Subchapter S Corporation Definition
An S corporation is a unique type of corporate entity that provides special taxation benefits to its shareholders, according to the rules of the Internal Revenue Code. To remain eligible for these benefits, an S corporation must adhere to certain restrictions in terms of size and ownership.
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Size
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No more than 100 shareholders may participate in an S corporation. An S corporation that exceeds 100 shareholders loses its S corporation status, and must operate as a regular C corporation. The inability to have more than 100 shareholders may limit the company's growth and options for raising capital. For this reason, S corporations tend to be better for smaller businesses (including businesses comprising only one person).
Taxation
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S corporations normally do not pay federal income taxes. Instead, the owners of the company report their portion of company losses and profits on their personal income tax returns. By contrast, C corporations pay federal income taxes, and shareholders also pay taxes on income received from the company on their personal income tax returns. Thus, operating as an S corporation helps the company's shareholders to avoid the double taxation that may apply to the shareholders of C corporations.
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Formation
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Forming an S corporation involves the same process as forming a C corporation. After filing its articles of incorporation with the state, the S corporation has 75 days to file Form 2553 with the Internal Revenue Service. The S corporation must provide information about the company's business activities, as well as the name and address of the company. All shareholders must indicate their approval of the S corporation election by signing Form 2553.
Stock
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S corporations can issue only one class of stock. The IRS will automatically treat an S corporation that issues multiple stock classes as a C corporation. The inability to issue multiple classes of stock may limit an S corporation's ability to raise funds, compared to a C corporation. Furthermore, only certain trusts, estates and individuals may own stock in an S corporation. LLCs, partnerships, other corporations, and foreign entities and individuals may not own stock in an S corporation.
Regulations
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An S corporation must observe the same legal formalities as a C corporation. For example, S corporations must hold annual director and shareholder meetings, and record the minutes of these meetings. They must also create financial statements, file annual reports with the state and maintain strict accounting records. In addition, the IRS requires S corporations to separate the company's business assets from the personal assets of the company's shareholders.
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