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The right to elect S Corporation treatment permits the owners of a business to operate in corporate form and generally avoid a double tax on income - one at the corporate and again at the shareholders' level. A regularly taxed corporation (C Corporation) pays federal taxes on its taxable income at rates which range from 15% to 39%, unless the corporation is a personal service corporation, in which case the corporation pays a flat 35% on its taxable income. Its shareholders, upon receipt of a dividend distribution from the C Corporation (representing accumulated corporate after-tax profits) currently generally pay additional federal taxes at the tax rate of 15%. The C Corporation shareholder may pay a capital gains tax on the sale of his shares, the proceeds of which represent, in part, the accumulation of income previously taxed at the corporate level. TAX LOSSES OF "S" CORPORATIONS Tax losses incurred by the S Corporation pass through ratably to the
shareholders and are generally deductible on their individual returns. There are
restrictions on the deductibility of "passive investment losses," the rules of
which are complex and are beyond the scope of this summary. While S Corporation elections
are particularly applicable to new business ventures which anticipate losses in early
years,
shareholders of matured corporations also receive substantial tax benefits. If S Corporation status is desired, the company must file an election form on which all shareholders consent to the change in status. The election must be filed with the Internal Revenue Service by the 15th day of the third month of the start of the corporation's year. S Corporation elections are limited to domestic corporations, all of whose shareholders are individuals (or certain electing trusts) who must be citizens or residents of the United States. The number of shareholders of an S Corporation is currently limited to no more than one hundred (100). An S Corporation can elect to have a wholly-owned subsidiary treated as an S Corporation under certain circumstances. Also, an electing S Corporation may own 80% or more of a C Corporation subsidiary and 100% of another S Corporation without losing its S Corporation status. REVOCATIONS AND TERMINATION OF "S" CORPORATION ELECTIONS It is possible to revoke an S Corporation election for future years
in the event that business and tax circumstances warrant such a change. The Internal
Revenue Code and Regulations provide for the method of making a formal revocation which
must be filed on or before the 15th day of the third month of the tax year in order to be
effective There are also provisions for automatic termination of the S Corporation election by the Internal Revenue Service under certain conditions and therefore proper care must be taken to observe the income tax regulations. Once terminated, a re-election of the S Corporation treatment by the Company may require a waiting period of five years. The law and regulations governing S Corporation are extensive and cover a wide range of topics. There are a number of other advantages and disadvantages of the S Corporation elections which should be reviewed prior to deciding whether to use the S Corporation as the business entity. See also: LIMITED LIABILITY COMPANIES If you have questions about S Corporation Elections, or would like to receive our in-depth memorandum on this subject, Please contact us: Tel: 212 594-8155
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