WHAT IS A SUBCHAPTER S CORPORATION?
BY
MICHAEL J. LOMBARDO, ESQ.
Anyone who is considering
conducting business as a corporation should consider having the corporation
qualify as a Subchapter S corporation. Before there can be a qualification as a Subchapter S corporation, the
corporation has to actually be formed in accordance with State law.
WHAT IS A SUBCHAPTER S CORPORATION?
A Subchapter S corporation is
a corporation that, for tax purposes, is treated more like a partnership than a
corporation. It is called a Subchapter
S corporation because the tax election is made under Subchapter S of the
Internal Revenue Code. For a comparison
of different forms that may be used to conduct business in New York, see the
article Select Forms
of Conducting Business in New York.
WHAT ARE THE ADVANTAGES OF CONDUCTING BUSINESS AS A SUBCHAPTER S CORPORATION?
The main advantage to
conducting business as a Subchapter S corporation is that there is only one layer of tax. If
a corporation is not a Subchapter S corporation, it will be considered a
Subchapter C corporation. A Subchapter C
corporation is taxed at the corporate level on its net income and the shareholders
of the Subchapter C corporation are generally taxed on
the distributions made by the corporation to its shareholders in the form of a
dividend. If the corporation is a Subchapter
S corporation, the corporation generally does not pay tax at the corporate
level. Each shareholder will report the
allocated amount of income or loss on the shareholder’s personal income tax
return, whether or not the income is actually distributed to the shareholder
(the rules are complex with respect to the extent losses can actually be taken
by a shareholder against income received from other sources by the shareholder,
and is beyond the scope of this Article). Assuming the corporate generates a profit, the tax is paid at the
shareholder level, and not the corporate level. In many instances, this is an advantage. However, if the individual shareholders are in a tax bracket that is
greater than that of the corporation, then the better strategy may be to let
the corporation be a Subchapter C corporation rather than a Subchapter S
corporation. This analysis should be
made with the assistance of a qualified tax professional. For purposes of this Article, an assumption
will be made that the decision has been made to treat the corporation as a Subchapter
S corporation.
WHAT REQUIREMENT NEED TO BE SATISFIED TO QUALIFY AS A SUBCAHPTER S CORPORATION?
Not every corporation can
qualify to become a Subchapter S corporation. In order for a corporation to qualify as a Subchapter S corporation, the
corporation must satisfy eight requirements including (a) the corporation must
be a domestic corporation, (b) the corporation must have no more than 100
shareholders, (c) all of the shareholders must be individuals, estates or
certain kinds of domestic trusts, (d) there must be only one class of stock and
(d) the corporation must a adopt a tax year ending December 31 (with certain
limited exceptions).
HOW IS A SUBCHAPTER S ELECTION MADE?
All of the shareholders of
the corporation must make an election to have the corporation treated as a Subchapter
S corporation. The shareholders must
complete and file an election with the Internal Revenue Service and with the
New York State Department of Taxation and Finance. The election is generally made no later than
two months and 15 days after the beginning of the tax year the election is to
take effect. Once an election is made, a
change in shareholders does not require new shareholders to make another
election. The election will remain in
effect until there is an event that disqualifies the corporation from being a Subchapter
S corporation which may include shares of the corporation being acquired by a
shareholder who is neither an individual nor a qualified domestic trust.
CAUTION: THIS ARTICLE IS INTENDED TO PRESENT GENERAL
INFORMATION AND IS NOT INTENDED TO BE A SUBSTITUTE FOR CONSULTATION WITH LEGAL
COUNSEL.
IRS
CIRCULAR 230 Disclosure: To ensure compliance with requirements imposed
by the IRS, please be aware that any U.S. federal tax advice contained in this
communication (including any attachments or enclosures) is not intended or
written to be used and cannot be used for the purpose of (i)
avoiding penalties that may be imposed under the Internal Revenue Code or (ii)
promoting, marketing or recommending to any other person any transaction or
matter addressed herein.
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Last Update: March 30, 2011