have only one class of stock

Start-ups, small companies and certain corporations are able to avail themselves of the what many call “the best of both worlds”.

  1. Individual tax returns of shareholders include income and losses of the corporation which means that they pay only one level of federal tax.
  2. Taxes are paid on specific passive income and gains at the corporate level.

Shareholders of S Corps

Employees may be shareholders of an S corp. This means they can receive salaries, dividends and general distributions tax free. A shareholder may reduce liability for certain taxes (like self-employment) while still generating deductions like expenses. Federal taxes are not paid at the corporate level. The losses of the corporation may be used by shareholders to offset other income on their individual tax returns.

These savings are especially important for new businesses.

S corps and the IRS

The Internal Revenue Service looks at the payments distributed to a corporation's shareholders. The goal is to ensure that the characterizations of these distributions are accurate. For tax purposes, the IRS considers the S corp to be a separate and unique entity for the shareholders. An S corporation can be terminated (meaning that it goes back to being considered a C corp) if there are errors in filing requirements, stock ownership, notifications, consent, or election.

Steps to Becoming a S Corp

Before a company can become an S corp, first they must become a corporation. Once a company decides to incorporate, there are steps that they must follow at the state level. They should:

  • File articles of incorporation with either the Secretary of State or a division of the Secretary of State’s office
  • Register an agent for the business
  • Pay appropriate fees

Once the company has become a corporation, it must make the S election. This election must occur within 15 days after the first day of the taxable year. Many states offer no tax break to corporations who are S corps. However, some honor the S corp election automatically. There are also states that require state specific forms to complete the S corp election.

Is a S Corp Election a Good Idea for Your Corp?

There is some downside to electing to become an S corp.

  • Higher tax and legal service costs
  • S corp election means that taxes are not assessed on the corporate level
  • There are incorporation requirements at the state level in every state
  • Capital raising efforts may be affected by the limitation on issued stock to only one type of stock
  • S corps can have no more than 100 shareholder
  • S corps cannot have shareholders who are C corps, other S corps, many kinds of trusts, LLCs, partnerships or non-U.S. citizens.

It is imperative that a corporation seeks counsel to determine the best tax status for the corporation.

Professional attorneys and accountants spend their careers advising companies, business entities and solo practitioners on things like S corp elections. They understand the ins and outs of how these decisions can affect an organization long-term.

If you need help with setting up an S corporation or any other legal need, you can post your legal need on UpCounsel’s marketplace. Upcounsel is a marketplace of legal help for you and your business. 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.