"S Corporation" What is an S Corporation An S Corporation begins its existence as a general, for-profit corporation upon filing the Articles of Incorporation at the state level.  A general for-profit corporation (also known as a 'C corporation') is required to pay income tax on taxable income generated by the corporation.  However, after the corporation has been formed, it may elect "S Corporation Status" by submitting IRS form 2553 to the Internal Revenue Service (in some cases a state filing is required as well).  Once this filing is complete, the corporation is taxed like a partnership or sole proprietorship rather than as a separate entity.  Thus, the income is "passed-through" to the shareholders for purposes of computing tax liability. Therefore, a shareholder's individual tax returns will report the income or loss generated by an S corporation. Qualifying for S Corporation Status To qualify as an S corporation, a corporation must timely file IRS Form 2553 with the IRS. This election must be made by March 15 if the corporation is a Calendar year taxpayer in order for the election to take effect for the current tax year. However, a "New" corporation may make the filing at anytime during its tax year so long as the filing is made no later than 75 days after the corporation has began conducting business as a corporation, acquired assets, or has issued stock to shareholders (whichever is earlier).  To qualify for S corporation status, the corporation must be a U.S. corporation with only one class of stock.  In addition, the corporation cannot have more than 75 shareholders. Further, shareholders must be individuals, estates or certain qualified trusts, who consent in writing to the S corporation election. No shareholder can be non-resident alien. The Corporation: "C" Corporations Generally The "C-Corporation" designation merely refers to a standard, general-for-profit, state-formed corporation.  To be formed, an Incorporator must file Articles of Incorporation and pay the requisite state fees and prepaid taxes with the appropriate state agency (usually, the Secretary of State -- Corporations Division). Separate Legal and Tax Life A corporation which is properly formed and operated as a corporation assumes a separate legal and tax life distinct from its shareholders.  A corporation pays taxes at its own corporate income tax rates and files its own corporate tax forms each year (IRS Form 1120). Management and Control in Corporations Normally, a corporation's management and control is vested in the board of directors who are elected by the shareholders of the corporation. Directors generally make policy and major decisions regarding the corporation but do not individually represent the corporation in dealing with third persons. Rather, dealings with third persons are conducted through officers and employees of the corporation to whom authority is delegated by the directors of the corporation. Shareholders Shareholders are the owners of a corporation. Board of Directors The Board of Directors is responsible for the Management and policy decisions of the corporation.  There are, however, a few instances when the shareholders are required to approve of the Actions of the Board of Directors (e.g. amendment to the Articles of incorporation, sale of substantially all of the corporate assets, the merger or dissolution of the corporation, etc...). Corporate Officers Corporate officers are elected by the Board of Directors and are responsible for conducting the day-to-day operational activities of the corporation.  Corporate officers usually consist of the following: (President, Vice-President, Secretary, Treasurer). Number of Persons Required In most states, one or more persons may form and operate a corporation.  Some states, however, require that the number of persons required to manage a corporation be at least equal to the number of owners.  For example, if there are two shareholders, there must also be a minimum of two directors. Fringe Benefits Corporations may often offer their employees unique fringe benefits.  For example, owner-employees may often deduct health insurance premiums paid by the corporation from corporate income.  In addition, Corporate-defined benefit plans often afford better retirement options and benefits than those offered by non-corporate plans. Corporate Formalities To retain the corporate existence and thus the benefits of limited liability and special tax treatment, those who run the corporation must observe corporate formalities.  Thus, even a one-person corporation must wear different hats depending on the occasion.  For example, one person may be responsible for being the sole shareholder, Director, and Officer of the corporation; however, depending on the action taken, that person must observe certain formalities:  Annual meetings must be held, corporate minutes of the meetings must be taken, Officers must be appointed, and shares must be issued to shareholders.  