With a  sub-chapter "S" corporation  you can deduct the profits and losses from your corporation on your personal tax return. You will no longer be considered a "C" Corporation. Prior to March 15 you will file an IRS Form 1120-S with the IRS.

You MUST elect to be a sub-chapter "S" corporation by filing the IRS Form 2553. It has nothing to do with the state where you incorporate, but refers to the way you pay your income tax.

Upon approval by the IRS for this status, you can pass early losses through to the shareholders giving you and your investor a tax write-off against ordinary income, up to the actual amount of money they have invested in the company. Once the corporation turns a profit, the Sub-Chapter "S" status eliminates taxation for the company entirely. The tax liability is passed on to the stockholders.

"S" Corporation

With the Tax Reform Act of 1986, the "S" Corporation became a highly desirable entity for corporate tax purposes. An "S" Corporation is not really a different type of corporation. It is a special tax designation applied for and granted by the IRS to corporations that have already been formed. Many entrepreneurs and small business owners are partial to the "S" Corporation because it combines many of the advantages of a sole proprietorship, partnership and the corporate forms of business structure.

"S" Corporations have the same basic advantages and disadvantages of general or close corporation with the added benefit of the "S" Corporation special tax provisions. When a standard corporation (general, close or professional) makes a profit, it pays a federal corporate income tax on the profit. If the company declares a dividend, the shareholders must report the dividend as personal income and pay more taxes. 

"S" Corporations avoid this "double taxation" (once at the corporate level and again at the personal level) because all income or loss is reported only once on the personal tax returns of the shareholders. However, like standard corporations (and unlike some partnerships), the "S" Corporation shareholders are exempt from personal liability for business debt.

"S" Corporation Restrictions

To elect "S" Corporation status, your corporation must meet specific guidelines. As a result of the 1996 Tax Law, which became effective January 1, 1997, many of these qualifying guidelines have been changed. A few of these changes are noted below: 

• Prior to the 1996 Tax Law, the maximum number of shareholders was 35. The maximum number of shareholders
  for an "S" Corporation has been increased to 75. 

• Previously, "S" Corporation ownership was limited to individuals, estates, and certain trusts. Under the new law, stock of an "S" Corporation may be held by a new "electing small business trust." All beneficiaries of the trust must be individuals or estates, except that charitable organizations may hold limited interests. Interests in the trust must be acquired by gift or bequest -- not by purchase. Each potential current beneficiary of the trust is counted towards the 75 shareholder limit on "S" Corporation shareholders.

• "S" Corporations are now allowed to own 80 percent or more of the stock of a regular "C" corporation, which may elect to file a consolidated return with other affiliated regular "C" corporations. The "S" Corporation itself may not join in that election. In addition, an "S" Corporation is now allowed to own a qualified subchapter "S" subsidiary." The parent "S" Corporation must own 100 percent of the stock of the subsidiary.  

• Qualified retirement plans or Section 501(c)(3) charitable organizations may now be shareholders in "S" Corporations. All "S" Corporations must have shareholders who are citizens or residents of the United States. Nonresident aliens cannot be shareholders.

• "S" Corporations may only issue one class of stock. 

• No more than 25 percent of the gross corporate income may be derived from passive income. An "S" Corporation can generally provide employee benefits and deferred compensation plans. 

• "S" Corporations eliminate the problems faced by standard corporations whose shareholder-employees might be subject to IRS claims of excessive compensation. 

• Not all domestic general business corporations are eligible for "S" Corporation status. These exclusions include:

• A financial institution that is a bank

• An insurance company taxed under Subchapter L

• A Domestic International Sales Corporation (DISC)

• Certain affiliated groups of corporations

It should be noted that these lists of qualifying "S" Corporation aspects are not all inclusive. In addition, there are specific circumstances in which an "S" Corporation may owe income tax. For more detailed information about these changes and other aspects regarding "S" Corporation status, contact your personal accountant, attorney or local IRS office.

How to File as a "S" Corporation 

To become a " S" Corporation, you must know the mechanics of filing for this special tax status. Your first step is to form a general, close or professional corporation in the state of your choice. Second, you must obtain the formal consent of the corporation's shareholders. This consent should be noted in the corporation's minutes. Once the filing is approved, your company must complete Form 2553, Election by a Small Business Corporation. This form must be filed with the appropriate IRS office for your region. Please consult the IRS' instructions for Form 2553 to determine your proper deadline for completing and submitting this form. 

Mailing Information:

Internal Revenue Service
Cincinnati, OH  45999
Fax #  859-669-5748