In an S Corporation, all income and losses are divided and passed through to its shareholders. The shareholders then report the income or loss of the corporation on their own individual income tax returns. A corporation can elect to be treated as an S Corporation by filing Form 2553. Eligibility restrictions to make the election include not having more than 100 shareholders, all shareholders must be individuals, estates, exempt organizations, or certain types of trusts (note: cannot be another corporation), there can only be one class of stock, and no shareholder can be a nonresident alien.
The main benefit of an S corporation versus its C corporation counterpart is that S Corporations do not pay federal income taxes and accordingly there is only one level of taxation. In contrast, a C corporation has a double level taxation: It pays a corporate income tax and then shareholders pay tax on most received distributions. Also unlike a C corporation, an S corporation is not subject to the corporate alternative minimum tax.
Another benefit is how corporate losses can be deducted on the shareholders individual income tax return. This is especially useful for start-up companies that typically will have losses in its early years.
If you are planning on starting a new corporation that may have early losses or minimal profits, you should consider making an S Corporation election. If you do, then also consider adopting a shareholder restriction agreement to ensure that you do not accidentally lose eligibility by transferring stock to a non-qualified shareholder.
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