Subchapter S Corporations in the Articles of Incorporation

The Internal Revenue Code recognizes an S corporation under the Subchapter S Chapter 1. S corporations distribute profits and losses to shareholders instead of paying corporate taxes. Shareholders pay taxes on their distributions. In contrast, C corporations face double taxation. Corporate income and shareholder dividends are taxed.

S Corporation

An S corporation does not pay corporate taxes. Shareholders receive distribution of company income based on their percent ownership. Shareholders pay taxes on the distribution based on their individual tax return. In addition, employee-shareholders can deduct health and insurance premiums as business expenses (if they own less than 2 percent in the company). Employee-shareholders pay 15.3 percent of their wages for Social Security; however distributions are taxed a lower rate. S corporations are popular for new business start-ups because of these tax advantages.

Articles of Incorporation

The articles of incorporation for an S corporation are similar to a C corporation with two main exceptions. First, an S corporation can only have one class of stock. Secondly, an S corporation is limited to 100 shareholders. If the shareholders in an S corporation exceed 100, it must convert to a C corporation. An S corporation must maintain meeting minutes, update its by-laws, and keep records of stock transfers similar to the mandate for C corporations.

Limitations

An S corporation is limited to one class of stock, which may limit its ability to attract outside investors. Most investors are familiar with a C corporation structure. In order for an S corporation to have an initial public offering of its stock, it would have to convert to a C corporation, which could be expensive. Secondly, employee-shareholders must receive adequate compensation. Low compensation and a high distribution payout raise red flags with the IRS. Finally, an S corporation is geographically restricted to operating in the United States. Also, its shareholders must be U.S. citizens or residents. Shareholders are restricted to natural persons. Thus, corporations and partnerships cannot be shareholders.

Considerations

S corporations offer attractive tax advantages. However, there are a few things to consider. There are a number of complex tax rules regarding how and when you can use losses to offset other income. Talk with your accountant regarding the tax implications of setting up an S corporation based on your tax filing status. You may want to opt to register as C corporation if your future vision for the company involves more than 100 shareholders and taking your company public.

References

• "Boston Business Journal"; Subchapter S: Some Myths, Realities and Practical Considerations; Joseph G. Hadzima Jr.
• BusinessLawyerOfMilwaukee: A Lot of Readers Ask About S-Corp's So Here is a Good Summary
• Lectlaw: Articles of Incorporation (Chapter S)
• S-Corporation Association of America: The History and Challenges of America's Dominant Business Structure
• Business.gov: S Corporation

Resources

• Internal Revenue Service: S Corporations