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Under certain circumstances, a corporation can elect to be treated similarly to a partnership for federal tax purposes. The business must first be incorporated as a regular for-profit business corporation with the state and then, once formed and certain conditions are met, can file an election with the Internal Revenue Service (IRS) to be treated as a Subchapter S Corporation.

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Under certain circumstances, a corporation can elect to be treated similarly to a partnership for federal tax purposes. The business must first be incorporated as a regular for-profit business corporation with the state and then, once formed and certain conditions are met, can file an election with the Internal Revenue Service (IRS) to be treated as a Subchapter S Corporation. This form of corporation is sometimes called a “close corporation,” but most often it is simply called an “S corporation”. Here are some of the advantages of electing for S corporation status.

1. No “double-taxation”

In a regular corporation, referred to as a C corporation, taxes are imposed on earnings at 2 different levels. First, a corporate tax is imposed on the corporation itself for earnings. Then, that income is taxed again to shareholders when distributed as dividends. By electing for S corporation status, taxation is avoided at the corporate level. The S corporation acts as a conduit for earnings so they pass through to the shareholders. The income is then taxed only at the shareholder level, at each shareholder’s tax rate. Therefore, an S corporation avoids “double-taxation.”

2. Avoid disputes with the IRS

If a corporation is going to make payments to shareholders who have, for example, rendered services, rented property, or lent funds to the corporation, the corporation may deduct the salaries, rent, and interest it paid, pursuant to the Internal Revenue Code (IRC). This can result in no corporate tax being owed by the C corporation. However, these deductions can be examined for reasonableness, and there are other requirements that must be met. Thus, an S corporation may be desirable because there is no corporate tax imposed, so it avoids having to take deductions in the first place.

3. Alternative tax rate

A corporation’s financial plan may be to accumulate all of its earnings and profits, rather than distribute such income to shareholders. An S corporation may still be desirable in this situation, though, if the tax rates of the individual shareholders are lower than the rate that would be imposed on the corporation.

4. Deduction of losses

The operating losses of the S corporation are passed through to shareholders in accordance with each shareholder’s percentage of shares. The shareholders can then deduct those losses to offset their own taxable income, subject to limitations imposed by the IRC.

5. Voting rights

An S corporation is allowed to have only one class of stock. However, a difference in voting rights among the common stock does not, by itself, equate to more than one class of stock. This can be advantageous in, for example, a family-business situation. Parents involved in the corporation with their children can retain the voting stock while issuing to the children the non-voting stock. In such a situation, the parents can retain control of the business without violating the children’s right of participation. It is permissible for either one, or both, of the parents to hold the voting stock.

Source: Kelly Monroe, who practices law in Albany, New York, was selected to Super Lawyers for 2018-2019. He can be contacted at: Thuillez, Ford, Gold, Butler & Monroe, LLP; 20 Corporate Woods Boulevard, Albany, NY 12211; Phone: 518-455-9952