Business Sub Chapter S Corporation: Advantages, Disadvantages and Election

While to a layman, Business Subchapter S Corporation may sound like the name of an evil business empire, a Business Sub Chapter S Corporation is actually a special form of limited corporation that allows the protection of limited liability but direct flow-through of profits and losses.

Advantages of Sub-Chapter S Incorporation

For many small business owners, this is the perfect set-up because of its appealing tax benefits and the same protection of limited liability like a corporation.

It is called a Chapter S/S corporation because it has elected a special tax status with the Internal Revenue Service (IRS) and will be to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code (IRC).

Subchapter S corporations are generally not taxed. Under the concept of single taxation, the corporation's income or losses are divided and shared by its shareholders who must then report the income or loss on their own individual income tax returns.

While small business owners and entrepreneurs of an S corporation will be taxed as if they were sole proprietors or general partnerships, the number of shareholders is restricted. There can be no more than 75 shareholders.

Limited Liability Protection

S corporations are also separate legal entities from their shareholders and while the taxation of S corporation is similar to a partnership, certain corporate penalty taxes such as accumulated earnings tax, personal holding company tax and the alternative minimum tax do not apply.

Their shareholders have the same limited liability form as the shareholders of C corporations.

But an S corporation still has a few notable disadvantages such as its ineligibility for dividend received deductions and they are required by law to file articles of incorporation, hold directors and shareholders’ meetings, keep corporate minutes, and allow shareholders to vote on major corporate decisions and lastly, they may only issue common stock, which can hinder raising their capital.

Requirements of Sub-Chapter S Incorporation

The mere thought of paying less taxes alone would be enticing to any businessman but there are certain requirements before one can be considered a Business Sub Chapter S Corporation and these are:

• Company must offer only one class of stock
• Has no more than 75 shareholders
• Shareholders must be residents of the United States
• Equitable sharing of earnings and liabilities for all shareholders per their shareholding amount
• Company must be a legal, eligible corporate entity itself

Eligible entities interested in starting or creating a Business Sub Chapter S Corporation may be in a domestic corporation or a limited liability company form.

Also, as to shareholders, only the following entities may be shareholders: individuals, estates, certain trusts, certain partnerships, tax-exempt charitable organizations, and other S corporations provided that the other S corporation is the sole shareholder.

Should all the above-mentioned requirements be met by the interested party/corporation, they must remember to make the subchapter S election no later than two months and 15 days after the first day of the taxable year to elect.

Subchapter S election requires the consent of all shareholders. They may file Form 2553: "Election by a Small Business Corporation" with the IRS.

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