The major difference between a regular “C” corporation and an “S” corporation is that the “C” corporation pays taxes on its income and an “S” corporation doesn’t.
The “S” corporation files Form 1120S and distributes K-1s to shareholders. Shareholders then report their pro rata share of income, losses, and credits on their individual tax returns.
The double taxation that regular corporations face is thereby avoided with an “S” corporation.
A corporation is allowed to elect “S” status only if it meets certain qualifications and files Form 2553 in a timely manner.
- There is a limit on the number of shareholders.
- Only one class of stock is allowed.
- All shareholders must sign an agreement to be classified as an “S” corporation.
- All “S” corporations have a mandatory year end of December.
The big ADVANTAGE of “S” status is that it combines the limited liability of a regular corporation with tax treatment similar to that of a partnership.
A DISADVANTAGE is that “S” corporations have some fringe benefit restrictions for employees who own more than 2% of the corporation.