What Is a Sub S Corp.?

By Ari Mushell, J.D.

What Is a Sub S Corp.?

By Ari Mushell, J.D.

Per Subchapter S of the Internal Revenue Code, you can incorporate your business as an S corporation. As an S corporation, you can enjoy the benefits of limited liability, favorable taxation, and an ability to raise capital through the sale of shares in the company. An S corporation has many similarities to a C corporation, but an S corporation tends to be a smaller entity.

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Creating an S Corporation

To organize your business as an S corporation, you need to file the proper documentation with the Internal Revenue Service and your Secretary of State. Per IRS regulations, you must fill out an Election by a Small Business Corporation (Form 2553) and elect for Subchapter S treatment.

All states require you to draft articles of incorporation, a document containing basic information about the S corporation, such as names and addresses of key figures and the number of shares the company plans to issue. Some states also require you to file an operating agreement, a document that includes more detailed information, including the business purpose, a meeting schedule, and procedures for certain situations.

The S corporation has several key components. Here's what you need to know about this specific business entity.

Limited Liability and Formalities

An S corporation provides limited liability, which shields the assets of the owners from the S corporation's liabilities. Legally, through filing as an S corporation, the owners of the S corporation and the corporation itself are distinct, so an owner is not personally liable for the S corporation's debts. Limited liability is probably the main reason why people choose to incorporate their businesses as S corporations.

S corporations, like C corporations, have a number of formal requirements. For instance, state law requires S corporations to hold regular meetings with board members and record minutes of those meetings. It must also hold meetings and record minutes when the S corporation makes a strategic decision.

Capital and Favorable Tax Treatment

Businesses often need to raise capital to invest in projects, and S corporations can accomplish this by selling shares in the corporation. However, unlike a C corporation, which can raise capital by selling shares on the open market, an S corporation can only sell shares on a specific market. As such, its ability to raise capital through the sale of shares is somewhat limited.

An S corporation provides its owners with pass-through taxation, which avoids the double taxation levied against C corporations. An S corporation does not pay taxes on the profits it earns. Instead, the profits pass through to the shareholders, who pay taxes against those profits on their personal income tax returns. C corporations pay taxes on profits earned by the corporation, and then shareholders and employees are taxed again on a personal level.

Limitations Regarding Shares and Shareholders

Although S corporations can issue stock, there are limitations when it comes to its shares and shareholders. S corporations can issue only one class of stock, and each S corporation has a cap of 100 shareholders. If the number of shareholders exceeds 100, it can lose its S corporation status. In addition, the following entities cannot be shareholders in an S corporation:

  • C corporations
  • Other S corporations
  • Non-U.S. citizens who are not residents of the U.S.
  • LLCs
  • Partnerships
  • Various types of trusts

S corporations have liability, tax, and capital funding advantages. There are, however, limitations about raising funds through selling shares. There are also formalities associated with creating and managing an S corporation.

It is important to understand the key components of an S corporation before you decide to file. A business law attorney may be a valuable resource for helping entrepreneurs determine whether forming S corporation is the right choice. While an S corporation can issue only one class of stock to a limited number of shareholders, this business entity provides limited liability, favorable taxation, and an ability to raise capital that many entrepreneurs may find appealing.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.