The term “Subchapter S Corporation” refers to a specific tax status designated by the IRS (Internal Revenue Service), not a particular type of company. Businesses with 75 or fewer shareholders can apply for this status, which allows them to be taxed similarly to partnerships or sole proprietorships. Typically, companies apply for Subchapter S status shortly after incorporation. A company can withdraw from this status by filing a form with the IRS before the start of a new tax year.
**Subchapter S Corporation: Eligibility**
To qualify as an S Corporation, businesses must meet the following requirements:
* Have 75 or fewer shareholders, with each shareholder consenting to S Corporation status.
* Each shareholder must be a U.S. resident or citizen.
* The company must have only one class of stock.
* The company’s fiscal year must be the calendar year.
If a corporation meets these criteria, they must file Form 2553 with the IRS to obtain Subchapter S Corporation tax status.
**Advantages of Subchapter S Corporation Status**
This tax status appeals to many business owners for several key reasons:
* **Pass-Through Taxation:** Income is passed directly to shareholders, who report it on their personal income taxes. This avoids double taxation, where the corporation’s income is taxed at the corporate level and again when distributed to shareholders.
* **Tax Savings:** S Corporations generally do not pay income tax, and losses can be absorbed by the shareholders.
* **Self-Employment Tax Benefits:** Return on investment earnings are not subject to self-employment tax, provided the shareholder/employee receives reasonable compensation for their work.
* **Simplified Accounting:** Financial documentation and accounting are less complex compared to traditional corporations.
* **Access to Credit:** S Corporation status may improve access to credit resources, depending on the corporation’s business history.
**Disadvantages of Subchapter S Corporation Status**
Companies should also consider potential drawbacks before electing Subchapter S Corporation tax status:
* **Shareholder Disagreements:** Because shareholders hold financial power, all executive decisions require agreement. Disagreements can hinder progress.
* **Taxable Employee Benefits:** Stockholder/employees owning more than 2% of the stock must declare health insurance and other employee benefits as taxable income.
Subchapter S Corporation tax status is most advantageous for corporations with a small number of shareholders who share a common vision for the company’s future.