S Corporations: How They are Structured and Taxed

By Greg Lindberg, 1800Accountant.com Writer

Decision-making is a huge part of being an entrepreneur and, eventually, a start-up business owner. One of the decisions you have to make during this often challenging process is to settle on a specific business entity to operate. An S corporation is one option you can go with. 1800Accountant.com, a partner of MyCorporation, recommends understanding the following information about how S corporations are structured and taxed before choosing to set one up.

The term “S corporation” originally took on its name from Subchapter S of Chapter 1 in the federal Internal Revenue Code. In general, an S corporation does not pay federal income taxes at the corporate level. However, this does not mean it is exempt from paying taxes altogether. The difference with this type of business entity is that it elects to have its profits, losses, deductions, credit, and all other activities passed through to the shareholders who are invested in the company. These shareholders must report this financial activity on their personal income tax returns.

Because of this pass-through structure, the shareholders in an S corporation are taxed based on their personal income tax rates. S corporations are taxed this way to prevent double taxation on the income that a company earns. One caveat is that S corporations are often required to cover any taxes levied on passive income and any built-in gains that are part of the business.

For a company to take on S corporation status, it has to meet certain qualifications. First and foremost, the business must be based in the U.S. It can only have allowable shareholders that include individuals or certain trusts and estates. S corporations cannot be established through partnerships or non-resident alien shareholders. Additionally, they can only have a maximum of 100 shareholders invested in them, along with one class of stock. Corporations that are ineligible for taking on this status include certain financial and insurance organizations.

There are several advantages to operating an S corporation. Like other formal entities, it gives a business credibility by putting “Inc.” after its name. It offers protection for the personal assets of each shareholder. As a pass-through entity, any losses incurred by the business can offset other forms of income on the personal tax returns of its shareholders. These shareholders can also work as employees and take on a salary or receive dividends.Finally, the ownership of an S corporation can be easily transferred to others without any major consequences to the tax structure of the business.

About 1800Accountant.com
1800Accountant.com is a national full-service accounting firm that assists startup companies, established small businesses, and individuals with tax planning and preparation, bookkeeping, payroll, and business development.