S Corporation Description

An Illinois corporation can elect to be taxed as an S Corporation by filing Form 2553 –  S Corp Tax Election.  Only domestic corporations with one class of stock are eligible.  An S corporation is limited to 100 shareholders, and may not have another corporation as a shareholder.  An exception exists for qualified subchapter S subsidiaries.  Other restrictions apply.

S Corporation Tax Election

An S corporation is taxed similarly to an Illinois partnership.  Income and expenses flow through to shareholders.  Pass-through items retain the character they had in the corporation once in the hands of the shareholder.

Wages & Self Employment Tax

An employee-shareholder of an S corporation receives wages (or salary) for services rendered.  The wages must be reasonable.  Additional profits are passed through to the shareholder and are taxable for income tax purposes but not self employment tax purposes.  Double taxation of profits is avoided.

Business Losses

Business losses flow through to shareholders.  Recognition of business loss is limited by shareholder’s basis, at-risk rules and passive activity rules.

Bookkeeping & Accounting

The balance sheet on an S corporation’s income tax return must agree with the corporate books.  An S corporation must use double-entry bookkeeping.  An S corporation must file all required payroll and income tax returns.

Transfer of Ownership

Ownership is easily transferred by selling shares of stock to eligible shareholders.  The corporate charter may place certain restrictions on the sale of stock.

S Corporation tax election considerations include the number of shareholders involved in the corporation, and the advantages and disadvantages inherent in the type of entity.

Business Advantages

  • Limited liability and perpetual life
  • Avoids double taxation of profits
  • Profits passed through are not subject to self employment tax as in a partnership
  • Ability to raise capital through issuance of stock

Business Disadvantages

  • Shareholders pay tax on earnings even if undistributed
  • Less flexibility in choosing a tax year
  • Contribution limits to a qualified retirement plan are based on employee-shareholder’s wages, not overall profits such as a sole proprietor or partne

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