1.3 S- Corporation

The S-Corp is a pass essentially a pass through entity, which means the indivual shareholders take the income of the corporation in their own tax return. The S-Corp must file an election to be treated as such and meet certain definitional requirements including limitations on the type of shareholders. The drawback of the S-Corp is the difficulty in determining who may be a shareholder. The restrictions are as follows:

  1. Only a domestic corporation
  2. 100 shareholder limit
  3. Only natural persons and certain qualified trusts may be shareholders
  4. Only one class of stock (can have non-voting)

One main advantage of S-Corps is that it allows for individuals to limit their liability for non-tax purposes, without incurring the double taxation to which C-Corporations are subject. There is generally no corporate income tax, accumulated earnings tax, or personal holding company tax, so long as the Subchapter S election is in effect.

Most S-Corporations are not subject to double tax upon a liquidating sale or distribution of the assets. Although the corporation and shareholder would be subject to tax on the liquidating sale or distribution of assets, any gain should increase the shareholder's stock basis, thereby eliminating an additional shareholder tax on the distribution of the assets. This favorable tax treatment may not apply for a number of years, if the S-Corp is an ideal vehicle for conducting business and carries with it the tax advantages of pass through entities. Failure to adhere to corporate formalities and tax rules may subject the shareholders to creditor liability and adverse tax consequences.