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"S"
Corporation
“S” Corporations (which are not available
to non-residents) are very popular for small businesses
in the US. An S corporation is a regular corporation
(normally taxable under subchapter C of the Internal
Revenue Code, and thus referred to as a C corporation),
or a limited liability company which has elected to
be taxed like a corporation, which files form 2553
with the Internal Revenue Service. The result is that
the corporation's net income (after business expenses
and other permissible deductions) is required to be
included in the individual returns of the stockholders
of the corporation, in the same percentages as their
percentages of ownership of the corporation.
The imposition of a maximum corporate tax bracket
in 1988 that was higher than the maximum individual
tax bracket made S corporation status very attractive.
A corporation must meet the following qualifications
to be eligible for an S election:
- It
must not have more than 35 shareholders;
-
All shareholders must be either individuals, estates
or certain types of trusts; a corporation or partnership
may not be a shareholder;
-
Nonresident aliens may not be shareholders;
- The
corporation may have only one class of stock;
-
The corporation must be a domestic corporation.
A
shareholder's share of net operating loss of an S
corporation is limited to the sum of the shareholder's
adjusted basis in the stock of the corporation plus
his adjusted basis in any debt the corporation may
owe him. Disallowed losses and deductions may be carried
forward to sebsequent years.
Distributions
by an S corporation are treated as a tax-free return
of capital to the shareholder, provided the corporation
has no accumulated earnings and profits, to the extent
of the shareholder's basis in his stock. Such distributions
are treated as taxable gain to the extent of the shareholder's
basis in his stock. Such distributions are treated
as taxable gain to the extent they exceed the shareholder's
basis in his stock.
One
disadvantage of an S corporation election is that
employee status is denied to those shareholders with
stock ownership exceeding 2 percent. As a consequence,
an S corporation cannot deduct the cost of fringe
benefits provided at the corporation's expense (for
example, accident and health insurance) for the benefit
of these shareholder-employees. Thus, an S corporation
cannot provide many fringe benefits on a tax-free
basis.
In
July, 2005, Internal Revenue Service officials announced
that the agency was to launch a comprehensive study
of tax reporting compliance amongst America's rising
number of S corporations, a form of corporate entity
that had grown enormously in popularity over the last
twenty years.
According
to the IRS, the study would examine 5,000 randomly
selected S corporation returns from tax years 2003
and 2004.
Since
the mid-1980s, the number of S corporations had risen
rapidly, growing from 724,749 in 1985 to 3,154,377
in 2002. Among S corporations with more than $10 million
in assets, the growth rate has been even faster. From
1985 to 2002, the number of these larger S corporations
grew more than ten-fold, from 2,305 to 26,096.
“The
use of S corporations has exploded,” observed IRS
Commissioner at the time, Mark W. Everson. “The
IRS needs a better understanding of what this means
for tax compliance. This research is critical for
achieving our strategic goal of ensuring that corporations
and high-income individuals are paying their fair
share," Everson added.
S
corporations are now the most common corporate entity.
In 2009, the IRS reported that the number of S corporations
increased 5.1 percent to 3.9 million for tax year
2006, so that S corporations represent nearly two-thirds
of all U.S. corporations. The number of shareholders
in S corporations also increased 5.1 percent to 6.7
million. Total net income (less deficit) increased
7.0 percent to $386.2 billion.
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