An S corporation structure is chosen for its taxation policy, but is otherwise identical to any other corporate structure. The shareholders in an S corporation are responsible for paying the corporation’s taxes as individuals, proportional to their share ownership. Along with paying the taxes on the S corporation’s profits, the shareholders can deduct the corporation’s losses on their individual tax returns. This taxation strategy ensures that the corporation’s profits are only taxed once, at the individual level. Otherwise, the profits would be taxed both at the corporate tax rate and again when distributed to the shareholders as taxable income, as in a C corporation. The shareholders are responsible for electing S corporation status and will do so when the corporation is either profitable and distributing most of its profits to shareholders, or is incurring losses which the shareholders wish to use as deductions on their personal tax returns. An S corporation structure is generally not used when a corporation is operated entirely by insiders who can utilize alternate strategies for making tax deductions with the corporation’s profits.
There are several requirements to qualify as an S corporation:
- The corporation must have no more than 75 shareholders. Qualified shareholders are individuals, certain tax-exempt organizations, and qualifying trusts or estates. None of the aforementioned may be nonresident aliens.
- The corporation must only have one class of stock. It is generally permitted if there are differences in voting rights and options.
- The corporation must not own more than 80% of another corporation unless they meet certain additional requirements.