Subchapter S corporation
Subchapter S corporations, or S corporations, are corporations that are taxed on a "flow -through" basis. This means that tax liabilities from income (or deductions from losses) are passed onto the corporations' shareholders to be declared individually. This tax scheme is distinct from that of ordinary corporations, or C corporations, in which profits are taxed at both the corporate level and (again) when distributed to stockholders. As a result, those wishing to avoid the "double taxation" of an ordinary corporation would find electing S corporation status desirable.
Still, S corporations, which otherwise operate in the same manner as ordinary corporations, are subject to stock class and shareholder limitations. Specifically, an S corporation may not have more than 100 stockholders, and none may be nonresident aliens. Stockholders of an S corporation may also not be partnerships or corporations. Additionally, a S corporation may only have one class of stock. Because of these characteristics, S corporations are generally reserved to those entities that: (1) are profitable corporations that distribute a significant portion of their profits to their stockholders; and (2) closely owned businesses that obtain capital from individuals or debt. Indeed, entities seeking to raise capital from institutional investors, such as venture capital funds (which typically operate as partnerships or LLCs), in exchange for equity, may not elect for S corporation status.
A corporation may elect to be taxed as an S corporation by submitting Form 2553 with the Internal Revenue Service. However, certain entities, such as financial institutions and insurance companies, are ineligible for electing S corporation status.
See also: 26 US Code Subchapter S
[Last reviewed in April of 2022 by the Wex Definitions Team]
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