S Corporation

source by: quickmba.com

S Corporation

For a corporation organized under subchapter S of the Internal Revenue Code (S stands for small business corporation), there is pass-through taxation. An S corporation can be formed by making a subchapter S election when forming a C corporation. This distinction is at the federal level, but some states recognize it as well.

The subchapter S election affects the corporation only from a taxation viewpoint. The income, gains, losses, and deductions are passed through in proportion to one's share of ownership in the S corporation.

The subchapter S election has some additional requirements:

1. The S corporation must be a domestic corporation.
2. The maximum number of shareholders is 75. Before 1997 this limit was 35. There are ways around this limitation, for example, by forming two S corporations that form a joint venture.
3. The shareholders of an S corporation must be individuals or certain estates and trusts.
4. The shareholders of an S corporation must not be non-resident aliens.
5. An S corporation may not have more than one class of stock, for example, common stock. However, there can be two types of common stock - voting and non-voting. In some cases, options and warrants may count as a second class of stock. Debt is not considered a second class of stock unless it is classified as equity. There are three requirements for debt to be acceptable for subchapter S election:

 

a. Its interest is not tied to profits.
b. The debt is not convertible.
c. The creditor must be an individual.

 

6. The corporation must make the S election within 75 days of formation, otherwise it will be a C corporation for the first year, and an S corporation thereafter.

If the exit strategy is to be acquired, for a small non-dot com an S corporation is a better choice than a C corporation. C corporations require a higher selling price to make up for the tax differences to the owners. A corporation can change from a C corporation to an S corporation fairly easily, but it is much more difficult to change from an S to a C corporation.

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