One way to avoid the double taxation of a C-Corporation is for a corporation to make an election under Subchapter S of Chapter 1 of the Internal Revenue Code (Election by a Small Business Corporation, Form 2553). So long as the corporation qualifies for Subchapter S treatment, taxation will be passed on directly to the owners as individuals (pass through taxation). In short, the owners will be taxed as if they were a partnership or Limited Liability Company, or in the case of a sole shareholder, as a sole proprietor. The corporation itself is not subject to the corporate tax rate on its profits.
To qualify for a subchapter S election, the corporation must: be a domestic corporation; have only one class of stock; distribute profits and losses proportionate to each shareholder’s ownership interest; and be limited to no more than 100 shareholders who are natural persons and United States citizens. Spouses are automatically treated as a single shareholder and certain lineal family members may elect to be treated as a single shareholder. 501(c)(3) non-profit corporations and certain other tax-exempt corporations, trusts and estates may also be shareholders in an S-Corporation. In addition to these qualifications, there are limitations on tax deductible fringe benefits an S-Corporation can offer.
Nonetheless, for many companies any disadvantageous are far outweighed by the pass through taxation available to S-Corporations. It’s also a good idea for those considering an S-Corporation to weigh the advantageous and disadvantageous of an LLC alongside those of the S-Corporation. Contact San Diego Corporation Attorney Donald R. Oder for a free consultation.