Tax Aspects of S Corporations

An 'S' Corporation is a small business that has filed a Form 2553 with the U.S. Internal Revenue Service. The Form 2553 is an official corporate document representing a 100% shareholder approval of the desire to become recognized as an 'S' Corporation as governed by Section 1362 of the U.S. tax code Title 26 . Both new and pre-existing companies regulated by different tax statutes may become S corporations provided they meet the requirements.

Qualification to become an S Corporation

Form 2553 must be filed before March 15 of a given year to qualify as an S corporation for that year.
To Form a S corporation, there may only be 99 or less owners/shareholders. The Shareholders must also be legal U.S. residents. If an existing company is filing the Form 2553, that company may not be a 'C' Corporation i.e. a more formal business subject to different tax regulations.

Tax benefits and taxation of S Corporation:

S Corporations are able to avoid what is known as 'double taxation'. Double taxation is when profits a company earns are taxed, and then the profits distributed to the owners are taxed again on their individual tax forms. S corporations avoid this by not always having to pay tax on earnings. Instead, as with Limited Liability Corporations, those earnings or losses are either added to or deducted to the shareholder's personal income.

Another tax benefit of S corporations is the ability of the corporation to pay dividends. Dividends are profits that are passed on from companies to shareholders. Since dividends are not taxed the same way as employee income, S corporations can avoid paying extra federal employment taxation, thus saving money.

IRS tax forms for S Corporations:

The tax forms required of S corporations by the Internal Revenue Service include the following. These requirements can be viewed at the Internal Revenue Service website.

Form 1120S: The company's tax documentation form
Form 941 or 943: Employment taxes withholdings
Form 940: Additional employment withholdings such as social security, Medicare etc.
Form 1040: Individual Tax documentation for shareholders

TIPS on Becoming an S Corporation:

Check State laws regarding S Corporations, as they may not recognize S corporations the same way the Federal Government does, thereby excluding them from the same taxation rules applied at the Federal level.

Paralegal services may be all that is needed to set up an S corporation if a company does not do so independently. Tax accountants and/or attorneys specializing in taxation law may also be of assistance in certain situations.

According to Title 26, Code 1362 of the U.S. tax code, an S corporation is no longer a S corporation if the company no longer meets the requirements of a S corporation or if the company earns a specific amount of income after 3 years i.e. more than 25% of total revenue over 3 years.

Forecasting your corporations growth, needs, size and capitalization requirements may be useful when determining if an S corporation is the right classification for your business. This may be beneficial as if the company outgrows itself, it may have to change its tax status causing added complications in the future.

If a company pays out all its earnings as dividends, it may not have to withhold income tax if there are no salaried employees, thereby avoiding double taxation. This would make formation as an S corporation not as attractive if it is formed entirely on the premise of avoiding double taxation.

Deciding whether or not to form an S corporation or switch to an S corporation from an LLC or sole proprietorship may not be a decision one makes in a couple of minutes over a coffee. There are several aspects of earnings distribution, taxation code, number of employees and corporate forecasting that may all impact the benefits of such a decision. S corporations are generally have less responsibility in terms of IRS regulations than do C corporations. In spite of this, C corporations may have its unique advantages over an S corporation such as charitable contributions tax deductions exclusive to the C corporation.