The IRS website states that an s corporation is basically a domestic corporation that is eligible to avoid taxation both on the corporation and on the shareholders. This type of corporation is usually exempt from federal income tax and certain capital gains and income taxes. The IRS ultimately decides if a corporation is eligible to be taxed under subchapter S of the Internal Revenue Code based on the number and characteristics of the stockholders, the type of stock issued and other characteristics. Public notice of the formation and continued operation of thecorporation must be maintained and filed with the Secretary of State’s Office.
After 1996 the number of stockholders allowed in an s corporation went from 35 to 75 people. The IRS keeps limits on the number of stockholders allowed in an s corporation because the s subchapter of the Internal Revenue Code is basically designed to benefit smaller corporations. Certain types of people such as non-US residents, other corporations, certain partners and certain trustees are not allowed to hold stock in thesecorporation.
When a corporation is filed under subchapter S of the Internal Revenue Code, it becomes an entity separate of its stockholders and owners. An s corporation’s finances and records must be established and maintained completely separate from those of the stockholders. Because s corporations are their own entity, and most businesses are not capable of running themselves, the shareholders must hold a meeting and designate officers or employees of the corporation to conduct business on behalf of the corporation. The people that are designated to run the corporation are authorized by the shareholders to borrow and repay money, to a certain extent, when needed for the operation of the corporation. Credit arrangements for s corporations are made in the name of the corporation, but the officers designated by the shareholders sign loan documents. Usually the officers who sign the loan documents have liability for the corporation’s debts.
One of the more controversial advantages of s corporations is that the liability of stockholders in these corporations is limited to their capital investment. Since the corporation is considered a separate entity in the eyes of the government, the company can continue to operate unhindered pending the death or loss of a shareholder. Along this same line, stock can change hands and it will not effect the operation of the s corporation, just as long as the number of shareholders does not exceed 75. As stated earlier, the corporation is also exempt, with a few exceptions, from income and capitol gains taxes. Income or loss is passed directly to the shareholders.
While there are clear advantages to naming a corporation as an s corporation, there are also some drawbacks. Lenders may require that the corporation’s officers provide them with a personal guarantee before lending money. The small number of stockholders and their voice in the actions of the corporation may immobilize business. Stock may be passed from one shareholder to his or her family, which may cause conflict. The corporation can also be subject to abuses by stockholders at which time the stockholder’s shield of limited liability is lost.
By Alex Turman