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Avoiding Double Taxation: The S Corporation

S corporations are taxed only once -- at the shareholder level.

S corporations can avoid paying corporate income taxes if all the shareholders consent to taxation of corporate income at the shareholder level. Although there are exceptions, most often the corporation itself is not a tax-paying entity. This is in sharp contrast to the separate taxpayer status held by regular corporations who are subject to double taxation. In effect, the election makes the S corporation a tax-reporting rather than a tax-paying entity. The income of the corporation flows through to the individuals as if the reporting entity was a partnership. Simplified, the S election treats the corporation as if it is a partnership. S corporations file Form 1120S annually.

In order to qualify under Subchapter S, a corporation must be a small business corporation. The following additional requirements must be met in order to be a small business corporation.

  1. Must be a domestic corporation.

  2. Must not have more than 35 shareholders (75 shareholders for tax years starting in 1997).

  3. Must include only eligible shareholders.

  4. Must have only one class of stock.

There are other limitations as well.

OBSERVATION The corporation may not have more than 35 (75 in 1997) shareholders. Thus, if a husband and wife own shares as joint tenants, they are considered as one shareholder for this purpose. However, should the couple later divorce, then each would count as a separate shareholder even if the stock is still held jointly. If one spouse dies while the couple is married, there is only one shareholder as long as the stock remains in the deceased shareholder's estate.

Individuals (other than nonresident aliens), estates, and certain trusts are eligible to hold stock in an S corporation. Among the trusts, which are not eligible shareholders of S corporation stock, are trusts adopted to administer tax-qualified retirement plans.

The IRS has also ruled that a corporation cannot qualify for an S election if it has a partner as a shareholder.

POINT TO REMEMBER To elect S corporation status, the corporation must be a domestic corporation, owned by not more than 35 shareholders. Only one class of stock may be issued, although differences in common stock voting rights are permitted. Finally, none of the shareholders can be nonresident (an individual who is not a citizen or resident of the United States) shareholders.

Election to be Classified As an S Corporation: Time for Election

Election to be an S corporation must be filed either at any time during the taxable year that immediately precedes the first taxable year for which the election is to be effective or at any time before the 16th day of the third month of the year to be so affected. A small business corporation must file Form 2553 (Appendix 7) (Election by a Small Business Corporation). See completed form in Basic Forms and Materials in back of text. All of the shareholders who own stock on the date the S corporation election is filed must consent to the election. If the stock is jointly owned, both joint owners must sign the consent form. Persons who are shareholders during any part of the year preceding the date of the election is made must also consent to the election even though they are not shareholders on the election date. An election made after the 15th day of the third month of the election year is treated as made for the next tax year.

EXAMPLE Sundial Wheat Growers, Inc. is incorporated on January 1, 20XX and decides to be an S corporation beginning in 20XX. The election must be made no later than March 15, 20XX to be effective for the year 20XX. If the election is made after March 15, 20XX, Drake will not have S corporation status until 20X1.

OBSERVATION Generally, the IRS will give notification of acceptance of an S corporation election within 60 days after Form 2553 has been filed. Form 1120S is not to be filed until notification of acceptance is received.

When Corporation Tax Return and Remaining Tax Due Must be Paid

Filing of the corporate tax return and payment of any balance of taxes owed are due in full by the 15th of the third calendar month following the close of the tax year. If the corporation uses a December 31 year end, it files its tax return by March 15. If it uses a fiscal year end and it ends, for example, on June 30, the tax return, and any payment, is due by September 15 (two and half months later).

A corporation can also get an automatic extension to the 15th day of the sixth month after the month of the due date of the corporate tax return by filing Form 7004 by the regular due date of the tax return. This form is an application for extension in place of filing the actual corporate tax return. Any remaining taxes due with the regular tax return must be filed with the extension.

A corporation may also have to pay estimated taxes by making four installments of estimated tax each year.

 


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