Define S Corp

by Michael Keenan
The S corp election is made solely for tax purposes.

The S corp election is made solely for tax purposes.

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An S corp is not a separate type of corporation. Instead, it is merely an election that a corporation makes that changes its tax treatment under the Internal Revenue Code, Subchapter S. However, not all corporations are eligible to elect S corporation status. Knowing your options for your company can help you save money on your taxes so you can have more money to reinvest in your company.

S Corp Election

An S corp is just a C corp -- an ordinary corporation -- that meets certain criteria and makes the choice to be taxed as an S corp. To become an S corp, the company must first register as a corporation in the state in which it does business. After doing that, the company must file Form 2553 with the Internal Revenue Service to elect to be taxed as an S corporation. This form must be filed by February 15th of the year in which it will be active. For example, if you want the election to take effect in 2014, you must make the election before February 15, 2014.

S Corp Criteria

S corporations must meet a strict set of criteria in order to have S corp status. First, the corporation's shareholders can only be U.S. citizens, U.S. residents, estates of owners, certain nonprofits and certain qualifying trusts. For example, if a nonresident owner buys stock in the S corp, the S corp no longer qualifies. In addition, the S corp cannot have more than 100 different shareholders. However, family members and descendants can choose to be treated as one owner. Finally, the S corp cannot issue more than one class of stock. The only difference between the shares can be voting rights.

S Corp Taxes

By making the S corp election, the company's income and losses flow through directly to the shareholders' personal income taxes rather than first being taxed at the corporate level. S corp owners who provide services to the organization must receive a fair salary for their services, which is subject to self-employment taxes. Any excess income generated by the investment is capital gain to the shareholders. Even though the S corp doesn't owe corporate taxes, it must still file a Form 1120-S for informational purposes. It must also issue each shareholder a Schedule K-1 so each shareholder knows how much to income to report on their individual tax return.

S Corp Management

In terms of management, an S corporation functions the same way as any other corporation. When the corporation is formed, the incorporators must create a certificate of incorporation. After incorporation, the corporation has to adopt bylaws and elect a board of directors to run the company. However, if the S corp qualifies as a close corp -- a type of corporation with a small number of stockholders -- the corporation can incorporate as a close corporation and the shareholders themselves serve as the board of directors.