What Is a Sub S Corp?
Entrepreneurs file formation documents with their state's corporations division to create business entities. Once a corporation is created, the owners elect a board of directors to act for the corporation. There are several different types of corporations, and the Internal Revenue Service (IRS) taxes each type according to the relevant chapters of the Internal Revenue Code. Sub S Corps, or S Corps, are corporations taxed under Subchapter S of Chapter 1 of the tax code.
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C Corporation
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A C corporation is the default corporate form. The IRS assesses taxes on the net profits of C corporations. Essentially, the C corporation pays its share of taxes, just as individuals pay taxes for income they receive during the course of a tax period. In addition, the shareholders of a C corporation also must pay taxes on the distributions made to them, which exposes the owners of a C corporation to a "double-tax."
S Corporation
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Subchapter S of the tax code allows certain corporations to elect to be taxed differently from a standard C corporation. If the business qualifies for taxation under subchapter S, it can file IRS Form 2553 and become an S Corps, which is not taxed on its net income. Instead, the income of an S corp "passes through" the corporation to the owners, who pay taxes on the amount of net income distributed to them from the S corp.
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S Corp Eligibility Requirements
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As of 2010, domestic corporations with 100 or fewer shareholders and only one class of stock could elect to become a Subchapter S corporation. Typically, the one one class of stock must grant voting and distribution rights to the shareholder without any restrictions. Corporations from other countries cannot elect to be taxed under Subchapter S.
Warning
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Even if a corporation qualifies for S corp status, making an election to be taxed as an S corp is not always the right move. According to Joe Hadzmia Jr., a senior lecturer at MIT, entrepreneurs must look at the tax rates for C corporations and S corporations and determine which is more advantageous for their specific situation.
Alternatives
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The corporate business structure may not be the right fit for every business. State laws require all corporations, even S corporations, to abide by strict rules regarding board members, meetings and record keeping. Business owners looking to receive the same tax benefits of an S corporation have alternatives when choosing a business structure. A limited liability company (LLC), for instance, offers the same type of "pass-through taxation" that S corporations enjoy and allow for greater flexibility in terms of management.
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