What Is an S Corporation and Why Would You Want One?
S corporation is a bit of a misnomer — it is not actually a distinct type of business entity. Rather, it is a tax option available under the Internal Revenue Code for certain domestic business corporations validly organized under state law. Typically, it is an option for relatively small domestic corporations. What’s more, the S election is not always beneficial. Its use depends greatly on the individual’s nature and the circumstances of the business in question. Under the right conditions, however, it can result in substantial tax savings.
One of the chief downsides of the corporate form — as businesspeople know all too well — is double taxation. Corporations pay income tax on all profits at the corporate rate and then individual shareholders must again pay income tax on their distributions and dividends at their personal rates. The S election allows corporations to avoid this by making each shareholder responsible for paying income tax on a pro rata share of the company’s profits at their respective personal rates. This treatment is available to corporations that:
- Are incorporated domestically in the U.S.
- Have no more than 100 shareholders
- Only are in one class of stock
It is not available in instances where shareholders are partnerships, corporations or non-residents.
Making the S election is a big decision. Because it requires shareholders to personally take on a share of the corporation’s tax liability, each shareholder must consent individually. However, depending on the company’s annual revenues and the tax position of its individual shareholders, making the S election can sometimes result in substantial overall tax savings. A DC small business attorney can help explain what is required to make the S election and whether it is in your company’s best interests.