Tax Treatment of Business Entities Part 5: S Corporations

Startup business owners must consider the legal and tax considerations associated with selecting a particular type of business structure. This is the fifth part of a series of blogs on the tax treatment of business entities. This final segment will address the tax treatment of S corporations.

S corporations are entities that elect to pass corporate income, losses, deductions, and credits through to their shareholders who report any flow-through income and losses on their personal tax returns and taxed at individual income tax rates, similar to a partnership. Thus, S corporations avoid double taxation on corporate income, unlike C corporations. However, S corporations are responsible for tax on some capital gains and passive income at the corporate level. The rules for Subchapter S corporations are found in Subchapter S of Chapter 1 of the Internal Revenue Code.

An S corporation is no different than a C corporation structurally, as it is chartered under state law and is a legal entity separate from its shareholders and officers. Shareholders of S corporations also are subject to limited liability for corporate actions.

No business entity begins its corporate existence taxed as an S corporation. In order to be treated differently than C corporations for federal tax purposes, S corporations must file an election on Form 2553, Election by a Small Business Corporation.

S corporations also report their income and deductions much like partnerships. Like partners, shareholders must pay tax on their share of corporate income, whether or not it is actually distributed. An S corporation files an information return (Form 1120S) reporting the corporation’s yearly income, deductions, profits, losses, and tax credits.

Like partners, shareholders must be provided a Schedule K-1 Shareholder’s Share of Income, Credits and Deductions, listing their shares of the items on the corporation’s Form 1120S. Schedule K-1 is completed and filed with Form 1120S for each shareholder. Shareholders file Schedule E with their personal Form 1040 listing their share of corporation income or losses.

To qualify for S corporation status, the following is required:

  • The corporation must be a domestic corporation.
  • The corporation must have only shareholders permitted by law. Partnerships, corporations or non-resident alien shareholders may not be shareholders in S corporations.
  • The corporation must have no more than 100 shareholders.
  • The corporation must have only one class of stock. For example, preferred stock granting some shareholders special rights may not be issued.
  • The corporation may not be ineligible (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

if you already have an LLC, LLP, or partnership, and S corporation tax treatment sounds attractive to you, you should consider filing an S corporation election. But see a tax professional before making this important decision. In order to ensure that taxpayers make a smooth transition in light of this important law change, contact THE TAX EXPERTS at the Thorgood Law Firm For a FREE consultation, call 212-490-0704.Tax Treatment of Business Entities Part 5: S Corporations

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