| The sub-chapter S corporation was originally created | | | | The IRS position on dividends seems to hold that profit |
| in 1958 to provide the benefits of operating a business | | | | in an S-Corporation needs to be generated by |
| inside a corporation, with the liability protection of a | | | | something other than the efforts of the owner in order |
| corporation but it has many similarities to a partnership. | | | | for dividends to be paid and not be subject to |
| If a business is incorporated, the corporation will pay | | | | employment tax. Realtors are a case in point. If all their |
| the taxes as a C corporation unless you elect to be | | | | income is generated by their own efforts, there is little |
| taxed as an S corporation. The owners of the | | | | rationale, according to the IRS, for paying out profits as |
| corporation must file an S corporation election on form | | | | dividends. |
| 2553. It may be filed anytime during the year prior to | | | | There is a fringe benefit problem with an |
| election as an S corporation or up to the 15th day of | | | | S-Corporation. If getting health insurance and certain |
| the third month after the beginning of the year. In | | | | other fringe benefits are an issue to the owners, they |
| community property states the spouse of the | | | | should be wary of an S-corporation. Health benefits |
| shareholder must also sign. Basically, this is consent by | | | | are passed through to an owner as though he |
| the owners to have the profits flow through to them | | | | received the income and paid for them himself. He is |
| as individuals and not be taxed at the corporate level. | | | | allowed to deduct them on schedule A of his personal |
| Normally S-Corporations must operate on a calendar | | | | return, but oftentimes with income limitations on |
| year. | | | | personal medical deductions that does him little good. |
| There are some limitations on who can be an owner | | | | S-elections of existing C Corporation can have tricky |
| of an S-corporation. A C corporation cannot be a | | | | tax consequences. That is beyond the scope of this |
| shareholder, nor can a nonresident alien. The | | | | article. Look carefully before you leap. |
| S-corporation must have 100 or fewer shareholders. | | | | Liquidation of an S-corporation is less difficult than a C |
| There can be only one class of stock. Shareholder | | | | corporation. The basis of the stock is usually roughly |
| debt convertible into stock can be a trap and invalidate | | | | equal to the basis inside the corporation, so there is |
| the S-election. If one shareholder sells so much as one | | | | usually no gain on liquidation. |
| share of stock to an ineligible shareholder it will | | | | As with all corporations it is wise upon forming a |
| terminate the election and the S-Corporation is not | | | | corporation to file articles of incorporation and create |
| allowed to reelect for five years. | | | | bylaws with corporate minutes. Jump through all the |
| The income or losses, of the corporation are taxed to | | | | legal hoops. A federal corporate identification number is |
| the owners, in the same percentage as they own | | | | required for payroll, depending on the state, a state |
| stock in the corporation. If they own 20% of the | | | | number for payroll and corporation tax or sales tax will |
| business they are taxed on 20% of the profits, 100% | | | | normally be necessary. Attorneys currently often |
| ownership taxes 100% of the profits. This is reported | | | | favor forming an LLC and then filing an S-election. This |
| on schedule E of their personal income tax return, | | | | will work. Some attorneys feel there is a slight |
| form 1040. | | | | advantage in doing so. |
| It should be noted that an owner is not allowed to take | | | | There is no magic, if you incorporate your business. |
| a loss from a corporation if that loss exceeds his basis | | | | Generally with very few exceptions, you are not able |
| in the S-corporation. Basis is the amount the | | | | to deduct any expenses, which you could not deduct |
| shareholder has invested in the company, including both | | | | as a sole proprietor, partnership or other form of |
| stock and loans. It is a very important point to | | | | business organization. The standard for allowing a |
| remember that a bank loan to an S corporation even | | | | deduction is that it must be an ordinary and necessary |
| though guaranteed by the owner does not create | | | | business expense. |
| basis. Should the S corporation have a loss exceeding | | | | One final piece of business advice. The lawyers are |
| the investment by the owner, it would not be | | | | quick to make the argument for incorporation as a |
| deductible by the shareholder even if covered by the | | | | protection of personal assets from business liability. |
| bank loan the shareholder has guaranteed. | | | | Each case must be examined separately, because |
| The corporation is required to pay out reasonable | | | | circumstances vary. However more than 30 years of |
| salaries. Much litigation has taken place on what is a | | | | business experience have convinced me the best |
| reasonable salary. Wages and salaries of owners are | | | | protection is to carry adequate insurance coverage. |
| subject to payroll taxes. Profits beyond salary can be | | | | S-Corporations are complicated. The above gives the |
| paid out as dividends. There is a tax advantage to this. | | | | general rules, but the tax law, and life are riddled with |
| Dividends are not subject to self-employment tax. This | | | | exceptions. Setting up an S-Corporation is not a do it |
| can be a huge savings over a sole proprietor. | | | | yourself project. |