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S Corporation

An S Corporation is not a separate form of legal structure, but rather a special tax status granted by federal tax law to a corporation to tax the business’ income like a partnership or a sole proprietorship. A corporation elects S Corporation status by filing with the IRS on Form 2553, “Election by a Small Business Corporation.” Generally, the election must be filed within 75 days of incorporating. Otherwise, a corporation may not change its status until the beginning of each new calendar year. Form 2553 must to be filed by March 15th to be effective for the new tax year. Once elected, S Corporation status will continue until the shareholders revoke the choice or a corporation no longer meets the qualifications.

Advantages — An S Corporation has all the general advantages of “regular” corporations except it does not pay corporate income taxes. It divides the expenses and income among its shareholders. Individual shareholders report profits and losses on their personal income tax returns.

Disadvantages — To apply for S Corporation status, the business must comply with the following restrictions:

  • It must be a domestic corporation. It cannot be a financial institution using the reserve method of accounting for bad debts, an insurance company, a corporation that takes tax credits for doing business in a U.S. possession, or be a domestic international sales corporation (DISC).
  • It may only have one class of stock issued and outstanding.
  • It may not have accumulated earnings and profits at the close of each three consecutive taxable years if 25 percent of its gross receipts for each of the years are passive investment income. Passive investment in- come includes royalties, rents, dividends, interest, annuities, and sales or exchanges of stocks or securities.
  • It may have a maximum of 75 shareholders. It may not have as a shareholder any person who is not an individual, except for certain qualifying trusts or certain qualifying exempt organizations. Shareholders must be U.S. citizens or resident aliens.
  • It must have a tax year ending December 31.
  • All shareholders must agree to elect S Corporation status.

While an S Corporation is not subject to double taxation as a regular corporation, it loses the ability to deduct the full cost of medical insurance as a business expense under current tax law. Corporate officers are still treated as employees. There are also differences in how business losses are carried forward, which may be positive or negative depending upon the individual situation. A competent tax advisor should be consulted before applying for S Corporation tax status. It is important to note that the corporation must file the “Articles of Incorporation” with the Secretary of State before it can apply to the IRS for S Corporation status. For more specific information about qualifying and applying as an “S” Corporation, visit https://mybiz.colorado.gov/intro.