S-Corporation Tax Election
Corporations come in two primary forms, C-corporations—named for
Subchapter C of the Internal Revenue Code—and S-corporations, named
for Subchapter S.
C-corporations are the most standard version of this business entity,
while S-corporations are entities that begin as C-corporations, but
later elect to be subject to pass-through taxation like a sole
proprietorship or partnership.
When a corporation files to be an S-corporation, it is strictly a tax
adjustment, not a legal status adjustment. Though the entity will be
taxed differently, it retains the same abilities and obligations as a
S-Corporations vs C-Corporations
An S-corporations is a tax concept. You create your corporation under
state law. Then, Federal income tax laws permit you to elect to be
treated as an S-corporation.
Corporations that choose not to make this election are described for
tax purposes as C-corporations. Here’s the difference:
- C-corporations must file tax returns and pay tax on corporate
taxable income. Items of loss, gain, and credit are all taken into
account at the corporate level.
- However, S-corporations have no corporate income tax return. Items
of income, gain, loss, credit, or deduction are taken into account
or passed through at the shareholder level in proportion to a
shareholder’s ownership interest.
Not every corporation can become an S-corporation. Certain technical
requirements must be met to qualify. These include:
- The corporation must be formed in the United States;
- The corporation can have no more than 100 shareholders;
All shareholders must be individuals (with certain exceptions for
trusts or estates);
- None of the shareholders can be non-resident aliens;
- The corporation can issues only one class of stock
The corporation cannot be an insurance company or a domestic
international sales corporation.
These eligibility standards must exist at the time the S-corporation
election is made and exist continuously throughout its corporate
existence. If an eligibility standard ceases to exist, the
S-corporation status is terminated immediately. If this happens, the
corporation would be taxed as a C-corporation with no pass-through of
tax attributes to shareholders.
For purposes of applying these eligibility standards, husbands and
wives owning shares jointly count as a single shareholder. Joint
owners other than husbands and wives are counted separately.
S-corporation election is a popular choice for many small businesses
when they form a corporation. Many businesses that choose to
incorporate decide that S-corporation status is the best choice for
the following reasons:
Pass-Through Taxation -This refers to the taxing of business
income through the owners’ personal income tax returns. In other
words, the business entity itself isn’t taxed, but the business
earnings are taxed as part of the owner’s individual personal
income.This is also one of the fundamental factors that distinguish
S-corporations from C-corporations.
limited liability companies (LLCs) and sole proprietorships are also
subject to pass-through taxation. C-corporations, however, are
subject to double taxation, meaning that they are taxed at the
corporate level and again at the individual level when dividends are
Note: When business income is taxed via pass-through taxation, the
business entity itself is classified by the IRS as a disregarded
entity, meaning, an entity that exists but is not directly taxed.
Annual Taxation - Unlike C-corporations that must file their
taxes quarterly, S-corporations only need to file their taxes
The Ability to Attract Investors - S-corporations provide a
great deal of investment opportunities due to their ability to be
bought and sold in the form of shares, or stock.
Perpetual Existence - This refers to the presumption that a
corporation has perpetual existence unless its articles of
incorporation provide otherwise.
Limited Shareholders - S-corporations can have no more than
Ownership Restrictions - Partnerships and corporations can’t
be shareholders of an S-corporation. In contrast, partnerships,
C-corporations, and LLCs don’t have restrictions on who can be a
partner, shareholder, or member.
Only One Class of Stock - S-corporation can issue only one
class of stock. This single-class of stock issue often comes up when
shareholders loan money to the corporation.
More IRS Scrutiny - Because of the way they distribute
dividends and salary, S-corporations generally receive more IRS
scrutiny. Filing mistakes can cause your S-corporation status to be
The Expense - S-corporations are generally more expensive to
form and maintain than other entity structures.
How to Form an S-Corporation
All corporations begin as C-corporations. So, to form an
S-corporation, you must start by forming a C-corporation under state
law. Once you have formed a C-corporation you can then file IRS Form
2553 to elect S-corporation status.
In most cases, an LLC will first need to file IRS Form 8832 to elect
to be taxed as a C-corporation, and then file IRS Form 2553 to switch
to S-corporation status.
In either case, IRS Form 2553 must be signed by all shareholders and
must generally be filed within 75 days of the date your corporation
For more detailed information regarding S-corporation election in
Texas, consult with an experienced Texas business law attorney.