What is a Subchapter S Corporation: Everything You Need to Know
What is an example of an S-Corporation? There are many S-Corps operating successfully, and they can look very different from one another, depending on the industry. What makes them similar is their corporate structure and the eligibility requirements they must meet to elect this special tax status with the IRS.3 min read
What is an example of an S-Corporation? There are many S-Corps operating successfully, and they can look very different from one another, depending on the industry. What makes them similar is their corporate structure and the eligibility requirements they must meet to elect this special tax status with the IRS.
One Example of What S-Corporation Taxation Looks Like
Jakes, Inc. forms as an S-Corp in Georgia. Tom owns 51% of the company, and Sarah owns 49%. In 2017, the corporation's net profits total $40 million. When each shareholder files a personal tax return, Tom will report an income of $20.4 million, and Sarah will report $19.6 million.
The corporation may decide to put the company proceeds back into the business instead of distributing them. Even so, for this example, the shareholders would still pay taxes on their portion of company profits.
Common S-Corporation Types
Common professions that elect for S-Corp tax status include the following:
- Real estate agents
- Certified Public Accountants
- Financial advisers
- Construction contractors
It's especially advantageous for businesses with owner-operators who make a significantly higher salary than the average in their field.
What Is an S-Corporation?
S-Corps function like corporations but are taxed like partnerships. In an S-Corporation, corporate income, deductions, taxes, and losses are paid by the shareholders — or owners — instead of by the business itself.
S-Corps are an option if a corporation has no more than 100 shareholders. Shareholders report their portion of the business income and losses on their individual tax returns. Therefore, their taxes are not assessed at the corporate rate, which is generally higher than the individual rate.
A corporation may elect for S-Corp status for tax purposes or to be treated as a pass-through entity. This is similar to a partnership, where income or losses pass through to company shareholders, while still providing the benefit of liability protection. This advantage is similar to some of the protections that a C-Corp offers.
Shareholders pay taxes based on the S-Corp's income, even if the income isn't distributed. They avoid the double taxation that a standard C-Corp is subject to. A shareholder runs the risk of losing money he or she has invested when buying shares, but this is usually the only personal risk an owner takes.
Eligibility Requirements for an S-Corporation
Not all corporations are eligible for S-Corp status. The IRS sets certain eligibility criteria which a corporation must meet.
These criteria include the following:
- The business can't have more than 100 shareholders.
- It must be a domestic corporation.
- It can only issue one class of stock.
- It cannot be an ineligible corporation.
- All shareholders in an S-Corp must be permanent U.S. residents or U.S. citizens.
- The passive income level can't pass the limit of 25% of gross receipts.
- You must get permission from the IRS to have a fiscal year end other than December 31.
If your corporation fails to meet any of these criteria or if conditions change, you may lose your S-Corp status.
A corporation may enjoy some substantial benefits by electing S-Corp tax status.
Chief among them is the goal of limited liability, which can mitigate the impact of personal lawsuits, for instance. In addition, shareholders generally cannot be held personally liable for company debts.
The pass-through taxation benefit is another major advantage. Although S-Corps have limits to the number of shareholders they're allowed to have, most corporations that meet this criteria — generally having anywhere from 75 to 100 shareholders — elect S-Corp status because individual shareholders are able to receive a larger distribution of company income.
S-Corps enjoy some advantages of the corporate structure, while avoiding taxation issues that public companies are subject to.
While S-Corporations come with a number of advantages, some corporations won't be eligible to elect this status. Others may choose not to because it's not in the best interest of the business. Tax benefits are attractive, but they shouldn't be the only consideration when choosing the most appropriate business type for you. Think about your short- and long-term goals when formulating a business plan, since you may be attached to a company for a long time.
If you need help understanding S-Corporations or other business types, 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.