In some cases, to alleviate a tax burden, individuals may choose to form an S corporation. An S corporation is a corporation in the United States for which an election has been made with the Internal Revenue Service for the income to pass through and be taxed directly to the stockholders on a pro-rata basis. This allows the small business owner to avoid dealing with the double taxation of profits and dividends. Also, shareholders may be able to offset business losses by the corporation against their personal income, subject to certain restrictions.
Some provisions for forming an S corporation are:
- The corporation must have 35 or fewer shareholders who are individuals, estates, or certain qualifying trusts.
- The corporation may have only one class of stock.
- Nonresident alien shareholders are ineligible.
- All shareholders must consent to an election.
- The corporation may not own 80 percent or more of another corporation.
- At least 75 percent of the company’s receipts must be derived from the business rather than outside investments or passive income.
- Former S corporations that have revoked or had their S status terminated must wait five years before making a new election.
Although the federal government in the U.S. allows an S corporation to be taxed as an individual, state governments might not necessarily do the same. Therefore, you need to ask your accountant or lawyer what the current tax status of S corporations is for state taxes in your particular state.
Today in the U.S., however, new companies are more likely to use the LLC structure than the S corporation structure.