S-Corps Basics

While the majority of corporations are C corporations, it is not the only kind of corporate form. There are some benefits to smaller corporations electing to operate as S corporations. S corporations were formerly known as Sub-Section S corporation, as these corps are taxed under Subchapter S of Chapter 1 of the IRS Code. S corporations contain all the benefits of the corporate protections previously discussed, though not every corporation qualifies for S corp status. It must be small, as it cannot have more than 100 shareholders. The corporation must be domestic and cannot have any shareholders that are not U.S. citizens or U.S. residents and all shareholders must agree to electing to become an S corp. Only a human being can be a shareholder, thus excluding corporations or partnerships from being able to hold shares. However, a spouse, family or an estate can be defined as a single shareholder for these purposes. This makes it a good choice for family-owned businesses.

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S corps also differ in the way it issues stock. S corps can only have one class of stock, unlike C corps that allow for different classes of stock, with varying rights to dividends. Since there is only one class, there cannot be different distribution rights. All shareholders are treated the same, though there can still be the designation of voting and non-voting shares.

An S corp must go through all of the steps and formalities to incorporate as a C corp does. All shareholders must agree to electing to operate as an S corp and does so by filing a Form 2553, Election by a Small Business Corporation, within 75 days of the corporate formation if it wants to have that status immediately. A C corp can elect to be an S corp at other times as well. To convert from a C corp to an S corp for the following tax year, the Form 2553 can be filed at any time prior to the start of that year. All shareholders must sign this form, plus the shareholder’s spouse, if the shareholder resides in a community property state.

Electing to operate as an S corp does not guarantee that it will always be able to remain an S corp indefinitely. Although most of these requirements are not that difficult to meet for a small corporation, an S corp can and will lose its status (causing it to revert a C corp) if it does not adhere to the above-mentioned requirements and can limit who ownership can be transferred to, as corporations cannot be shareholders.