Subchapter S Corporation Definition: Everything You Need to Know
The Subchapter S corporation definition refers to a specific type of corporation. It is also known as an S corp. The other type is a C corporation. 3 min read
2. Considerations of an S Corporation
3. Pass-Through Tax Treatment
4. Estate Planning Effects
5. Additional Considerations
6. Disadvantages of S Corporations
What Is the Definition of a Corporation?
The Subchapter S corporation definition refers to a specific type of corporation. It is also known as an S corp. The other type is a C corporation.
An S corporation provides advantages such as those of a corporate business by allowing what is referred to as "passing through" the profits and losses of the corporation to the individual shareholders, like the way it's done with a partnership or limited liability company (LLC).
A sub S corp is basically a smaller version of a C corporation that has met certain requirements, and upon attaining those requirements, has elected to be taxed as a pass-through business entity as per Subchapter S of the IRS code.
The corporation is owned by its shareholder(s) who are not liable for the finances and actions of the business; liability falls to the corporation. The structure of shifting liability from the owner(s) to the corporation is one of an S corporation's main advantages.
The forming of an S corporation is achieved by first forming a standard corporation. Once formed, the owner(s) would then file Form 2553, which is the form used to elect to be a Subchapter S business entity.
Considerations of an S Corporation
Limited liability is like having a wall between the company and a shareholder's personal assets. The wall serves as protection between the personal assets and creditors of the S corporation. In a sole proprietorship, for example, personal assets can be taken if the sole proprietorship, or other unincorporated business, has a lawsuit filed against it. In general, in an S corporation, a person(s) will lose only what they've invested in the company.
Pass-Through Tax Treatment
The pass-through tax treatment is an advantage for S corporation business structures as can save owners their money. The standard process for a corporation is to pay the corporate income tax due on its profits. It will then distribute dividends to its shareholders who then pay taxes for those dividends on their personal tax return. An S corporation bypasses this process by distributing the profits straight to the shareholders. This results in the avoidance of double taxation.
Estate Planning Effects
With an corporations">S corporation, transference of an owner's interest in the business is easier to attain at the time of an owner's passing. There's also the fact an S corp exists in perpetuity even after an owner's death and even if there is only one owner. An owner(s) has the option to transfer shares to his or her heirs while alive to lower the estate tax bill. Voting and non-voting shares can be designated to the heirs, allowing them more ownership while the owner maintains control of the business operations.
- There are restrictions placed on qualifying to become an S corporation.
- S corporations are allowed no more than 100 shareholders.
- The type of shareholder allowed is limited to U.S. citizens, estates of shareholders, U.S. residents, and certain trusts and organizations that are tax-exempt.
- If 25 percent of an S corporation's gross receipts are from passive activities, such as investments or interest income, it will revert to a C corporation.
- A regular corporation, which is often referred to as a C corporation, is taxed as a separate business entity. Corporations use Form 1120 to file taxes and use C corp tax rates.
Disadvantages of S Corporations
- An S corporation must file articles of incorporation the same as a C corporation.
- A variety of tax forms are associated with an S corporation.
- Common stock is the only allowable type to be issued to shareholders.
- The Internal Revenue Service scrutinizes the distribution of payments to shareholders as either a dividend or salary to ensure proper characterization of the income (wages or dividends) is applied.
- If mistakes are made involving consent, election, stock ownership, notification, or filing requirements, the outcome could result in the termination of the S corporation.
- S corporation formation under Subchapter S requires money and time.
- The money portion pertains to the filing of paperwork such as the articles of incorporation, the hiring of a registered agent to serve the business, and all applicable fees while the time portion is attributed to the time it takes to complete the many forms.
If you need help with the subchapter S corporation definition, 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.