Entity Choice: S Corporations
Legally a corporation under state law.
An S Corporation is a flow-through entity for tax
purposes.
Income and loss items are allocated among
shareholders based on their % ownership of stock (this
allocation is not flexible like partnership agreements).
Flow-through items retain their character on the
individual tax return (e.g. ordinary income core
operations, and separately stated capital losses,
charitable contributions, etc) just like for partnerships.
S Corporation Eligibility – Many Restrictions
Only individuals, estates and some trusts may be
shareholders (no corporations or partnerships).
The number of shareholders (not including
spouses & family) is limited to 100 all of whom must
be US citizens or residents.
The corporation must be domestic and may only
have one class of outstanding common stock.
Can be both voting and non-voting to aid succession
planning
Shareholders elect S Corp status on Form 2553.
S Corporation Operation
Owners/shareholders can be paid a salary.
Salary is subject to payroll taxes and reduces ordinary
income of the S Corporation.
S Corp can use corporate employee benefit plans for
shareholder/employees.
Share of ordinary income is NOT subject to SelfEmployment tax → HUGE advantage given 15.3% rate.
Allocable share of loss items can only be deducted
up to BASIS, like with partnerships. Losses in
excess of basis are carried over (suspended) until
the shareholder has basis again.
Entity Choice: Partnership versus S Corporation?
S Corps require an IRS election, incorporation
documents, possible corporate state tax payments.
Partnership agreements have more flexibility, but
require more careful legal drafting.
Partners (but not S Corp shareholders) receive tax
basis for general liabilities of the partnership.
Means partners can absorb more losses
S Corporation distributive share not subject to SE
tax!
S Corp shareholders can be employees, while partners
cannot; thus, benefit planning favors S Corps.