The S corp shareholder limit has certain conditions to meet to be eligible for an S subchapter election. The limit stipulates that there can be no more than 75 shareholders.

Overview of a Subchapter S Corporation

An S corporation is appealing to small business owners versus a standard corporation also referred to as a C corporation. An S corporation is a special option for corporations that allows limited liability protection as well as direct flow-through of profits and losses to its owners.

Because the income and losses are passed through to the shareholders to be included on their personal tax returns, there is just one level of taxation to pay.

When defining the shareholder limit of an S corporation, husbands and wives are counted as one shareholder.

S corporations are limited to who may be shareholders. These include certain trusts, tax-exempt charitable organizations, individuals, certain partnerships, estates, other S corporations, and individuals. In the case of other S corporations, this is possible if the other S corporation is the sole shareholder.

Owners of S corporations that do not have inventory are able to use the cash method of accounting versus accrual. The cash method taxes income as it's received and deducts expenses when paid.

Disadvantages of Subchapter S Corporations

S corporations are required to file articles of incorporation, keep corporate minutes, hold meetings for directors and shareholders, and when major corporate decisions are to be made, shareholders are allowed to vote.

An S corporation's accounting and legal costs for set-up are similar to those of a standard corporation. The S corporation's capital-raising efforts may be negatively impacted due to the limitation of common stock as the only type that can be issued by the corporation.

A corporation must make the subchapter S election within two months and 15 days after the first day of the taxable year to elect has arrived. Before the election to S status can be approved, the consent of all shareholders is required.

Different states have different ways to treat S corporations. Some states may not take into account subchapter S status entirely while other states offer no tax break. Others honor the automatic federal election. Then there are states that require a state-specific form be filed to finalize the subchapter S election. It is recommended to consult with an attorney where your business is incorporating to determine the rules of the state.

S corporations can do one of two things to revoke subchapter S status; fail to meet the eligibility requirements for S corporations or file paperwork with the Internal Revenue Service. Once approved and the revocation becomes effective, the business will be taxed as a corporation.

S Corporations vs Limited Liability Companies

S corporations and limited liability companies (LLCs) are similar and often entrepreneurs have difficulty choosing which structure is best for their business. There are also non-similarities. These include:

  • Both offer limited liability protection and are pass-through entities.
  • With pass-through taxation, the income and losses of the corporation are reflected on the owner's personal income tax return.
  • Pass-through tax status eliminates the possibility of double taxation for LLCs and S corporations.
  • An S corporation can have no more than 75 shareholders. Limited liability companies are allowed an unlimited number of owners (members).
  • S corporations cannot have non-U.S. citizens as shareholders whereas a limited liability company can.
  • Limited liability companies are more flexible in the manner in which profits are distributed.
  • A corporation has only one class of stock. The ownership percentage determines the percentage of pass-through income. An LLC can have different classes of interest and the percentage of the income is not associated with the ownership percentage.
  • While one person can form an S corporation in a few states, it takes at least two people to form an LLC.
  • S corporations have perpetual existence while LLCs have limited lifespans.
  • S corporation stock can be transferred freely without the need to obtain approval from other shareholders. LLCs need the approval of the other members before selling their interest in the corporation.
  • An S corporation is intended for small businesses and family businesses to obtain protection from personal liability the same as large corporations.

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