Is an S Corporation Election Right for Your Business?
Business Law Articles
By Raymond M. Roberts, Esquire
Rothman Gordon
Pittsburgh, Pennsylvania
When a corporation is formed, it is taxed as a “C Corporation.” All corporations are separate legal entities from their shareholders and have their own taxpayer identification number (an employer identification number or EIN). Corporations file separate income tax returns and pay corporate income tax on their income. If the C Corporation distributes any money to its shareholders as a dividend, it distributes after tax dollars. The shareholders then pay tax again on those distributions, essentially resulting in double taxation of the C Corporation’s income.
Other types of legal entities are taxed differently. Partnerships (both general and limited) and limited liability companies are taxed as pass through-entities. The entity will file an information return, but does not pay any income taxes on the entity level. Instead, the profits and losses are passed through to the partners or members, who pay tax on their pro-rata share at their individual tax rates. Corporations can receive the same pass-through treatment by filing a Subchapter S Corporation Election.
What is an S Corporation?
The definition of an “S Corporation” is a corporation that is treated, for federal (and state) tax purposes, as a pass-through entity. An S Corporation is created through the filing of an election made with the Internal Revenue Service (IRS) to be considered an S corporation. S corporations are taxed under Subchapter S of the Internal Revenue Code (IRC), which is where their name is derived. Like a sole proprietorship or a partnership, an S corporation passes through most of its income and loss items to its shareholders. Unlike a regular, C Corporation, there is no “double taxation,” meaning that the owners do not need to pay taxes twice – once at the corporate level and again on the individual shareholder level. Each shareholder is subject to his or her own individual tax rate on the profits and losses passed through to him or her, recorded as net income on the income tax return.