Making an S-Corporation election is ideal for smaller businesses looking to take advantage of the special tax status and income flow that S-Corporations offer. This is accomplished by filing various governmental forms.
S-Corporations have their disadvantages (although these disadvantages have been tempered by the Small Business Job Protection Act of 1996, which amended the Internal Revenue Code and by conforming amendments to California's Revenue and Taxation Code). Internal Revenue Code § 1361 (b) limits S-Corporations to no more than 75 shareholders, who must be individuals, estates, tax-exempt organizations, certain trusts, or a single-member limited liability company. In addition, no shareholder may be a nonresident alien.
In S-Corporations, income flows to you without the "double taxation" that occurs in C-Corporations. Double taxation occurs when a C-Corporation pays out a dividend to its shareholders. The C-Corporation must pay tax on its profits first, and then the shareholder must pay tax on the dividend income. S Corporations’ income, in contrast, is only taxed once, making them ideal for smaller businesses. As your S-Corporation grows, you can always elect to become a C-Corporation. However, certain restrictions apply when trying to take the subchapter S election. It is always a good idea to discuss these differences and restrictions with an attorney or your tax advisor before you form your corporation or issue your stock.
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