Most importantly, however, the corporation should issue stock to its shareholders and keep adequate capitalization on hand to cover any "foreseeable" business debts. Shareholder Liability for Corporate Debts Where corporate formalities are not observed, shareholders may be held personally liable for corporate debts.  thus, if a thinly capitalized corporation is created, funds are commingled with employees and officers, stock is never issued, meetings are never held, or other corporate formalities required by your state of incorporation are not followed, a court or the IRS may "pierce the corporate veil" and hold the shareholders personally liable for corporate debts. Avoiding Double Taxation Generally, the corporation is taxed for its own profits; then, any profits paid out in the form of dividends are taxed again to the recipient as dividend income and the individual shareholder's tax rate.  However, most small corporations rarely pay dividends.  Rather, owner-employees are paid salaries and fringe benefits that are deductible to the corporation.  The result is that only the employee-owners end up paying any income taxes on this business income and double taxation rarely occurs. S-Corporation Election Another alternative is to elect the S-Corporation Status as discussed earlier.   Please consult an accountant or C.P.A. who knows and understands the intimate details of your business along with federal and local tax rules so that you can make the best decision regarding which form of business entity (S-Corporation or C-Corporation) will best suit your needs. Duration of a Corporation As a separate legal entity, a corporation is capable of continuing indefinitely. Its existence is not affected by death or incapacity of its shareholders, officers , or directors or by transfer of its shares from one person to another. Constitutional Protections for Corporations Although a corporation is not a "citizen" under the privileges and immunities clause of the Fourteenth Amendment to the U.S. Constitution, a corporation may exercise some of the constitutional protections granted to natural persons: Right to Due Process and Equal Protection: Corporations enjoy the right to equal protection and due process of law under the Fourteenth and Fifth Amendments to the U.S. Constitution and under similar provisions of the California Constitution. Freedom of Speech: Absent some narrowly drawn restrictions serving compelling state interests, corporations have the right to express themselves on matters of public importance whether or not those issues "materially affect" corporate business. Right to Counsel: While a corporation cannot be imprisoned, a criminal action can result in fines and other penalties that could harm shareholders, officers, and other persons. Thus, a corporate criminal defendant has a Sixth Amendment to a Right to Counsel. But note, because a corporation faces no risk of incarceration, it has no right to appointed counsel if it cannot afford to retain private counsel No Privilege Against Self-Incrimination: Corporations have no privilege against self-incrimination (e.g. to prevent disclosure of incriminating corporate records). Accumulated Earnings Tax A corporation can accumulate its earnings for a possible expansion or other bona fide business reasons. However, if a corporation allows earnings to accumulate beyond the reasonable needs of the business, it may be subject to an accumulated earnings tax of 39.6%. If the accumulated earnings tax applies, interest applies to the tax from the date the corporate return was originally due, without extensions. To determine if the corporation is subject to this tax, first treat an accumulation of $250,000 or less generally as within the reasonable needs of most businesses. Treat an accumulation of $150,000 or less as within the reasonable needs of a business whose principal function is performing services in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts. In determining if the corporation has accumulated earnings and profits beyond its reasonable needs, value the listed and readily marketable securities owned by the corporation and purchased with its earnings and profits at net liquidation value, not at cost. Reasonable needs of the business include the following. Specific, definite, and feasible plans for use of the earnings accumulation in the business. The amount necessary to redeem the corporation's stock included in a deceased shareholder's gross estate, if the amount does not exceed the reasonably anticipated total estate and inheritance taxes and funeral and administration expenses incurred by the shareholder's estate. The absence of a bona fide business reason for a corporation's accumulated earnings may be indicated by many different circumstances, such as a lack of regular distributions to its shareholders or withdrawals by the shareholders classified as personal loans. However, actual moves to expand the business generally qualify as a bona fide use of the accumulations. The fact that a corporation has an unreasonable accumulation of earnings is sufficient to establish liability for the accumulated earnings tax unless the corporation can show the earnings were not accumulated to allow its individual shareholders to avoid income tax.