An S-corporation isn’t a legal business entity you can create at the state level; it is purely a designation that certain small businesses can elect for income tax purposes. In most cases, corporations make S-corp elections because it allows them to avoid corporate double taxation and take advantage of pass-through taxation instead. As a 50 percent owner of an S-corp, you’ll be reporting half of a corporation’s net profit or loss on your personal income tax return.
S-Corp vs. C-Corp
A C-corp refers to corporations that don’t make an S-corp election and are subject to traditional corporate tax rules. In general, the Internal Revenue Code treats corporate entities as taxpayers. This means the corporation is assigned its own Employer Identification Number and is responsible for paying taxes and filing returns. As a 50 percent shareholder, your personal tax return isn’t affected by the corporation. However, you will be responsible for paying the second tax assessed on half the dividend payments the corporation makes to shareholders. With an S-corp election in effect, the IRS disregards the corporation as a separate taxpayer entity and instead, shareholders are responsible for reporting their respective shares of corporate income or loss on their personal tax returns. S-corps must still file a separate informational tax return on Form 1120S and send each shareholder a Schedule K-1 that reports the amount of corporate income they’re responsible for reporting on their personal returns.
S-Corp Election Requirements
Not every corporate entity is eligible to make an S-corp election on Form 2553 with the IRS. Only those entities that have 100 shareholders or less will qualify as a small business corporation under the S-corp tax rules. Moreover, there can only be one class of stock and no nonresident aliens who own shares in the corporation. Therefore, if you own 50 percent of the stock in the corporation, there must be between one and 99 other shareholders who own the other 50 percent of the stock – and they all must agree to make the election.
Income Tax Implications
The income tax implications of owning 50 percent of an S-corp are fairly straightforward in that you are responsible for reporting half of the corporation’s income, deductions, tax credits and other tax items on your personal tax return. You do this by completing a Schedule E attachment to your 1040 to report all S-corp activity and combining it with your other non-corporate income. Because you pay tax on corporate earnings only once, you won’t have to pay a second tax when you receive the 50 percent profit distributions that you’re entitled to.
It is important to remember that despite making an S-corp election, your business retains its traditional corporate status for all other non-tax purposes. As a 50 percent shareholder, you’re able to control half of all shareholder votes, which gives you significant influence over board member elections and other important issues affecting the business. However, if you ever want to terminate the S-corp election, your 50 percent ownership alone is insufficient to effectuate the termination because the tax code requires a majority of all shareholders to agree on terminating the election.