Some companies are formed as S corporations to avoid “double taxation”: The corporation does not pay federal income tax. Instead, income flows through to the shareholders, who pay income taxes (as in a partnership).
This potential tax benefit is available, however, only if stringent requirements are met. Most notably:
- There must not be more than 100 shareholders.
- Permissible shareholders are limited to individuals (other than non-resident aliens), estates, tax-exempt organizations, and certain qualified trusts.
- Only one class of stock is permitted.
Failure to meet a requirement, even if inadvertent, results in loss of S corporation status.
Entrepreneurs should think carefully about whether S corporation status is appropriate for the long term. Here’s why.