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"S" Corporations (IRC §§ 1361-1368)

An S corporation is a corporation that elects to have its profits and losses passed through and taxed to its shareholders for federal income tax purposes. 14A W. Fletcher Cyclopedia of Corporations § 6970.191 Generally, an S corporation is not subject to corporate income tax (except in limited circumstances for excess "built-in" gains, IRC §§ 1366(f)(2), 1374, excess passive investment income, IRC §§ 1366(f)(3), 1375, and recaptured investment credits, IRC § 1371(d)(2).) Rather, the corporation's income and expenses are divided among and passed through to its shareholders. To be able to elect and retain S corporation status, certain eligibility requirements must be met. Id. In addition to the eligibility requirements, all the shareholders must consent to the S-corp. election (IRC § 1362(a)(2).) It should be noted that although Delaware recognizes S corporations, they are not recognized as a matter of state income tax law in all states.

The aspects of the S corporations: The shareholders must elect to be an S corporation by filing an IRS Form 2553. The election permits the income of the S corporation to be taxed to the shareholders of the corporation rather than to the corporation itself, except as noted below under Taxes an S corporation may owe.

Who may elect. A corporation may elect to be an S corporation only if it meets all of the following tests:

  1. It is a domestic corporation.

  2. It has no more than 75 shareholders. A husband and wife (and their estates) are treated as one shareholder for this requirement. All other persons are treated as separate shareholders.

  3. Its only shareholders are individuals, estates, exempt organizations described in section 401(a) or 501(c)(3), or certain trusts described in section 1361(c)(2)(A). See the instructions for Part III regarding qualified subchapter S trusts (QSSTs).

  4. A trustee of a trust wanting to make an election under section 1361(e)(3) to be an electing small business trust (ESBT) should see Notice 97-12, 1997-1 C.B. 385. Also see Rev. Proc. 98-23, 1998-10 I.R.B. 30, for guidance on how to convert a QSST to an ESBT. If there was an inadvertent failure to timely file an ESBT election, see the relief provisions under Rev. Proc. 98-55, 1998-46 I.R.B. 27.

  5. It has no nonresident alien shareholders.

  6. It has only one class of stock (disregarding differences in voting rights). Generally, a corporation is treated as having only one class of stock if all outstanding shares of the corporation's stock confer identical rights to distribution and liquidation proceeds. See Regulations section 1.1361-1(l) for details.

  7. It is not one of the following ineligible corporations:
    a. A bank or thrift institution that uses the reserve method of accounting for bad debts under section 585;
    b. An insurance company subject to tax under the rules of subchapter L of the Code;
    c. A corporation that has elected to be treated as a possessions corporation under section 936; or
    d. A domestic international sales corporation (DISC) or former DISC.
  8. It has a permitted tax year as required by section 1378 or makes a section 444 election to have a tax year other than a permitted tax year. Section 1378 defines a permitted tax year as a tax year ending December 31, or any other tax year for which the corporation establishes a business purpose to the satisfaction of the IRS. See Part II for details on requesting a fiscal tax year based on a business purpose or on making a section 444 election.

  9. Each shareholder consents as explained in the instructions for column K.

See sections 1361, 1362, and 1378 for additional information on the above tests.

A parent S corporation can elect to treat an eligible wholly-owned subsidiary as a qualified subchapter S subsidiary (QSSS). If the election is made, the assets, liabilities, and items of income, deduction, and credit of the QSSS are treated as those of the parent. For details, see Notice 97-4, 1997-1 C.B. 351. If the QSSS election was not timely filed, the corporation may be entitled to relief under Rev. Proc. 98-55.

To download IRS forms and instructions, click here

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