Business formats -- Subchapter S small corporation

    The Subchapter S corporation is a good format in many cases. For one thing, the much-maligned "double-taxation" of regular corporations, where the corporation is liable for tax on it's profit but then the stockholders are later also liable for tax on dividends received, is avoided with a Subchapter S corporation. It is particularly appropriate for many professional services but may suit others, too. In this corporation, the primary result the owners will notice is that the corporation is not separately taxes on it's own profits. It is a "pass-through" form of business entity. This means that the profits, or losses, pass on to the shareholders, pro-rata, and are directly placed in a line on their Form 1040 above the AGI  or Adjusted Gross Income line.

    In order to be eligible to be a Subchapter S corporation, the Subchapter S election form must be filed with the federal government within 2 1/2 months of the date of incorporation of the business, or it will lose that right for the tax year concerned.  The Subchapter S format is available only for domestic "U.S." corporations having 75 or fewer shareholders and only one class of stock. The shareholders must be individual people or their estates, although some trusts and qualified retirement plans may qualify as shareholders. If a nonresident alien is a shareholder, the Subchapter S choice is not available. The government does not want profits to "pass through" to someone who may not reside in the U.S. and may not be a citizen and may therefore not therefore be easily pursued to pay their taxes on their share of any profit that passes through to shareholders of a Subchapter S corporation.

    With a Subchapter S format being relatively simple, one may wonder, "Why would anyone choose to go the regular "Subchapter C" corporation route? One of the primary motivations may be that the founders plan it as a "C" from the beginning because it is going to be a corporation in which shares of stock will be offered publicly. In order to raise millions of dollars, the founders may know that more than 75 shareholders will be needed. Further, it is true that after paying salaries of officers and all employees, and all other business expenses, the "C" corporation will then have to pay tax on any profit it has, and the shareholders will have to pay taxes on any dividends declared. However, the "C" corporation does not pay out all of it's profits as dividends. Instead, it typically plans to retain earnings for corporate growth and pay out only a market rate of dividends to it's shareholders. In return, it will have access to much more investment capital than the usual smaller corporation.

    A Subchapter C corporation may not be public at first, but the owners may plan to take it public later. In that case, too, they want to start out the right way from the very beginning, retaining much of the earnings in the corporation accounts and just paying whatever the market rates should be for salaries, bonuses, and whatever else the officers and other employees may need to be paid as compensation. They may plan from the very beginning not only to have their taxes prepared by professional accountants but to have annual financial audits done on their records by large accounting firms designated by the SEC or Securities Exchange Commission for auditing records of publicly held corporations, something that will be necessary if they plan to later go public.

    For the business that does not plan to have many stockholders and does not plan to go public and where the owners feel the profits will not be so huge that it would be ridiculous to pay individual income taxes on their shares each year, the Subchapter S corporation election should be made as soon as the Articles of Incorporation are filed, to avoid possibly missing the 2 1/2 month deadline.