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A Subchapter S (S Corporation) corporation is a form of corporation that meets the IRS requirements to be taxed under Subchapter S of the Internal Revenue Code. Also known as "S corporation" or "S-Corp". This form gives a corporation with 100 shareholders or less the benefit of incorporation, while being taxed as a partnership. This means that any profits earned by the corporation will not be taxed at the corporate level, but instead will be taxed only at the level of the individual shareholders. I.E. That the corporation pays no Federal Corporate Income Tax.

Having S corporation status can prove a huge benefit for a corporation. The corporation can pass income directly to shareholders and avoid the double taxation that is inherent with the dividends of public companies, while still enjoying the advantages of the corporate structure. In order to qualify, a corporation must be a small business corporation. This means the following requirements must be met:

1) Must be a domestic corporation.

2) Must not have more than 100 shareholders.

3) Shareholders must be U.S. citizens or residents, so corporate shareholders must be excluded.

4) Must have only one class of stock.

5) Profits and losses must be allocated to shareholders proportionately to each one's interest in the business.

Dividend Treatement - Federal Tax

Unlike C-Corp dividends which are taxed at the federal rate of %15.00, S-Corp Dividends (or more properly titled 'Distributions') are taxed at the shareholder's marginal tax rate.

However, the C-Corp Dividend is subject to the 'double-taxation'. The income is first taxed at the corporate level before it is distributed as a dividend. The dividend is then taxed at the personal capital gains rate (currently 15%) when issued to the shareholder.

S-Corp Distributions (some times refered to as S-Corp Dividends) are only taxed once at the marginal rate of each shareholder who received a distribution. Additionally, the S-Corp shareholder will pay taxes on the S-Corp earnings whether or not a distribution is made. Example: Widgets Inc, an S-Corp makes 10,000,000 in net income and is owned 51% by Bob and 49% by John. On Bob's personal tax return, he will report 5,100,000 in income and John will report 4,900,000. If for some reason, Bob (as the majority owner) decides not to distribute the money, both Bob and John will still owe taxes on the earnings, even though neither recieved any cash distribution. This is a classic 'squeeze-play' to force out a minority partner.

See Also

C corporation

Source: This entry was originally based on this Wikipedia article.