“Special tax treatment for corporations”
“S” status for a corporation is granted by the IRS to any regular business corporation or close corporation which meets specific criteria. Domestic corporations having 100 or fewer shareholders all of the same class who are citizens of the U.S. or resident aliens may elect to pass gains or losses, credits or deductions, on to shareholders in much the same manner that partnerships are taxes. “S” status avoids the corporate potential problem of “double taxation.” Individual shareholders may benefit from a reduction in their taxable income if the corporation operates at a loss. Despite their unique tax treatment, “S” corporations maintain full corporate attributes like limited liability and continuity of life. Whether a corporation is a regular “C” corporation or a close corporation, it may become an “S” corporation for tax purposes.
- Limited shareholders–no more than 100 shareholders.
- Domestic corporation–must be organized in the United States.
- One class—must have only one class of stock, but may have voting and non-voting.
- Citizen shareholders–must have shareholders who are citizens of the U.S. or resident aliens.
- Legal basis–IRS Code and Regulations Sections 1361, 1362, and 1378.
- Special action necessary–all shareholders must consent to “S” corporation status.
- Special action necessary–the corporation must file IRS Form 2553. See Form 2553 and Instructions.
- Tax advantage–small corporations may avoid double taxation by passing gains and losses on to shareholders.
- Corporate attributes–offers shareholders limited personal liability and offers the corporation continuity of life.
- Tax advantage–corporate income tax payments are not required. Gains and losses are passed on to shareholders who pay taxes in a manner similar to partnerships.
- Early loss benefit–corporations may operate at a loss in their first years. Shareholders may benefit from a reduction in their personal taxable income by receiving their share of corporate losses.
- Limited capital sources—may have 100 or fewer shareholders which may limit capital raising activities.
- Class limitation—may not have debt convertible to stock or preferential rights to assets or profits that would tend to create more than one class of stock.
- Shareholder restrictions—foreigners, corporations, and partnerships cannot be shareholders of an “S” corporation.