What is an S corporation tax election and why might one elect as one?
An S corporation is a tax election in which corporations may pass corporate income, losses, deductions, and credits to their shareholders for federal tax purposes. Shareholders of S corporations report the income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on their corporate income, but they are still responsible for tax on certain built-in gains and passive income at the entity level. To qualify for S corporation status, the corporation must meet the following requirements (1) be a domestic corporation, (2) have only allowable shareholders (may be individuals, certain trusts, and estates, and may not be partnerships, corporations, or non-resident alien shareholders), (3) have no more than 100 shareholders, (4) have only one class of stock, and (5) not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations). To become an S corporation, the corporation must submit Form 2553, Election by a Small Business Corporation signed by all the shareholders.
There are many advantages to an S corporation election, although business owners should evaluate both their short- and long-term goals to see if an S corporation is right for them. Some advantages, in addition to pass through taxation, include asset protection, salary and dividend payments, and ease of conversion. Overall, S corporations appeal to business owners because they can reduce taxation and provide liability protections. Although not the best choice for all business owners, they can provide great benefits. If you would like to know more about S corporations and are interested in electing for S corporation status, our attorneys are well versed in this area, so do not hesitate to reach out for a consultation on this matter.