Subchapter S Corporation Examples

Subchapter S corporation examples are important to review so that you can be aware of the eligibility requirements before electing to operate as an S corp. An S corp is a business structure that functions similar to a C corp, but is taxed like a partnership.

It is generally a favorable business structure for smaller businesses, as it is actually aimed to help small businesses since companies with more than $50 million in gross receipts aren’t usually eligible to operate as an S corp. The business doesn’t file corporate income taxes; instead, the profits, losses, credits, and deductions of the business are reported on the shareholders personal tax returns, proportionate to the percentage of shares they own.

Examples of S Corp Taxation

Below are some examples of S corp taxation, so that you can be fully aware of how S corp shareholders are taxed, and what other documentation must be reported to the IRS for tax purposes.

Jack Smith Inc. is established as an S corporation in the State of California. John owns 51% of the corporation while Mary owns 49%. In 2013, the company has a net profit of $10 million. When John and Mary file their personal income tax returns, John will report $5,100,000 and Mary will report $4,900,000.

Thereafter, the S corp can choose to either distribute the proceeds to John and Mary, or instead reinvest the proceeds into the retained earnings account. Even if the company chooses not to distribute the funds to John and Mary, they will still need to report it on their personal income since that is the way in which S corps operate (pass-through tax entities).

Let’s look at another example. Assume now that Jack Smith Inc. is owned equally by John, Mary, and Renee (1/3 ownership portion each). If the business has a profit of $600,000, each individual will report $200,000 on his or her personal income tax return.

However, let’s assume that the business has a loss of $30,000. Now, each individual will report $10,000 of loss on his or her tax return. This loss will be reported on IRS Form 1040. While the income from the business is subject to both federal and state income taxes, it’s not subject to self-employment taxes. Therefore, the individual shareholder doesn’t have to pay self-employment tax on the business’s earnings.

Eligibility Criteria

In order to operate as an S corp, your business must be eligible to do so, as not all corporations are eligible.

Below are some criteria that must be met in order for the IRS to approve your S corp status:

• Your business must be a domestic corporation

• Your business must have no more than 100 shareholders

• Your business can only have eligible shareholders (natural citizens)

• You can have only one class of stock

If any of the above-mentioned conditions aren’t met, then your S corp is ineligible. Furthermore, if one of the conditions changes at any time, then you will risk losing S corp status.

Termination of an S Corp

You can voluntarily terminate your S corp status by filing a statement with the Secretary of State where your corporation was formed. The state will then provide instructions for who can terminate the S corp, i.e. shareholders with a certain percentage of the company, registered agent, etc.

Keep in mind that before terminating your business, you must obtain consent from all S corp shareholders who hold more than 50% of the shares of stock before you can move forward with the termination process. Once the document is filed, additional information must be submitted to the IRS. You will need to submit Form 1120S to the IRS on an annual basis, and once you’ve terminated your company, you will submit this form to the IRS indicating that you have revoked your status as an S corp. This form must be submitted by the 15th day of the third month after the tax year has ended, i.e. March 15. If you don’t submit this form by the deadline, your S corp revocation will not take effect until the following tax year.

If you need help learning more about an S corporation or need assistance forming your S 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.