Definition: An S-corporation is a C-corporation that has elected to be incorporated under Sub-chapter S. Sub-chapter S allows S-corporations to be treated like a partnership for tax purposes. A key note here is that S-corporation status is simply a tax designation. The company is still organized as a corporation—not as a partnership.
What Does Sub-S Corporation Mean?
Individuals and businesses can incorporate to form a new entity called a corporation. Based on state and federal laws these corporations are organized under Sub-chapter C. That is why these corporations are called C corporations. C-corporations limit the liability to the shareholders and are taxed as a separate entity.
In other words, C-corporations pay a separate income tax than the shareholders who own the corporation. The only way to pass profits from a C-corporation to the shareholders is through a dividend. These dividends are then taxed when the shareholder receives them. The form of double taxation is one of the biggest problems with the C-corporation structure.
That is why S-corporations have become popular. S-corporations do not pay a separate income tax. Instead, all the corporate profits flow through to the shareholders income tax returns. Each shareholder pays income tax on his or her share of profits. S-corporations can also distribute income to shareholders without the shareholders having to pay an extra dividend tax like dividends from C-corporations.
Requirements to Become an S-Corporation
The only catch is that not all C-corporations can elect to become S-corporations. The IRS has set specific rules for what corporations are eligible to become an S-corporation. S-corporations must:
- Be a domestic corporation
- Not have partnerships, corporations or non-resident alien shareholders
- Not have more than 100 shareholders
- Have one class of stock
- Not be certain financial institutions, insurance companies, and domestic international sales corporations